-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, QHch4pVAl2zx6Qv5lJxdGWbOrh3Ckg12O/22vn2RiHrCkFBnW+F6Vghai95xvHCF V09k9gvY0i0Q4C6eE6DceA== 0001047469-04-011663.txt : 20040412 0001047469-04-011663.hdr.sgml : 20040412 20040412165906 ACCESSION NUMBER: 0001047469-04-011663 CONFORMED SUBMISSION TYPE: 6-K PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 20031231 FILED AS OF DATE: 20040412 FILER: COMPANY DATA: COMPANY CONFORMED NAME: ALLSTREAM INC CENTRAL INDEX KEY: 0001045359 STANDARD INDUSTRIAL CLASSIFICATION: TELEPHONE COMMUNICATIONS (NO RADIO TELEPHONE) [4813] IRS NUMBER: 431656187 FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 6-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-29536 FILM NUMBER: 04728983 BUSINESS ADDRESS: STREET 1: SUITE 1600, 200 WELLINGTON STREET WEST STREET 2: TORONTO ONTARIO CANADA CITY: CALGARY ALBERTA STATE: A0 BUSINESS PHONE: 4032622255 FORMER COMPANY: FORMER CONFORMED NAME: AT&T CANADA INC DATE OF NAME CHANGE: 19990819 FORMER COMPANY: FORMER CONFORMED NAME: METRONET COMMUNICATIONS CORP DATE OF NAME CHANGE: 19970903 6-K 1 a2132723z6-k.htm FORM 6-K
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 6-K

Report of Foreign Private Issuer

Pursuant to Rule 13a-16 or 15d-16 of
the Securities Exchange Act of 1934

For the month of February, 2004

Allstream Inc.
(Translation of registrant's name into English)

Suite 1600
200 Wellington Street West
Toronto, Ontario
Canada M5V 3G2
(Address of principal executive offices)

Indicate by check mark whether the registrant files or will file annual reports under cover Form 20-F or Form 40-F.

Form 20-F

Form 40-F

Indicate by check mark whether the registrant by furnishing the information contained in this Form is also thereby furnishing the information to the Commission pursuant to Rule 12g3-2(b) under the Securities Exchange Act of 1934.

Yes

If "Yes" is marked, indicate below the file number assigned to the registrant in connection with
Rule 12g3-2(b): 82-

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

	Allstream Inc. (Registrant)
Date: April 12, 2004
	By:	/s/ SCOTT EWART Name: Scott Ewart Title: Senior Vice President, General Counsel, Secretary & Chief Privacy Officer

Exhibit		Description
99.1		2003 Annual Report.
99.2		Consolidated Financial Statements for AT&T Canada Inc. (the "Predecessor") for the year ended December 31, 2002.
99.3		Management's Discussion and Analysis of Financial Condition and Results of Operations for the Predecessor for the period from December 31, 2001 to December 31, 2002.

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SIGNATURES
EX-99.1 3 a2132723zex-99_1.htm 2003 ANNUAL REPORT
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Allstream Inc. 2003 Annual Report

There's more to networks.™

2003

In 2003 we positioned Allstream for long-term success:

•: Further strengthened our management team
•: Restructured our balance sheet
•: Launched more new services than any year in our history
•: Established a new corporate brand in Allstream
•: Significantly improved customer satisfaction for the second straight year
•: Assembled a world-class Board of Directors
•: Delivered solid financial results
•: Generated strong cash flow and returned $70 million to our shareholders
•: Expanded our distribution channels by doubling our quota carrying sales force and establishing a U.S. sales presence
•: Ratified collective agreements with our bargaining unit employees
•: Continued pursuit of regulatory balance

Allstream is a leading communication solutions provider with a world-class portfolio of Connectivity, Infrastructure Management and IT Services. Focused on the business market, Allstream collaborates with customers to create tailored solutions that meet their unique needs and help them compete more effectively. Spanning more than 18,800 kilometres, Allstream has an extensive broadband fibre-optic network and the greatest reach of any competitive communication solutions provider in Canada, and provides international connections through strategic partnerships and interconnection agreements with other international service providers.

message to shareholders 1

message from the chairman 8

management's discussion and analysis 9

report of management 28

auditors' report 29*

consolidated balance sheet 30*

consolidated statements of operations 31*

consolidated statement of shareholders' equity 32*

consolidated statement of cash flows 33*

notes to consolidated financial statements 34*

corporate governance 60

board of directors 61

leadership team 61

corporate information 62

*: The Company's financial statements for 2003 included herein comprise the consolidated financial statements of Allstream Inc. for the nine months ended December 31, 2003 and the consolidated financial statements of AT&T Canada Inc. (the Predecessor) for the years ended December 31, 2002 and 2001, all of which can be found on SEDAR at www.sedar.com and on the SEC Filings & Forms (EDGAR) at www.sec.gov/edgar. shtml.

John T. McLennan
John A. MacDonald

message to shareholders

A Solid Foundation For Long-Term Success. 2003 was a year of significant accomplishment for Allstream. During the year we strengthened our management team, and restructured our balance sheet. More new products were launched than in any other year in our history, and we had success in winning new business and renewing existing customer relationships. In addition, we established a new corporate brand in Allstream. In the nine months after completing our restructuring the Company generated $141 million in free cash flow, and to share this success with our shareholders Allstream declared and paid a $70 million special dividend.

In Our View 'There's More to Networks.' With the launch of our new brand Allstream, we re-affirmed our commitment to being an innovative, agile and responsive partner for our customers. In the Allstream brand we have established a corporate identity that reflects who we are and what we stand for. Allstream's tagline 'There's more to networks' embodies the Company's awareness that a successful customer relationship is more than the data and voice traffic that flows on the network, but is about understanding a customer's needs and working in collaboration to deliver effective business solutions.

Allstream Inc. 2003 Annual Report 1

Growth In Our Core Business

A Rich Customer Base. One of Allstream's key strengths is our established customer base. We do business with 40% of the top 500 companies in Canada. These relationships are built on the credibility we have earned in delivering complex business solutions. That Allstream can count 40% of Canada's 500 largest companies as customers is a significant accomplishment. That there are an additional 60% in the waiting is a significant opportunity.

We have built on our credibility by improving customer satisfaction significantly in each of the last two years, while growing operating profit. In a recent survey of telecom decision makers, Allstream scored higher than the incumbents in the important areas of overall quality, network reliability and service design. These results support our conviction that Allstream has the infrastructure and service capabilities to further deepen our competitive position in the Canadian marketplace.

Diverse Services, Integrated Solutions. Allstream offers a comprehensive product portfolio focused on delivering integrated solutions to our customers. Connectivity services represent the core transport and access technologies that connect our customers locally, nationally and globally. Infrastructure Management, including our industry-leading suite of security services, brings our customers higher value managed solutions on top of the connectivity layer. And we offer IT Services that tie to customer's applications to their telecom infrastructure.

2 Allstream Inc. 2003 Annual Report

More and more we are having success in binding together our Connectivity, Infrastructure Management and IT Services offerings into a complete and integrated enterprise solution. We refer to this as the triple threat, as it demonstrates the real promise and value proposition we bring to the marketplace. We will continue to develop offers that leverage the full Allstream portfolio to increase the number of our customers who receive services across our entire service model. We introduced 50% more new products in 2003 than in the previous year, and we will continue our rapid introduction of next generation services by launching 50% more in 2004.

Expanded Distribution Channels. As a part of our revenue growth initiative, we have expanded our distribution channels. First, we doubled the size of our quota carrying sales force, to increase new sales volume. Second, we established a sales force dedicated to the United States market. These individuals are targeting U.S. decision makers to ensure they recognize the value of working with Allstream for their Canadian telecom requirements. We are already having considerable success with several major wins.

AT&T — A Significant Business Partner. During the year Allstream continued to work closely with AT&T. We won a significant amount of new business in collaboration with AT&T, under our seamless voice services agreements. In fact, in 2003 we grew the revenues associated with AT&T North American voice services.

Allstream Inc. 2003 Annual Report 3

Growth In New Markets

Expanded Wholesale Offering. In 2004 we will expand our wholesale offering to support the entry of other service providers into local telephony, including VoIP services in the residential market. We will support these wholesale services with a full suite of products from basic PSTN access to a fully managed outsourced VoIP service.

Joining Forces In Broadband Wireless. Part of Allstream's strategy is to pursue technologies that are disruptive to the status quo. In November we announced a venture with Microcell and NR Communications to offer wholesale voice and data broadband wireless services for residential and small business users. This venture is making excellent progress with commercial launches having started in February, and with discussions with several large retail partners well under way.

In addition to providing a mobile broadband alternative to the incumbent's wireline service, we believe that as this technology matures, it will provide us with a cost effective way of accessing our customers and a platform over which we can layer services without relying on incumbent facilities. With a small commitment of capital upfront we have positioned ourselves to participate in the sizable consumer and small business markets.

4 Allstream Inc. 2003 Annual Report

Customer Centred IP Strategy. Allstream launched its Business IP/MPLS network service in 2000, the first of its kind in Canada. Over the course of the last four years we have made significant investments to enable converged IP services through this next generation network. In addition, our Business IP service was designed to provide a clear and cost effective path to IP through inter-working capabilities with Frame and ATM based networks. With our long planning horizon, we have developed an evolutionary path for our customers that will avoid the disruption that would be associated with a forced migration. We plan to extend IP/MPLS services internationally in 2004. With our national IP infrastructure in place, Allstream is well positioned to participate in the wholesale market with those who are planning to offer VoIP services to residential customers, including our own broadband wireless joint venture.

Pursuing Regulatory Balance. During 2003 we continued our pursuit of a balanced regulatory structure. Early in 2003 the Government re-affirmed their commitment to support competition, and acknowledged that regulatory and policy framework are crucial to fostering competition. We have been encouraged by the steps taken by the regulator to remove hindrances to a healthy telecommunications environment, and are hopeful the regulator will continue to improve the balance between incumbent providers and competitive entrants.

Allstream Inc. 2003 Annual Report 5

Enforcement of regulatory safeguards intended to prevent anti-competitive behaviours will be an important regulatory theme in 2004. Near the end of 2003 the CRTC expressed its intention to address the anti-competitive pricing practices of Bell Canada. A decision to limit their ability to engage in these practices would be an important step in leveling the playing field. We believe that an improved regulatory environment would make Allstream more competitive across an expanded addressable market.

New Collective Agreements. Allstream has always had a strong and progressive relationship with the unions representing our employees. In 2003 we announced the ratification of collective agreements with our 780 bargaining unit members that will run for a term of three years to the end of 2006. These new agreements include a variable pay component tied to the accomplishment of overall corporate objectives, in effect aligning all Allstream employees towards achievement of a common set of goals.

Looking Ahead. With the revenue generating initiatives we announced in 2003, and those in the pipeline for 2004, it is our goal to achieve quarterly revenue growth in the second half of 2004. From a margin and expense standpoint, while the costs of our successful brand transition are essentially behind us, in 2004 our product development and new service launch costs will increase in support of new revenue generating initiatives. We will also adopt new accounting rules related to expensing the cost of stock options. As a result, EBITDA for 2004 will be relatively stable compared to 2003, and the Company will continue to generate strong free cash flow. In addition, we expect capital expenditures will be approximately 10% of revenue in 2004.

6 Allstream Inc. 2003 Annual Report

Positioned To Win. With our rich customer base and solid service platform, combined with our expanded points of distribution and the addition of important next generation services, we believe we have positioned Allstream to capture market share by becoming even more relevant to our customers.

The successes we had in 2003 were directly the result of the dedication and commitment of our world-class team of employees, who continue to help us build value for shareholders and customers every day.

We extend Allstream's great appreciation to our customers for their continued support and confidence, as we maintain our commitment to bring choice and innovation to Canadian businesses.

And to our shareholders, thank you for your interest and investment in Allstream.

/s/ JOHN T. MCLENNAN

John T. McLennan
Vice Chairman and Chief Executive Officer

/s/ JOHN A. MACDONALD

John A. MacDonald
President and Chief Operating Officer

2004

Allstream has a solid foundation from which to grow:

•: Blue chip customer base
•: National network and infrastructure
•: Broad product set and solutions capability
•: Experienced management team
•: No long-term public debt and generating positive cash flow and net income

In 2004 our focus is on generating profitable growth by:

•: Developing and launching innovative new services
•: Continually improving customer-facing processes
•: Generating operating efficiencies through productivity gains
•: Pursuing opportunities to compete with the established cost structure of the incumbents
•: Enabling converged IP services through next generation network development

Allstream Inc. 2003 Annual Report 7

Purdy Crawford

message from the chairman

Positioned To Succeed. 2003 was another year of significant change and evolution for the Canadian telecommunications industry, during which we took important steps forward to position Allstream for long-term success.

Allstream is ready to strengthen its position as Canada's largest alternative communications solutions provider to business. We have deep customer relationships with many of Canada's largest corporations, and our national network is one of the most modern in the world. I believe the capabilities of our management team to be second to none in the Canadian telecommunications industry, as they combine extensive experience, with a predisposition for innovation and urgency. In addition, our new Board of Directors is made up of top business leaders with a depth of experience across multiple industries and disciplines.

All of these strengths position Allstream to deepen relationships with customers by helping them compete more effectively whether locally, nationally or around the world. We have the platform in place to create value for our shareholders.

Focus On Corporate Governance. Mr. John McLennan, our C.E.O., and I worked with a Committee of Bondholders to select seven new directors to join John and I on the Board. As a result, when our restructuring was completed on April 1, 2003, we were up and running with a new Board of Directors. Our overall approach to corporate governance is outlined later in this Annual Report under "Corporate Governance" and in Schedule "A" to the Management Proxy Circular. I would like to mention a few specific initiatives.

i.: One of the principal mandates we have established for the Board is for it to satisfy itself, to the extent feasible, regarding the integrity of all senior management and that they "walk the talk", by creating a culture of integrity throughout the organization.
ii.: We have an in-camera session of outside directors at the start of each Board and Committee meeting. These sessions have proven very helpful in bringing together the new Board and building strong mutual respect between management and the Board.
iii.: We had an in-depth review of the performance of the C.E.O. against his 2003 objectives and all other relevant factors. We reported the results of this to the C.E.O. as part of his performance review.
iv.: We also had an in-depth review of my performance as non-executive Chairman against my 2003 objectives and all other relevant factors. The results of this were reported to me.
v.: We are in the course of developing a process for reviewing the performance of the Board, as a whole, and of individual directors.
vi.: The Board has become very involved in the strategic planning process and in the ability of management to execute the strategy. Going forward we will have an in-depth review of the strategic plan at least once a year and at each Board meeting there will be an update on one or more aspects of the overall strategy.

Developing Leadership. Allstream management is committed to leadership development at all levels of the Company. With the understanding that what differentiates an organization in the eyes of its customers is the quality of its people, the senior leadership team has successfully developed a culture that expands opportunities for employee engagement, accountability and the leadership of change.

A Bright Future. I am very pleased with the achievements we had in 2003, and I am equally excited about the opportunities that lie ahead for Allstream in 2004. We are confident that we will capitalize on these opportunities to the benefit of our shareholders.

/s/ PURDY CRAWFORD

Purdy Crawford
Chairman of the Board of Directors

8 Allstream Inc. 2003 Annual Report

management's discussion and analysis of financial condition and
results of operations

February 24, 2004
(Dollar amounts are stated in thousands of Canadian dollars except where otherwise noted)

Forward-looking statements

On April 1, 2003, AT&T Canada Inc. (the "Predecessor") implemented the Consolidated Plan of Arrangement and Reorganization (the "Plan") and emerged from protection under the Companies' Creditors Arrangement Act (Canada) ("CCAA"). Pursuant to the Plan, a new parent company ("New AT&T Canada Inc.") was incorporated under the Canada Business Corporations Act (the "Act") and pursuant to Articles of Reorganization dated April 1, 2003 (the "Articles of Reorganization") became the sole shareholder of the Predecessor. On June 18, 2003, New AT&T Canada Inc. changed its name to Allstream Inc. (the "Company" or "Allstream" or "Successor").

This management's discussion and analysis of financial condition and results of operations ("MD&A") explains Allstream's financial condition for the period from April 1, 2003 to December 31, 2003 ("nine months ended December 31, 2003"). Where appropriate, the analysis will include results of operations for the nine months ended December 31, 2003 together with the Predecessor's three months ended March 31, 2003 ("twelve months ended December 31, 2003") compared with the twelve months ended December 31, 2002 of the Predecessor. The Predecessor's unaudited consolidated financial statements for the three months ended March 31, 2003 can be found on the Company's website at www.allstream.com, on SEDAR at www.sedar.com and on the SEC Filings & Forms (EDGAR) at www.sec.gov/edgar.shtml. This discussion is intended to help shareholders and other readers understand the Company's business and certain key factors underlying its financial results. The consolidated financial information and other operating performance information of the Company issued subsequent to the Plan implementation are not comparable with the consolidated financial information and other information issued by the Predecessor prior to the Plan implementation. Accordingly, the MD&A of the Company compared to the Predecessor's should be reviewed with caution, and should not be relied upon as being indicative of future results of the Company or providing a directly comparable analysis of financial performance. Certain statements in this MD&A and consolidated financial statements constitute forward-looking statements. Such forward-looking statements involve known and unknown risks, uncertainties, and other factors including those described under the "Risks and Uncertainties" section, which may cause the actual results, performance or achievements of the Company to be materially different from future results, performance or achievements expressed or implied by such forward-looking statements.

Overview

Allstream is a leading communications solutions provider committed to being an innovative, agile and collaborative partner with its customers. Supported by a world-class portfolio of Connectivity, Infrastructure Management, and IT Services, Allstream listens to and collaborates with customers to deliver business solutions that meet their unique needs and to help them compete more effectively. Spanning more than 18,800 kilometres, Allstream's broadband fibre-optic network has the greatest reach of any competitive carrier in Canada, and provides international connections through strategic partnerships and interconnection agreements with other international service providers. Additional information about Allstream, including Allstream's Annual Information Form, can be found on the Company's website at www.allstream.com, on SEDAR at www.sedar.com and on the SEC Filings & Forms (EDGAR) at www.sec.gov/edgar.shtml.

During the twelve months ended December 31, 2003, the Predecessor and the Successor entities underwent significant change. On April 1, 2003, the Predecessor implemented the Plan and the Successor emerged from protection under CCAA with its Class A Voting Shares and Class B Limited Voting Shares trading on both the Toronto Stock Exchange (the "TSX") and the NASDAQ National Market System ("NASDAQ"). The absence of long-term public debt, as a result of the Company's new capital structure, has contributed to the generation of positive results. The Company launched its new brand name "Allstream" on June 18, 2003 almost three months ahead of the required date. In addition, on December 9, 2003, the Company declared a special cash dividend of $3.50 per share, or a total of approximately $69.4 million.

Allstream Inc. 2003 Annual Report 9

Core business strategy

Upon emergence from CCAA protection on April 1, 2003, the Company focused on those key priorities that were considered necessary to its core business strategy of building and growing the value of the Company in an environment where competition is constantly evolving. This business strategy included:

•: Working with large and medium sized customers including blue chip private and public sector customers;
•: Providing excellent customer service by being responsive and agile in meeting customer needs;
•: Delivering customized business solutions that are supported primarily by data and Internet products and services that are in high demand; and
•: Working with AT&T Corp., as both a customer and a supplier, when it is in the Company's customers' best interests to do so, while at the same time expanding the Company's global reach by partnering with new international suppliers.

To deliver against this business strategy, the Company's priorities in 2003 were to restructure its balance sheet, re-establish itself with a new name and brand, and develop new commercial arrangements with AT&T Corp. In addition, the Company focused on higher margin products and services, reacted where considered appropriate to meet pricing pressures, optimized its service delivery and enhanced its distribution channels. The Company's key priorities during 2004 will also focus on continued development of new products and services, and optimizing its cost infrastructure through regulatory cost reductions and operating efficiencies. The following is an overview of the events that have supported the Company's progress towards achievement of its strategy.

Consolidated plan of arrangement and reorganization

On April 1, 2003, the Predecessor implemented the Plan and the Company emerged from protection under CCAA with its Class A Voting Shares and Class B Limited Voting Shares trading on both the TSX and the NASDAQ. As a result, the Company's balance sheet and equity were restructured, certain liabilities were compromised, and the corporate structure was simplified. The primary impacts of the Plan on the results of 2003 were an improvement in net income through decreased foreign exchange and lower interest expense as a result of no U.S. denominated public debt and foreign exchange derivative instruments, and decreased depreciation expense as a result of the lower carrying cost for property, plant and equipment.

Commercial agreements with AT&T Corp

Revised commercial agreements were signed with AT&T Corp. on January 17, 2003, providing a timeframe for continuity of the Company's global connectivity, technology platform and product suite, and maintaining network ties between the two companies for the benefit of customers. The agreements contemplate that the Company and AT&T Corp. will continue working together on a non-exclusive basis, and provide the Company with the ability to forge additional supplier relationships. The agreements recognize AT&T Corp.'s ability to compete directly with Allstream in serving AT&T Corp.'s Canadian customers. On July 22, 2003, the Company signed a master services agreement with AT&T Corp. for the continued use of certain AT&T Corp. technology and capabilities. Absent agreements to the contrary with AT&T Corp., the Company will be required to stop using certain of AT&T Corp. technology and capabilities by December 31, 2005. The Company is in the process of creating and/or obtaining alternative products or services to replace the products and services based on the AT&T Corp. technology and capabilities. Once these alternative products and services are in place, a program will be created to migrate the Company's customers to the new products and services. The cooperation of certain customers will be required in order to complete a transition to the new products and services. Development of the Company's own technology and capabilities, as well as operating initiatives to implement those requirements, will be funded through the Company's cash flow from operations. The Company is currently negotiating with AT&T Corp. to extend the continued use of certain AT&T Corp. technology and capabilities for several years. It is anticipated that these discussions will be concluded by May 15, 2004, subject to a further extension. While the Company is confident that it will meet the requirements of the AT&T Corp. agreements, no assurances can be given that it can effect a seamless migration of existing customers to the new products and services.

10 Allstream Inc. 2003 Annual Report

The Allstream brand

The Company launched its new brand, "Allstream," on June 18, 2003 in conjunction with an advertising campaign to promote the new brand. The Company spent $15.5 million on rebranding activities, including marketing and media costs for on-air advertising campaigns, changes to signage and changes to internal and customer facing systems, for the nine months ended December 31, 2003. Independent research and feedback from customers indicates that progress has already been made with regard to the brand attributes of being innovative, agile and collaborative partners. These results support the Company's conviction that it has the infrastructure and service capabilities to further deepen its competitive position in the Canadian marketplace.

Regulatory environment

During 2003, Allstream continued to pursue regulatory changes required to create a balanced regulatory framework through the Canadian Radio-television and Telecommunications Commission ("CRTC"). The Company's regulatory initiatives focused on reducing existing costs to access the public network and on increasing the Company's network reach by gaining tariffed access to 'next generation' network facilities and to services increasingly being utilized by the incumbent local exchange carriers ("ILECs").

While dismissing the Company's appeal to Cabinet of the 2002 price cap decision, which dealt with, among other things, the costs incurred by competitive providers to utilize the ILECs network facilities and services in order to service customers, the Government of Canada indicated that the CRTC should continue its 'pro-competitive momentum' by addressing in a timely way, the barriers to competitor access to the ILEC networks. During 2003, the CRTC broadened interim competitor access to competitor digital network access service ("CDNA") resulting in further cost savings in service costs. In addition, the CRTC continued to express, in several proceedings, its intention to address anti-competitive ILEC behaviour in the marketplace.

With respect to foreign ownership and control restrictions, Parliament's Industry Committee reported back to the Government of Canada and recommended removal of existing restrictions. The Government of Canada responded by agreeing with the appropriateness of that recommendation and committed itself to developing options for implementation that reconcile with recommendations of the Heritage Committee concerning the broadcasting industry, by the spring of 2004.

New products

The Company launched a significant number of new and innovative products during 2003 including:

•: Enhanced Business Internet Protocol ("IP") Service enabling customers to converge diverse applications onto a single IP network using Dynamic Class of Service capabilities to prioritize traffic;
•: High Availability Internet Access with guaranteed 99.995% Internet uptime;
•: Transparent LAN Ethernet Services;
•: International Data Services with seamless connections to over 50 countries;
•: Global Internet Access enabling mobile workers to connect to their enterprise network from more than 35,000 wired and nearly 2,000 WiFi access points; and
•: Managed Intrusion Security providing a comprehensive managed security service and further enhancing the Company's world-class security portfolio.

These enhancements were implemented in the latter half of 2003. During 2004, the Company will expand its business IP service offerings through its existing national IP infrastructure, and expand its participation in the wholesale market through offering new and different technologies in support of wholesale customers. These enhancements are being funded from the Company's cash flow from operations.

Allstream Inc. 2003 Annual Report 11

Fixed wireless venture

On November 18, 2003, the Company announced a venture with Microcell Telecommunications Inc., and NR Communications, LLC to offer high speed Internet, IP-based voice and local networking services using broadband wireless access technology (see "Risks and uncertainties" reference (i)). In addition to providing a mobile broadband alternative to the ILECs wireline service, the Company believes that as this technology matures, it will provide the Company with a cost-effective way of accessing the Company's customers and a platform over which the Company can add services without relying as much on ILECs facilities. Investments in this venture will occur in phases. The initial phase commits the Company to a $5 million investment, of which, $0.1 million has been spent in 2003; and potential additional investments of up to $40 million in cash and services in a later phase depending upon the outcome of the initial phase.

Ratification of collective agreements

In December 2003, the Company announced the ratification of its collective agreements by both the National Automobile Aerospace, Transportation and General Workers Union of Canada — Local 2000 and the United Steelworkers of America. Both agreements are for a term of three years, expiring on December 31, 2006 and will raise wages for the Company's bargaining unit members by 2.5 per cent starting January 1, 2004, followed by an increase of 2.5 per cent on January 1, 2005 and 2.75 per cent on January 1, 2006. In addition to wage increases, the agreements will also improve employee benefits, pension, vacation entitlement and health and safety provisions. Bargaining unit members will also participate in the Company's variable pay program with a component linked to individual performance. The ratification of these agreements has greatly reduced the risk of a work stoppage and will generate confidence among customers that the Company is committed to minimizing service disruption.

Engaged leadership and accountability

Throughout the year, employees receive regular communications about Company strategies and key initiatives which are linked to individual performance objectives. As a result of aligning employee performance to the Company's strategies and key initiatives, which include improved customer satisfaction, the Company exceeded 2003 customer satisfaction objectives.

Sale of Contour Telecom Inc. and Argos Telecom Inc.

On July 2, 2003, the Company completed the previously announced sale of its subsidiaries, Contour Telecom Inc. and Argos Telecom Inc. ("Contour Telecom"), to YAK Communications (Canada) Inc. for approximately $8.0 million in cash. There was a gain on disposal of $0.4 million.

12 Allstream Inc. 2003 Annual Report

Results of operations

The following table summarizes key financial results for the nine months ended December 31, 2003 and those of the Predecessor entity, AT&T Canada Inc., for each of the years ended December 31, 2002 and December 31, 2001.

Selected financial information

(in thousands of dollars, except per share amounts)		Nine months ended December 31, 2003			* * *	Year ended December 31, 2002			Year ended December 31, 2001
		(Successor)			*	(Predecessor)			(Predecessor)
Revenue:
	Data	$	307,445		*	$	457,962		$	485,031
	Local		162,906		*		235,095			209,207
	Internet and IT Services		127,935		*		195,600			171,852
	Other		10,289		*		26,693			20,843

		$	608,575		*	$	915,350		$	886,933
	Long Distance		339,221		*		572,795			657,788

Total Revenue		$	947,796		*	$	1,488,145		$	1,544,721

Service Costs		$	529,157		*	$	931,949		$	1,005,790
Gross Margin		$	418,639		*	$	556,196		$	538,931
Gross Margin %			44.2%		*		37.4%			34.9%
Selling, General and Administrative Costs ("SG&A")		$	230,875		*	$	333,004		$	385,966
Depreciation and amortization		$	77,493		*	$	273,142		$	465,600
Income (loss) from operations		$	110,271		*	$	(1,340,215	)	$	(334,536	)
Foreign exchange loss		$	—		*	$	(41,126	)	$	(10,097	)
Interest expense		$	(3,656	)	*	$	(431,625	)	$	(401,114	)
Income Taxes		$	(48,188	)	*	$	(6,741	)	$	(7,965	)
Net Income (Loss)		$	65,562		*	$	(1,831,659	)	$	(745,375	)
Basic earnings (loss) per Share		$	3.31		*	$	(17.95	)	$	(7.57	)
Diluted earnings (loss) per Share		$	3.29		*	$	(17.95	)	$	(7.57	)
Total Assets		$	1,064,342		*	$	1,687,700		$	4,763,625
Total Liabilities subject to compromise		$	—		*	$	4,719,591	*	$	—
Total Long-term Liabilities		$	162,375		*	$	170,765	*	$	4,747,293
Total Capital Expenditures		$	60,911		*	$	143,865		$	419,173

*: Under the CCAA proceedings and the Plan, all of the Company's liabilities to creditors under the Senior Notes, including accrued interest thereon, were segregated and classified as liabilities subject to compromise upon implementation of the Plan.

Allstream Inc. 2003 Annual Report 13

Twelve months ended December 31, 2003 compared to twelve months ended December 31, 2002 of the Predecessor

The following table summarizes selected results of operations for the nine months ended December 31, 2003 together with the three months ended March 31, 2003 compared with the twelve months ended December 31, 2002 to help shareholders and other readers understand the Company's business and key factors underlying its financial results.

Supplementary financial information

(In thousands of dollars, except per share amounts)		Nine months ended December 31, 2003			Three months ended March 31, 2003			* * * *	Twelve months ended December 31, 2003			* * * *	Twelve months ended December 31, 2002
		(Successor)			(Predecessor)			*	(Successor and Predecessor)			*	(Predecessor)
Revenue:
	Data	$	307,445		$	112,256		*	$	419,701		*	$	457,962
	Local		162,906			56,912		*		219,818		*		235,095
	Internet and IT Services		127,935			46,179		*		174,114		*		195,600
	Other		10,289			4,111		*		14,400		*		26,693

		$	608,575		$	219,458		*	$	828,033		*	$	915,350
	Long Distance		339,221			133,867		*		473,088		*		572,795

Total Revenue		$	947,796		$	353,325		*	$	1,301,121		*	$	1,488,145

Service Costs		$	529,157		$	216,061		*	$	745,218		*	$	931,949
Gross Margin		$	418,639		$	137,264		*	$	555,903		*	$	556,196
Gross Margin %			44.2%			38.8%		*		42.7%		*		37.4%
Selling, General and Administrative Costs ("SG&A")		$	230,875		$	70,970		*	$	301,845		*	$	333,004

Income (Loss) from operations		$	110,271		$	36,491		*	$	146,762		*	$	(1,340,215	)
Add:
	Depreciation and amortization		77,493			41,625		*		119,118		*		273,142
	Workforce reduction costs and provision for restructuring		—			(11,822	)	*		(11,822	)	*		87,069
	Write-down of long-lived assets		—			—		*		—		*		1,203,196

EBITDA*		$	187,764		$	66,294		*	$	254,058		*	$	223,192

Net Cash generated by (used in) operating activities		$	224,941		$	21,346		*	$	246,287		*	$	(147,759	)
Add/(Subtract):
	Changes in non-cash working capital		(23,131	)		(32,139	)	*		(55,270	)	*		24,308
	Addition to property, plant and equipment		(60,911	)		(33,227	)	*		(94,138	)	*		(143,865	)

Free cash flow**		$	140,899		$	(44,020	)	*	$	96,879		*	$	(267,316	)

*: EBITDA is a measure commonly used in the telecommunications industry to evaluate operating results and is generally defined as earnings before interest, income taxes, depreciation and amortization. The Company has also excluded the workforce reduction costs and provision for restructuring and the write-down of long-lived assets as these items are not expected to be recurring in nature as the Company completed the restructuring of its balance sheet and emerged from protection under the CCAA proceeding on April 1, 2003. EBITDA is a measure the Company believes is used by investors and management to evaluate the Company's financial performance, although it does not have a standardized meaning under Canadian Generally Accepted Accounting Principles ("GAAP") and is not necessarily comparable to similar measures disclosed by other issuers. Accordingly, EBITDA is not intended to replace income/(loss) from operations, net income/(loss) for the period, cash flow, or other measures of financial performance and liquidity reported in accordance with Canadian GAAP.
**: Free Cash Flow is a measure commonly used to evaluate operating and financial results and is defined as net cash generated from operating activities excluding changes in working capital less additions to property, plant and equipment. Free Cash Flow is a measure the Company believes is used by investors and management to evaluate the Company's operating and financial performance, although it does not have a standard meaning under Canadian GAAP, and is not necessarily comparable to similar measures disclosed by other issuers. Accordingly, Free Cash Flow is not intended to replace income/(loss) from operations, Net cash generated by (used in) operating activities, cash flow, or other measures of financial performance and liquidity reported in accordance with Canadian GAAP.

14 Allstream Inc. 2003 Annual Report

For the twelve months ended December 31, 2003, the sum of the nine months ended December 31, 2003 of the Successor and the three months ended March 31, 2003 of the Predecessor were used for informational purposes only. Accordingly, the discussion of financial condition and results of operations should be reviewed with caution, and should not be relied upon as being indicative of future results of the Company or providing a directly comparable analysis of financial performance.

EBITDA

EBITDA increased by $30,866 in the twelve months ended December 31, 2003 from $223,192 in the twelve months ended December 31, 2002. This improvement was the result of changes in revenue, service costs and selling, general and administrative expenses, as described below.

Revenue

Revenue from data, local, Internet and IT Services, and other services increased to 64% of total revenue for the twelve months ended December 31, 2003, from 62% in the twelve months ended December 31, 2002. The proportion of revenue from long distance services declined to 36% in the twelve months ended December 31, 2003, from 38% in the comparable period in the prior year. This change in mix between long distance products and data and Internet products resulted from expanded use of other technologies including email services, wireless and cellular services by customers. Total revenue declined by $187,024 or 12.6% compared to the twelve months ended December 31, 2002. Part of the decline in revenue was the result of the sale of Contour Telecom. During 2003, Contour Telecom contributed revenue totalling $23.0 million. The year over year decline in revenue attributed to the sale of Contour Telecom was $30.9 million. This was comprised of the following: lower long distance ("LD") revenue of $10,778, lower data revenue of $9,215, lower revenues from other sources of $5,702 and lower revenues from local of $5,200.

Data revenue decreased by $38,261 or 8.4% to $419,701 in the twelve months ended December 31, 2003 from $457,962 in the twelve months ended December 31, 2002. The decline in data revenue was the result of pricing pressures and industry-wide weakness in enterprise demand for certain legacy products, including private line, data access services and frame relay services, combined with the loss of revenue from the sale of Contour Telecom. Technology substitution is causing erosion of revenue as customers are benefiting from the Company's new technologies and related services, such as its digital subscriber line ("DSL") services which provide access at lower costs to customers. In addition, the Company's wholesale service prices were lowered to match market reductions and as a result of the regulatory price cap decision.

Local revenue decreased by $15,277 or 6.5% to $219,818 in the twelve months ended December 31, 2003 from $235,095 in the twelve months ended December 31, 2002. This decline in local revenues is the result of fewer access lines in service attributable to the Company's focus on profitable line growth and the loss of revenue from the sale of Contour Telecom. The Company's strategy targets potential business customers that require local lines to be carried on the Company's network and in excess of certain threshold volumes. Local access lines in service declined to 486,192 from 537,940 at December 31, 2002 of which 15,626 local access lines were removed as a result of the sale of Contour Telecom.

Internet and IT Services revenue declined by $21,486 or 11.0% to $174,114 in the twelve months ended December 31, 2003 from $195,600 in the twelve months ended December 31, 2002. The decline in Internet revenue is due to lower demand for dial-up Internet access as a result of technology substitution and new access arrangements. The decline in IT Services was attributable to lower demand for IT Services.

Other revenue decreased by $12,293 or 46.1% to $14,400 in the twelve months ended December 31, 2003, from $26,693 in the twelve months ended December 31, 2002. The decline was primarily attributable to lower sales of telecommunications equipment.

LD revenue decreased by $99,707 or 17.4% to $473,088 in the twelve months ended December 31, 2003 from $572,795 in the twelve months ended December 31, 2002. The decline was due to lower prices per minute, lower volumes and the sale of Contour Telecom. The Company was cautious in reacting to price pressures in the LD market as price elasticity is no longer a major factor and customers are migrating to alternative technologies such as email, wireless and cellular. Prices dropped by 7.8% and minutes decreased by 9.6%, primarily due to the effects of continued price competition. This is a trend the Company anticipates will continue in 2004.

Allstream Inc. 2003 Annual Report 15

Service costs, selling, general and administrative expenses and gross margin

The Company's principal operating expenses consist of Service Costs, Selling, General and Administrative expenses ("SG&A") and depreciation and amortization. Service Costs consist of expenses directly related to delivering service to customers and servicing the operations of the Company's networks, expenses associated with fibre and other leases where the Company does not presently have its own facilities, local and long distance transport costs paid to other carriers, maintenance costs, right-of-way fees, municipal access fees, hub site lease expenses, personnel costs and leases of utility space in buildings connected to the Company's networks. SG&A expenses include the personnel costs of sales and marketing employees, promotional and advertising expenses and corporate administrative expenses.

During 2003, both Service Costs and SG&A expenses were impacted by staff reductions. The number of full-time employees was reduced to 3,621 at December 31, 2003 from 4,039 at December 31, 2002.

Service Costs decreased by $186,731 or 20.0% to $745,218 in the twelve months ended December 31, 2003, from $931,949 in the twelve months ended December 31, 2002. Certain reductions have contributed to improving the Company's overall cost base and its gross margin percentage. These reductions were primarily due to lower costs to deliver cross border and international services primarily for LD customers, cost reductions from regulatory decisions and lower personnel and related costs from workforce reductions. Service Costs were further reduced as a result of lower revenue volumes as noted above and the impact of the sale of Contour Telecom.

Gross margin as a percentage of revenue increased to 42.7% in the twelve months ended December 31, 2003 from 37.4% reported in the twelve months ended December 31, 2002.

SG&A expenses decreased by $31,159 or 9.4% to $301,845 in the twelve months ended December 31, 2003, from $333,004 in the twelve months ended December 31, 2002. The decrease was attributable to lower salaries and wages as the Company achieved further operating efficiencies through staff reductions and from reduced bad debt expenses. The decreases were partially offset by employee termination costs and costs related to rebranding and new product developments.

Nine months ended December 31, 2003

On April 1, 2003, upon emergence from CCAA protection and the application of comprehensive revaluation of assets and liabilities under fresh start accounting, the Company's public debt and certain other liabilities were exchanged for cash and equity, and its net assets were revalued to their fair value as described in note 1 to the accompanying consolidated financial statements. The primary impacts of the Plan on the results of 2003 were the decreases in foreign exchange and interest expense because of the elimination of the Predecessor's U.S. dollar denominated debt and foreign exchange derivative instruments, and decreased depreciation expense as a result of the lower carrying value of property, plant and equipment.

Provision for income taxes

For the nine months ended December 31, 2003, the Company's provision for income taxes is $48,188. This primarily represents income tax expense calculated at the Company's effective tax rate on its income for the period. Of the total provision for income taxes recorded for the period, $46,715 does not give rise to a cash income tax liability as the Company utilized the Predecessor's tax losses to reduce taxable income of the Company. As described in note 15 to the consolidated financial statements for the nine months ended December 31, 2003, the tax benefit arising on the utilization of the Predecessor's tax assets is recorded as contributed surplus and not as a reduction of the provision for income taxes in the Company's statement of operations. The provision for the nine months ended December 31, 2003 includes $1,386 of Federal Large Corporations Tax ("LCT"). LCT is calculated by reference to the equity, liabilities and assets of the Company.

16 Allstream Inc. 2003 Annual Report

The Company's non-capital loss balance as at December 31, 2003 is $3.073 billion. During the nine months ended December 31, 2003, the Company utilized approximately $140 million of its non-capital losses to reduce taxable income. On implementation of the Plan, an acquisition of control ("AOC") occurred for tax purposes. As a result of the AOC, the Predecessor was required to write-down the tax carrying value of their assets to fair value. The write-down added approximately $1.78 billion to the consolidated tax loss pool. This write-down resulted in a reclassification of property, plant and equipment tax assets that were available prior to April 1, 2003 to the consolidated tax loss pool as at April 1, 2003. The implementation of the Plan and certain related transactions also resulted in a forgiveness of indebtedness that reduced the consolidated tax loss pool by approximately $769 million.

The tax losses available to the Company are described in note 15 to the consolidated financial statements. A substantial portion of these losses expire in 2009, to the extent not used.

Liquidity and capital resources

Liquidity

After payment of the $233 million to holders of the senior notes and other affected creditors of the Predecessor pursuant to the Plan, the Company emerged from CCAA on April 1, 2003 with no public debt and cash on hand of $176.6 million.

At December 31, 2003, the Company had cash on hand of $345.7 million. For the nine months ended December 31, 2003, the Company generated cash from operations of $224.9 million, primarily attributable to operating profitability and from improved working capital from a return to normal credit terms with the Company's trade creditors since emerging from CCAA. With the elimination of its U.S. dollar denominated public debt, the Company no longer requires financial derivatives to hedge foreign currency exposures, and consequently the Company is exposed primarily to foreign exchange gains or losses on its working capital, primarily for its international carrier payables denominated in U.S. dollars and receivables denominated in U.S. dollars. Furthermore, the Company has no off-balance sheet financing arrangements other than its supply contracts and operating lease commitments which are described in the contractual obligations table below.

Free cash flow

For the nine months ended December 31, 2003, the Company had Free Cash Flow of $140.9 million, which has improved from negative $267.3 million for the twelve months ended December 31, 2002 of the Predecessor. This improvement reflects increased cash flow generated from operations, and the elimination of interest expense on the Predecessor's public debt.

Cash expenditures on property, plant and equipment during the nine months ended December 31, 2003 totalled $60.9 million, representing 6.4% of revenues.

On December 9, 2003, the Company's Board of Directors declared a special dividend of $3.50 Canadian per share on the issued and outstanding Class A Voting Shares and Class B Limited Voting Shares. The special dividend was paid on January 6, 2004 to holders of record at the close of business on December 19, 2003 in the amount of $69.4 million.

The Company believes its current liquidity position and its positive free cash flow provide it with the financial flexibility to meet current operating requirements and to respond to opportunities as they arise. The Company plans to generate sufficient cash from operations to pay for capital expenditures (expected to approximate 10% of revenue in 2004), contractual obligations and other commitments described below.

Allstream Inc. 2003 Annual Report 17

Cash requirements

Contractual obligations

The table below provides a summary of the Company's contractual obligations as at December 31, 2003 and the payments required for the full years ended thereafter.

(In millions of dollars)	Total		Less than 1 year		1-3 years		3-5 years		More than 5 years
Capital Lease Obligations	$	30.1	$	6.0	$	3.7	$	3.7	$	16.7
Capital Purchase Commitments		10.5		8.0		2.3		0.2		—
Supply Contract and Operating Leases		658.3		145.8		167.6		112.0		232.9
Pension Obligation		113.6		31.5		62.2		19.9		—
Other Long Term Obligations		22.4		1.0		12.3		5.1		4.0

Total Contractual Obligations	$	834.9	$	192.3	$	248.1	$	140.9	$	253.6

The interest to be paid in connection with the capital lease obligations amounts to approximately $9.3 million.

Capital purchase commitments represent obligations under computer hardware supply contracts.

Supply contracts consist primarily of contractual obligations under network and software maintenance agreements and operating leases consist primarily of property leases and obligations under right of way agreements.

At December 31, 2003, the pension obligation represented an unfunded deficit in the Company's defined benefit pension plans of $101.9 million, as determined by an independent actuary on January 1, 2004, plus $11.7 million of estimated interest to be paid on the deficit. This deficit is being funded over the remaining 4-year period in accordance with Canadian federal legislation governing such matters. In 2004, it is estimated that the Company will pay $31.5 million for this pension obligation.

Other long-term obligations included in the table above reflect payments related to the cost of exiting certain office and equipment leases, cash outlays to be made under the management incentive plan and director compensation plan and certain other obligations under a long-term revenue contract.

Other cash requirements

In the fourth quarter, the Company entered into a venture to build a Multipoint Communications System ("MCS") network to offer high speed Internet, IP-based voice and local networking services using broadband wireless access technology (see "Risks and uncertainties" reference (i)). The Company will own one-third of the new venture, which operates as an independent entity. Investments in this new venture will occur in phases, and the Company has committed cash resources in the initial phase. During the initial phase, which will allow the parties to validate technological and commercial acceptance and to develop the detailed business plan, the Company will contribute $5 million in cash or services. In a later phase, planned for mid-2004, if the Venture partners decide to proceed with full-scale deployment, the Company may be required to contribute up to $10 million in cash and $30 million in services.

The Company has cash segregated as collateral against outstanding letters of credit of the same amount. The cash remains restricted until the letters of credit are cancelled or expired. As of December 31, 2003 the Company had outstanding letters of credit of $1.6 million. Restricted cash also includes an amount held in trust for $14 million for further protection for the directors and officers of the Predecessor with respect to their potential personal liability for certain statutory liabilities. The restrictions will terminate upon the earlier of (i) December 31, 2008 and (ii) three years from the date of the last claim being conclusively resolved.

18 Allstream Inc. 2003 Annual Report

Outlook

The Company expects to achieve quarterly revenue growth in the second half of 2004, facilitated primarily by new products launched in 2003 and those that will be launched in 2004. From a margin and expense standpoint, while the costs of the Company's brand transition are essentially complete, the Company's product development and new service launch costs will increase in 2004 in support of new revenue generating initiatives. In addition, in the first quarter of 2004, the Company will begin to measure and expense all equity instruments awarded to employees, including stock options issued to employees, as required by the standard set by the Canadian Institute of Chartered Accountants ("CICA"). As a result of the above, EBITDA for 2004 is expected to be relatively stable compared to 2003, and the Company expects to continue to generate strong free cash flow. In addition, the Company expects capital expenditures will be approximately 10% of revenue in 2004.

Risks and uncertainties

(a): Change in AT&T Corp. relationship

During the remaining term of its commercial agreements with AT&T Corp. (which expire on December 31, 2005, which date may be amended) and its wholly owned subsidiary, AT&T Enterprises Canada Company, the Company will make use of certain AT&T Corp. technologies and capabilities on a transitional basis.

The Company signed a master services agreement with AT&T Corp. on July 22, 2003 to allow for the continued use of AT&T Corp. technology and capabilities. The Company and AT&T Corp. have agreed on a framework and a detailed transition plan to deal with ongoing cooperation and a process to transition network support provided by AT&T Corp. for the Company's toll-free, calling card and customer care platforms by no later than December 31, 2005. The transitional network support arrangement may be extended by mutual agreement; may be accelerated under certain conditions; or accelerated in the event of an acquisition of 20% or more of the Company's equity by a strategic competitor or in certain other circumstances. Absent an agreement to the contrary with AT&T Corp., the Company will be required to stop using AT&T Corp. technology and capabilities by December 31, 2005. The Company is in the process of creating and/or obtaining alternative products or services to replace the AT&T Corp. products and services based on the AT&T Corp. technology and capabilities. Once these alternative products and services are in place, a program will be created to migrate the Company's customers to the new products and services. The cooperation of certain customers will be required in order to complete a seamless transition. The Company is currently negotiating with AT&T Corp. to extend the continued use of certain AT&T Corp. technology and capabilities for several years. It is anticipated that these discussions will be concluded by May 15, 2004, subject to a further extension. While the Company is confident that it will meet the requirements of the AT&T Corp. agreements, no assurances can be given that it can effect a seamless migration of existing customers to the new products and services.

AT&T Corp. has the ability to serve Canadian customers directly, including competing with the Company. There can be no assurance that the Company will not incur a significant loss of revenue from business ongoing with or influenced by AT&T Corp. as a result of the new commercial arrangements.

(b): Brand transition

The Company launched its new brand name, "Allstream," on June 18, 2003. The Company has implemented its brand implementation plan in accordance with the commercial agreements with AT&T Corp. and as required by those agreements has ceased, except with the consent of AT&T Corp., all use of the AT&T Canada brand as of December 31, 2003, with the exception of the use of the AT&T Canada brand for its calling card and Internet domain names, which must end no later than June 30, 2004.

Allstream Inc. 2003 Annual Report 19

(c): Competition

The Company faces intense competition in all of its markets for its existing and planned services from, among others, the ILECs, cable companies, competitive long distance providers, wireless providers, competitive local exchange carriers, internet service providers, Centrex resellers and other current and planned telecommunications providers. The Company's ability to compete effectively in the Canadian telecommunications industry may be adversely affected by continuing consolidation and expansion amongst its competitors.

In each of the business areas currently served by the Company, the principal competitor is the ILEC serving that geographic area. The ILECs have long-standing relationships with their customers and have historically benefited from a monopoly over the provision of local switched services. In addition, the ILECs have financial, marketing, technical, personnel, regulatory and other resources that exceed those of the Company. There can be no assurance that the Company will be successful in its attempt to offer services in competition with the services offered by the ILECs.

(d): Market and economic conditions

(e): Governmental regulation and potential for change in regulatory environment

The Company is subject to regulation by Canada's telecommunications regulatory authority, the CRTC, pursuant to the provisions of the Telecommunications Act (Canada) (the "Telecommunications Act") and, to a lesser extent, the Radiocommunication Act (Canada) (the "Radiocommunication Act"), pursuant to the provisions of Industry Canada. Since the enactment of the Telecommunications Act, the Government of Canada has indicated that the CRTC should continue its 'pro-competitive momentum' by addressing in a timely way, barriers to competitor access to the ILEC networks.

There can be no assurance that regulatory rulings of the CRTC within that policy framework will not have material adverse effects on competition, whether in relation to terms of access to the existing ILEC-controlled network, control of ILEC behaviour in view of their dominant market position or otherwise.

(f): Restrictions on foreign ownership and control

Pursuant to federal legislation, a "Canadian carrier" must be Canadian owned and controlled. The eligibility of Allstream Corp. to continue to operate as a Canadian carrier could be jeopardized if the Company and Allstream Corp., or any of their subsidiaries fail to comply with the requirements relating to ownership and control. Any issuances of equity securities of the Company to non-Canadians must be in the form of Class B Limited Voting Shares or, if Class A Voting Shares, such Class A Voting Shares must also be issued to Canadian residents in such amounts as are necessary to allow the Company to continue to meet the ownership restrictions. These ownership restrictions may limit the Company's ability to raise equity capital from non-Canadians.

Further to foreign ownership and control restrictions, Parliament's Industry Committee reported back to the Government and recommended removal of existing restrictions. The Government responded by agreeing with the appropriateness of that recommendation and committed itself to developing options for implementation that reconcile with recommendations of the Heritage Committee concerning the broadcasting industry, by the spring of 2004.

20 Allstream Inc. 2003 Annual Report

(g): Cash flow and liquidity

As at December 31, 2003, the Company had cash on hand of $345.7 million and had generated cash from operations of $224.9 million for the nine months ended December 31, 2003. If business conditions change and the Company is not able to achieve its planned levels of revenues and cash flows, there can be no assurance that the Company will be able to obtain sufficient funds on terms acceptable to it to provide adequate liquidity to finance the operating and capital expenditures. Failure to generate additional funds, whether from operations, additional debt or equity financing, may require the Company to delay or abandon some or all of its anticipated expenditures, which could have a material adverse effect upon the growth of the affected businesses and on the Company. Furthermore, the ability of competitors to raise money on more acceptable terms could create a competitive disadvantage for the Company.

(h): Rapid technological changes

The telecommunications services industry is subject to rapid and significant changes in technology that may reduce the relative effectiveness of existing technology and equipment. Although the Company has invested in what it currently views as the best technology available, all aspects of voice, data, and video telecommunications are undergoing rapid technological change. There can be no assurance that the Company's technologies will satisfy future customer needs, that the Company's technologies will not become obsolete in light of future technological developments, or that the Company will not have to make additional capital investments to upgrade or replace its technology. The effect on the Company of technological changes, including changes relating to emerging wireline and wireless transmission and switching technologies, cannot be predicted and could have a material adverse affect on the Company's business, financial condition, results of operations and prospects.

(i): Allstream/Inukshuk Inc./NR Communications, LLC venture

In the fourth quarter, Allstream entered into a venture with Inukshuk Internet Inc., a wholly owned subsidiary of Microcell Solutions Inc. ("Inukshuk") and NR Communications, LLC ("NR"). The new venture will build a MCS network to offer high speed Internet, IP-based voice and local networking services using broadband wireless access technology. Each party owns one-third of the new company, which operates as an independent entity.

During the first phase, which will allow the parties to validate technological and commercial acceptance and to develop the detailed business plan, the Company's commitment to the venture is $5 million in cash. The Company may invest an additional $10 million in cash and $30 million in services upon completion of the initial phase.

Inukshuk's contribution to the venture will be the transfer of the use of its 60 MHz MCS licensed spectrum, conditional upon Industry Canada's approval. There can be no assurance that Industry Canada will approve the transfer of Inukshuk's 60 MHz of spectrum.

Rogers Wireless Communications Inc. and Telus Corp. have each filed complaints with Industry Canada requesting that Industry Canada deny approval of the proposed transactions and demand the return of Inukshuk's MCS spectrum licences. The complaint alleges that a transfer of the licence from Inukshuk to the venture entity is a trade in licences or spectrum which is prohibited under Industry Canada's policy guidelines. It is not known how Industry Canada will respond to those complaints.

Unique Broadband Systems Inc. ("UBS") has made a claim that it has a right of first refusal over the 60 MHz of MCS spectrum to be transferred to the venture entity. While Inukshuk denies any such agreement with UBS, it is unknown how UBS will proceed, if at all, with such claim.

Allstream has one-third ownership in the venture entity. Pursuant to a Shareholder Agreement between the three shareholders, a number of material issues required unanimous shareholder approval and are beyond the control of Allstream. There can be no assurance that the shareholders will agree upon the future of the venture entity.

Allstream Inc. 2003 Annual Report 21

Critical accounting policies and estimates

Use of estimates

Management's Discussion and Analysis of Financial Condition and Results of Operations is based upon the Company's consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. Management bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgements about the carrying value of assets and liabilities that are not readily apparent from other sources. Senior management has discussed the development, selection and disclosure of these estimates with the Audit Committee of the Company's Board of Directors. Actual results may differ from these estimates under different assumptions or conditions.

An accounting policy is deemed to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made, and if different estimates that reasonably could have been used, or changes in the accounting estimates that are reasonably likely to occur periodically, could materially impact the financial statements. Management believes the following critical accounting policies reflect its more significant accounting estimates and assumptions used in the preparation of the consolidated financial statements.

Fair value of assets and liabilities upon application of fresh start accounting

The significant judgement and estimates which input into the determination of the fair value of its assets and liabilities are estimates of future cash flows of the Company's business, discount rate based upon an estimate of the Company's incremental cost of borrowing, terminal values based upon industry comparables and estimated market rates based on third party quotes and stated rates for obligations such as operating leases, rights-of-way supply contracts and customer contracts. These estimates form the basis of the opening balance sheet of the Company as at April 1, 2003 and are not expected to be revised. While other methods of estimation might have been used, the total enterprise value of the Company was estimated with the assistance of independent financial advisors and approved by the court and the Affected Creditors of the Predecessor. Such enterprise value established the value of the net assets of the Company as at April 1, 2003.

Valuation of accounts receivable

In evaluating the collectibility of trade receivables, a number of factors are assessed including the specific customer's ability to meet its financial obligations to the Company, as well as general factors, such as the length of time the receivables are past due, historical collection experience and the general economic environment. Based on these assessments, the Company records both specific and general allowances for bad debt to reduce the related receivable to the amount the Company ultimately expects to collect from its customers. If circumstances related to specific customers change or economic conditions worsen such that the Company's past collection experience is no longer relevant, the Company's estimate of the recoverability of our trade receivables could be further reduced from the levels provided in the consolidated financial statements.

22 Allstream Inc. 2003 Annual Report

Pension and other post-retirement benefits

The Company provides a number of retirement benefits, including defined benefit and defined contribution plans, providing pension, other retirement and post-employment benefits to most of its employees.

The amounts reported in the financial statements relating to pension, other retirement and post-employment benefits are determined using actuarial calculations that are based on several assumptions.

A valuation is performed at least every three years to determine the actuarial present value of the accrued pension and other retirement benefit liabilities. The valuation uses management's best estimates assumptions for the discount rate, expected long-term rate of return on plan assets, rate of compensation increase, healthcare cost trend, mortality rate and expected average remaining years of service of employees. The Company updates its assumptions with its actuary on an annual basis, or more frequently if events during the year indicate a change may be required.

While the Company believes that these assumptions are appropriate, differences in actual results or changes in assumptions, could affect employee benefit obligations and future pension expense.

Recoverability of property, plant and equipment

Due to the capital-intensive nature of the telecommunications industry, the Company has made significant investments in capital assets. These assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. Assessments of the recoverability of capital assets require estimates of useful lives, future cash flows, discount rates and terminal values. Management develops cash flow projections using assumptions that reflect the Company's planned courses of action and management's best estimate of the most probable set of economic conditions. If the total of the expected future undiscounted cash flows is less than the carrying amount of the asset, a write-down is recognized for the difference between the carrying value of the asset and its fair value.

The Company revalued its capital assets to fair value at April 1, 2003 as required by the principles of fresh start accounting. Since April 1, 2003, there have not been any events or circumstances, which in management's judgement require any reassessment of the recoverability of its capital assets.

Asset retirement obligations

Under U.S. GAAP, the fair value of asset retirement obligations is required to be recorded as a liability in the period in which the Company incurs a legal obligation associated with the retirement of tangible long-lived assets. In determining the fair value of an asset retirement obligation, key estimates include the likelihood that the retirement of the assets will be required, the timing and amount of retirement costs and the discount factor applied to arrive at fair value. The estimates of likelihood and the timing and amount of costs are subject to change and the Company will update its assumptions annually or more frequently if events during the year indicate a change may be required.

Valuation of stock option grants

The fair value of stock option grants is based on certain estimates applied to the Black-Scholes option-pricing model, including the expected life of the options, the volatility of the underlying stock, the risk free interest rate and expected dividends. Changes in these estimates could significantly impact the valuation of the options. As the Company's own share price history is insufficient to determine the expected volatility of its stock over the same period as the expected life of the options, the Company considers the volatility of comparable companies over the same approximate period.

Allstream Inc. 2003 Annual Report 23

Tax asset valuation

The Company has deferred tax assets resulting from net operating loss carryforwards and deductible temporary differences, all of which will reduce taxable income in the future. The Company assesses the realization of these deferred tax assets periodically to determine whether an income tax valuation allowance is required. Based on available evidence, both positive and negative, the Company determines whether it is more likely than not that all or a portion of the remaining net deferred tax assets will be realized. The main factors considered include:

•: future earnings potential determined through the use of internal forecasts;
•: cumulative losses in recent years;
•: history of loss carryforwards and other tax assets expiring;
•: the carryforward period associated with the deferred tax assets; and
•: the nature of the income that can be used to realize the deferred tax assets.

The future profitability and taxable income of the Company and its ability to utilize the Predecessor's loss carryforwards may change the valuation allowance.

Carrier charges

Due to the timing of billings from carriers, it is often necessary to accrue for the cost of telco services received at period end. The Company estimates the required accrued liability based upon estimates of its service usage and contractual terms that underlie the eventual billing and upon historical billings. In addition, in the normal course of business there are discrepancies with other carriers over the charges being billed. The Company reviews these discrepancies on a monthly basis and determines the amount of the provision required, if any.

New accounting standards and recent pronouncements

Hedging relationships

In December 2001, the CICA issued Accounting Guideline 13, Hedging Relationships ("AcG-13"). AcG-13 establishes new criteria for hedge accounting and will apply to all hedging relationships in effect for the Company's fiscal year commencing on January 1, 2004 under Canadian GAAP. To qualify for hedge accounting, consistent with U.S. GAAP, the hedging relationship must be appropriately documented at the inception of the hedge and there must be reasonable assurance, both at the inception and throughout the term of the hedge, that the hedging relationship will be effective. Effectiveness requires a high correlation of changes in fair values or cash flows between the hedged item and the hedge. The adoption of this standard is not expected to have an impact on the consolidated financial statements.

Asset retirement obligations

Effective January 1, 2004, the Company will adopt retroactively with restatement, HB 3110, Asset Retirement Obligations. The Section establishes standards for the recognition, measurement and disclosure of liabilities for statutory, contractual or legal obligations, when incurred, associated with the retirement of property, plant and equipment when those obligations result from the acquisition, construction, development or normal operation of the assets. Retirement includes the sale, abandonment, recycling or other disposal of an asset but not its temporary idling. The obligations are measured initially at fair value (using the present value of future cash flows discounted at a credit-adjusted risk-free rate of interest) in the period in which it is incurred. Upon initial recognition of a liability for an asset retirement obligation, a corresponding asset retirement cost is added to the carrying amount of the related asset. Following the initial recognition of an asset retirement obligation, the carrying amount of the liability is increased for the passage of time and adjusted for revisions to the amount or timing of the underlying cash flows needed to settle the obligation. The cost is amortized into income subsequently on the same basis as the related asset. The new standards are consistent with U.S. GAAP requirements under Statement of Financial Accounting Standards ("SFAS") No. 143, except that SFAS No. 143 is effective for U.S. GAAP as of January 1, 2003 (note 21).

24 Allstream Inc. 2003 Annual Report

Variable interest entities

In June 2003, the CICA issued Accounting Guideline AcG-15, Consolidation of Variable Interest Entities ("VIEs"). VIEs are entities that have insufficient equity and/or their equity investors lack one or more specified essential characteristics of a controlling financial interest. The guideline provides specific guidance for determining when an entity is a VIE and who, if anyone, should consolidate the VIE. The guideline is effective on a prospective basis for the Company's 2005 fiscal year. The Company is currently assessing the impact of adoption of AcG-15.

Generally accepted accounting principles

In July 2003, the CICA issued HB 1100, Generally Accepted Accounting Principles. This section establishes standards for financial reporting in accordance with Canadian GAAP. It describes what constitutes Canadian GAAP and its sources. This section also provides guidance on sources to consult when selecting accounting policies and determining appropriate disclosures when the primary sources of Canadian GAAP are silent. This standard is effective for the Company's 2004 fiscal year. The adoption of this standard is not expected to have a material impact on the consolidated financial statements.

Stock-based compensation

HB 3870 Stock-based Compensation and Other Stock-based Payments, permits the Company to treat employee stock options as capital transactions (the settlement method) until January 1, 2004. Effective on this date, the standard requires that all stock-based compensation payments to both employees and non-employees be accounted for using the fair value method. The Company will apply the new standard retroactively without restatement of prior periods. Consequently, opening deficit as at January 1, 2004 will be increased to reflect the expensing of the fair value of $3.1 million for awards granted on or after April 1, 2003.

Since the Company is following the settlement method, HB 3870 requires pro forma disclosure of net income and per share information as if the Company had accounted for these employee stock options under the fair value method. The Company uses the Black-Scholes option-pricing model to measure the fair value of stock options issued during the period for purposes of the pro forma disclosure, which is then allocated to compensation cost on a straight-line basis over the vesting period of the award.

Disclosure of outstanding share data

As of December 31, 2003, there were 937,582 Class A Voting Shares and 18,844,625 Class B Limited Voting Shares issued and outstanding. Class A Voting Shares are convertible, at the option of the holder, at any time, into Class B Limited Voting Shares on a one-for-one basis. Class B Limited Voting Shares are convertible automatically upon the full or partial removal of foreign ownership restrictions within the Telecommunications Act, into Class A Voting Shares on a one-for-one basis to the extent not otherwise restricted by law, provided the conversion right is available on a pro rata basis to all holders of Class B Limited Voting Shares in the case of partial removal. The Class B Limited Voting Shares are also exchangeable for Class A Voting Shares on a one-for-one basis, at the option of the holder, if the holder submits a Canadian residency declaration and in certain other limited circumstances.

At December 31, 2003, there were 572,220 stock options outstanding. Each option is exercisable into one share of Allstream at a price no less than the closing price of the Shares on the day immediately preceding the grant date and generally vest over three years. Upon exercise, the holder of an option who is a Canadian will receive Class A Voting Shares; otherwise, the holder of the option will receive Class B Limited Voting Shares.

Allstream Inc. 2003 Annual Report 25

Quarterly financial information

		2003
(In thousands of dollars, except per share amounts) (unaudited) Quarters ended		March 31		* * *	June 30		September 30		December 31
		(Predecessor)		*	(Successor)		(Successor)		(Successor)
Revenue:
	Data	$	112,256	*	$	105,528	$	101,317	$	100,600
	Local		56,912	*		43,636		53,182		52,249
	Internet and IT services		46,179	*		57,475		42,477		41,823
	Other		4,111	*		5,376		2,387		2,526

		$	219,458	*	$	212,015	$	199,363	$	197,198
	Long Distance		133,867	*		124,567		109,908		104,745

Total Revenue		$	353,325	*	$	336,582	$	309,271	$	301,943

Service Costs		$	216,061	*	$	195,663	$	169,946	$	163,548
Gross Margin		$	137,264	*	$	140,919	$	139,325	$	138,395
Gross Margin %			38.8%	*		41.9%		45.0%		45.8%
Selling, General and Administrative Costs ("SG&A")		$	70,970	*	$	71,817	$	73,210	$	85,848
Net Income (loss) from operations		$	36,491	*	$	41,233	$	39,747	$	29,291
Net Income (Loss)		$	229,804	*	$	24,382	$	24,087	$	17,093
Basic earnings (loss) per Share		$	2.14	*	$	1.23	$	1.22	$	0.86
Diluted earnings (loss) per Share		$	2.14	*	$	1.23	$	1.21	$	0.85
Total Assets		$	1,647,183	*	$	1,005,466	$	1,028,724	$	1,067,342
Total Long-term Liabilities		$	162,677	*	$	173,985	$	167,956	$	164,375

Supplementary financial information

		2003
(In thousands of dollars, except per share amounts) (unaudited) Quarters ended		March 31			* * *	June 30			September 30			December 31
		(Predecessor)			*	(Successor)			(Successor)			(Successor)
Income (loss) from operations		$	36,491		*	$	41,233		$	39,747		$	29,291
Add:
	Depreciation and amortization		41,625		*		27,869			26,368			23,256
	Workforce reduction costs and provision for restructuring		(11,822	)	*		—			—			—

EBITDA		$	66,294		*	$	69,102		$	66,115		$	52,547

Net Cash generated by (used in) operating activities		$	21,659		*	$	94,030		$	74,601		$	57,845
Add/(Subtract):
	Changes in non-cash working capital		(32,452	)	*		(21,288	)		(3,006	)		661
	Addition to property, plant and equipment		(33,227	)	*		(15,794	)		(22,483	)		(21,384	)

Free cash flow		$	(44,020	)	*	$	56,948		$	49,112		$	37,122

Net income for the three months ended March 31, 2003 of the Predecessor was $229,804 and is primarily the result of foreign exchange gains of $324,076 partially offset by interest expense of $104,566 on the Company's U.S. denominated public debt.

26 Allstream Inc. 2003 Annual Report

Quarterly financial information

		2002
(In thousands of dollars, except per share amounts) (unaudited) Quarters ended		2002
		March 31			June 30			September 30			December 31
		(Predecessor)			(Predecessor)			(Predecessor)			(Predecessor)
Revenue:
	Data	$	115,568		$	119,459		$	110,229		$	112,706
	Local		59,669			59,708			58,242			57,477
	Internet and IT services		48,980			50,210			47,509			48,900
	Other		5,313			8,508			7,620			5,252

		$	229,530		$	237,885		$	223,600		$	224,335
	Long Distance		154,300			146,972			136,261			135,262

Total Revenue		$	383,830		$	384,857		$	359,861		$	359,597

Service Costs		$	255,169		$	251,056		$	223,003		$	202,721
Gross Margin		$	128,661		$	133,801		$	136,858		$	156,876
Gross Margin %			33.5%			34.8%			38.0%			43.6%
Selling, General and Administrative Costs ("SG&A")		$	90,636		$	83,318		$	82,578		$	76,471
Net Income (loss) from operations		$	(53,001	)	$	(1,314,346	)	$	7,605		$	19,527
Net Loss		$	(157,619	)	$	(1,353,431	)	$	(256,839	)	$	(63,769	)
Basic loss per common share		$	(1.57	)	$	(13.45	)	$	(2.54	)	$	(0.60	)
Diluted loss per common share		$	(1.57	)	$	(13.45	)	$	(2.54	)	$	(0.60	)
Total Assets		$	1,672,045		$	1,735,068		$	1,672,045		$	1,687,700
Total Long-term Liabilities		$	4,589,065		$	4,707,298		$	194,441		$	170,765

Supplementary financial information

		2002
(In thousands of dollars, except per share amounts) (unaudited) Quarters ended		2002
		March 31			June 30			September 30			December 31
		(Predecessor)			(Predecessor)			(Predecessor)			(Predecessor)
Income (loss) from operations		$	(53,001	)	$	(1,314,346	)	$	7,605		$	19,527
Add:
	Depreciation and amortization		91,026			91,074			46,675			44,367
	Write-down of property, plant and equipment and goodwill		—			1,203,196			—			—
	Workforce reduction costs and provision for restructuring		—			70,558			—			16,511

EBITDA		$	38,025		$	50,482		$	54,280		$	80,405

Net Cash generated by (used in) operating activities		$	(182,782	)	$	6,434		$	(26,644	)	$	19,676
Add/(Subtract):
	Changes in non-cash working capital		156,783			(30,721	)		9,497			(42,509	)
	Addition to property, plant and equipment		(54,843	)		(19,265	)		(10,844	)		(22,422	)

Free cash flow		$	(80,842	)	$	(43,552	)	$	(27,991	)	$	(45,255	)

Allstream Inc. 2003 Annual Report 27

report of management

The accompanying consolidated financial statements are the responsibility of management. They have been prepared by management in accordance with generally accepted accounting principles, using management's best judgments and estimates, where appropriate. Management is responsible for the integrity, objectivity and reliability of the consolidated financial statements including the notes thereto, and other financial information contained in this report. Financial information used elsewhere in the annual report is consistent with that in the consolidated financial statements.

Management is also responsible for maintaining a system of internal control designed to provide reasonable assurance that assets are safeguarded and that accounting systems provide timely, accurate and reliable financial information. Management believes that the system of internal controls provides reasonable assurance that the financial records are adequate and can be relied upon for the preparation of financial statements in conformity with generally accepted accounting principles and that access to assets occurs only in accordance with management's authorizations.

The Board of Directors is responsible for ensuring that management fulfills its responsibilities for financial reporting and internal controls. The Board exercises these responsibilities through its Audit Committee whose members are all independent of management and are not involved in the daily activities of the Company. The Audit Committee meets at least quarterly with management and its internal and external auditors, to satisfy itself that management's responsibilities are properly discharged and to review and report to the Board with respect to auditing, internal controls, and the consolidated financial statements. The internal and external auditors have free and independent access to the Audit Committee.

The consolidated financial statements have been reviewed and approved by the Board and have been audited by KPMG LLP, whose report is presented herein.

/s/ JOHN T. MCLENNAN

John T. McLennan
Vice Chairman and Chief Executive Officer

/s/ JOHN A. MACDONALD

John A. MacDonald
President and
Chief Operating Officer

/s/ DAVID A. LAZZARATO

David A. Lazzarato
Executive Vice President
and Chief Financial Officer

28 Allstream Inc. 2003 Annual Report

auditors' report to the shareholders

We have audited the consolidated balance sheet of Allstream Inc. (formerly AT&T Canada Inc.) as at December 31, 2003 and the consolidated statements of operations, shareholders' equity and cash flows for the period from April 1, 2003 to December 31, 2003. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit.

We conducted our audit in accordance with Canadian generally accepted auditing standards. Those standards require that we plan and perform an audit to obtain reasonable assurance whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.

In our opinion, these consolidated financial statements present fairly, in all material respects, the financial position of the Company as at December 31, 2003 and the results of its operations and its cash flows for the period then ended in accordance with Canadian generally accepted accounting principles.

/s/ KPMG LLP

Chartered Accountants
Toronto, Canada
January 30, 2004

Allstream Inc. 2003 Annual Report 29

consolidated balance sheet

(In thousands of Canadian dollars)
December 31, 2003

Assets
Current assets:
	Cash and cash equivalents (note 4)		$	345,734
	Accounts receivable			120,598
	Other current assets			28,401

				494,733
Property, plant and equipment (note 5)				543,354
Long-term investments (note 6)				5,709
Other assets (note 7)				20,546

			$	1,064,342

Liabilities and Shareholders' Equity
Current liabilities:
	Accounts payable (note 8)		$	39,519
	Accrued liabilities (note 8)			163,845
	Dividends payable (note 12(b))			69,385
	Income taxes payable			104
	Current portion of capital lease obligations (note 9)			5,222

				278,075
Long-term portion of capital lease obligations (note 9)				15,618
Other long-term liabilities (note 10)				50,991
Accrued pension liability (note 11)				95,766
Shareholders' equity:
	Share capital:
		Class A Voting Shares and Class B Limited Voting Shares (note 12)		581,000
	Contributed surplus (note 15)			46,715
	Deficit			(3,823	)

				623,892

			$	1,064,342

Basis of presentation (note 1)
Reconciliation to accounting principles generally accepted in United States (note 21)
Commitments and contingencies (note 22)

See accompanying notes to consolidated financial statements.

On behalf of the Board:

/s/ PURDY CRAWFORD

Purdy Crawford
Director

/s/ JANE MOWAT

Jane Mowat
Director

30 Allstream Inc. 2003 Annual Report

consolidated statement of operations

(In thousands of Canadian dollars, except per share amounts)
Period from April 1, 2003 to December 31, 2003

Revenue		$	947,796
Expenses:
	Service costs		529,157
	Selling, general and administration		230,875
	Depreciation		77,493

			837,525

Income from operations			110,271
Other income (expense):
	Interest income		6,705
	Interest expense		(3,656	)
	Other (note 3)		430

			3,479

Income before income taxes			113,750
Income taxes (note 15)			48,188

Net income		$	65,562

Earnings per share:
	Basic	$	3.31
	Diluted		3.29

Weighted average number of shares outstanding (in thousands) (note 14):
	Basic		19,782
	Diluted		19,951

See accompanying notes to consolidated financial statements.

Allstream Inc. 2003 Annual Report 31

consolidated statement of shareholders' equity

(In thousands of Canadian dollars)
Period from April 1, 2003 to December 31, 2003

			Common shares outstanding
			Number (000's)
			Number (000's)							Accumulated deficit			Contributed surplus
			Class A		Class B		Total	Amount		Accumulated deficit			Contributed surplus		Total
Balance, beginning of period (note 12):
	Issuance of Class A
		Voting Shares and
		Class B Limited
		Voting Shares	1,043		18,715		19,758	$	581,000	$	—		$	—	$	581,000
	Class B Limited Voting
		Shares released from escrow account upon settlement of disputed claims (note 12(c))	—		24		24		—		—			—		—

			1,043		18,739		19,782		581,000		—			—		581,000
Class A Voting Shares converted to Class B Limited Voting Shares			(345	)	345		—		—		—			—		—
Class B Limited Voting
	Shares converted to
	Class A Voting Shares		240		(240	)	—		—		—			—		—
Net income			—		—		—		—		65,562			—		65,562
Dividends declared (note 12(b))			—		—		—		—		(69,385	)		—		(69,385	)
Recognition of benefit of tax loss carryforwards (note 15)			—		—		—		—		—			46,715		46,715

Balance, end of period			938		18,844		19,782	$	581,000	$	(3,823	)	$	46,715	$	623,892

See accompanying notes to consolidated financial statements.

32 Allstream Inc. 2003 Annual Report

consolidated statement of cash flows

(In thousands of Canadian dollars)
Period from April 1, 2003 to December 31, 2003

Cash provided by (used in):
Operating activities:
	Net income		$	65,562
	Adjustments required to reconcile net income to cash flows from operating activities:
		Depreciation		77,493
		Accretion of interest and amortization of fair value decrements		369
		Stock-based compensation expense (note 13)		4,413
		Benefit of tax loss carryforwards (note 15)		46,715
		Pension charge		8,169
		Gain on sale of investments		(430	)
		Other		(481	)

				201,810
Change in non-cash working capital (note 19)				23,131

Net cash provided by operating activities				224,941
Financing activities:
	Payment of capital lease obligations			(1,150	)
	Decrease in other long-term liabilities			(55	)

	Net cash used in financing activities			(1,205	)
Investing activities:
	Proceeds from dispositions of investments (note 3)			8,037
	Additions to property, plant and equipment			(60,911	)
	Proceeds from sale of assets			2,550
	Long-term investment (note 6)			(100	)
	Additions to other assets			(4,525	)

	Net cash used in investing activities			(54,949	)
Effect of exchange rate changes on cash				365

Increase in cash and cash equivalents				169,152
Cash and cash equivalents, beginning of period				176,582

Cash and cash equivalents, end of period			$	345,734

Supplemental cash flow information (note 20)

See accompanying notes to consolidated financial statements.

Allstream Inc. 2003 Annual Report 33

notes to consolidated financial statements

(Tabular amounts in thousands of Canadian dollars, except per share amounts)
Period from April 1, 2003 to December 31, 2003

Allstream Inc. (the "Company") is a communication solutions provider with a portfolio of Connectivity, Infrastructure Management and IT Services.

1. Basis of presentation:

On October 15, 2002, AT&T Canada Inc. (the "Predecessor") and certain of its subsidiaries, namely AT&T Canada Corp., AT&T Canada Telecom Services Company, AT&T Canada Fibre Company, MetroNet Fiber U.S. Inc., MetroNet Fiber Washington Inc. and Netcom Canada Inc. (collectively, the "AT&T Canada Companies"), voluntarily filed an application for creditor protection under the Companies' Creditors Arrangement Act (Canada) ("CCAA") with the Ontario Superior Court of Justice, Toronto, Ontario, Canada (the "Court") and obtained an order from the Bankruptcy Court in the Southern District of New York (the "U.S. Court") under Section 304 of the U.S. Bankruptcy Code to recognize the CCAA proceedings in the United States.

As part of the CCAA proceedings, the Predecessor formulated a consolidated Plan of Arrangement and Reorganization (the "Plan"). The purpose of the Plan was to restructure the balance sheet and equity of the AT&T Canada Companies, provide for the compromise, settlement and payment of liabilities of certain creditors of the AT&T Canada Companies (the "Affected Creditors"), to simplify the operating corporate structure of the AT&T Canada Companies and create a new entity New AT&T Canada Inc. (now Allstream Inc.).

The Affected Creditors approved the Plan and the Predecessor implemented the Plan and emerged from the CCAA on April 1, 2003. Pursuant to the Plan, a new parent company ("New AT&T Canada Inc.") was incorporated under the Canada Business Corporations Act (the "CBCA") and pursuant to Articles of Reorganization dated April 1, 2003 (the "Articles of Reorganization") became the sole shareholder of the Predecessor.

Pursuant to the Plan, there was a substantial realignment in the equity interests and capital structure of the Predecessor. The reorganization and opening balance sheet of the Company as at April 1, 2003 has been accounted for under the provisions of The Canadian Institute of Chartered Accountants' ("CICA") Handbook Section ("HB") 1625, Comprehensive Revaluation of Assets and Liabilities ("fresh start accounting").

In conjunction with the Plan, the Predecessor was required to estimate its post-emergence enterprise value ("Equity Value"). The Equity Value was determined with the assistance of independent financial advisors, utilizing three different valuation methodologies that were based upon the cash flow projections and business plan for the Company as contemplated by the Predecessor. The methodologies incorporated discounted cash flow techniques, a comparison of the Company and its projected performance to market values of comparable companies, and a comparison of the Company and its projected performance to values of past transactions involving comparable entities. The cash flow valuation utilized five-year cash flow projections with a terminal value multiple of projected 2007 projected earnings before interest, taxes, depreciation and amortization ("EBITDA"). The cash flow projections were net present valued using a debt free weighted average cost of capital range of 12.5% to 17.5%. The methodologies employed estimated a range of Equity Value between $531.3 million and $631.3 million. The Affected Creditors and the Court approved the establishment of the Equity Value at $581 million.

All assets and liabilities were revalued at estimated fair values and the deficit was eliminated by a reduction of shareholders' surplus on reorganization.

The consolidated financial statements of the Company issued subsequent to the Plan implementation are not comparable with the consolidated financial statements issued by the Predecessor prior to the Plan implementation.

34 Allstream Inc. 2003 Annual Report

The following table summarizes the adjustments from implementation of the Plan and the adoption of fresh start accounting:

			Adjustments
			Balance prior to Plan implementation, March 31, 2003			The Plan			Fresh start accounting^(vii)			Balance after Plan implementation, April 1, 2003
Assets
Current assets:
	Cash and cash equivalents		$	175,230		$	—		$	1,352		$	176,582
	Cash held in escrow			233,022			(233,022	)⁽ⁱ⁾		—			—

	Cash and cash equivalents			408,252			(233,022	)		1,352			176,582
	Accounts receivable			153,994			—			(3,171	)		150,823
	Other current assets			28,695			—			78			28,773

				590,941			(233,022	)		(1,741	)		356,178
Property, plant and equipment				927,072			—			(383,849	)		543,223
Intangible assets				6,410			—			(870	)		5,540
Deferred pension asset				67,437			—			(67,437	)		—
Long-term investments				2,120			—			(1,411	)		709
Other assets				53,203			(37,381	)⁽ⁱⁱ⁾		(2,129	)		13,693

			$	1,647,183		$	(270,403	)	$	(457,437	)	$	919,343

Liabilities and Shareholders' Equity (Deficiency)
Current liabilities:
	Liabilities not subject to compromise:
		Accounts payable	$	31,326		$	—		$	(2,011	)	$	29,315
		Accrued liabilities		184,388			(29,834	)^(iv)		(35,584	)		118,970
		Income taxes payable		472			—			—			472
		Current portion of capital lease obligations		4,255			—			—			4,255
	Liabilities subject to compromise			4,528,426			157,895	⁽ⁱⁱⁱ⁾
							(4,686,321	)⁽ⁱ⁾		—			—

				4,748,867			(4,558,260	)		(37,595	)		153,012
Long-term portion of capital lease obligations				16,602			—			—			16,602
Accrued pension liability				—			—			120,176			120,176
Other long-term liabilities				46,917			—			1,636			48,553
Deferred foreign exchange				99,158			(99,158	)^(iv)		—			—
Shareholders' equity (deficiency):
	Old common shares			1,393,844			(1,393,844	)^(v)		—			—
	New Class A Voting and Class B Limited Voting Shares			—			581,000	⁽ⁱ⁾		—			581,000
	Warrants			496			(496	)^(v)		—			—
	Deficit			(4,658,701	)		5,200,355	^(vi)		(541,654	)		—

				(3,264,361	)		4,387,015			(541,654	)		581,000

			$	1,647,183		$	(270,403	)	$	(457,437	)	$	919,343

Allstream Inc. 2003 Annual Report 35

Summary of adjustments:

Plan adjustments:

(i): In accordance with the provisions of the Plan, each Affected Creditor received a pro rata share of the cash distribution of $233 million and 100% of the equity of Allstream, consisting of Class A Voting Shares and Class B Limited Voting Shares in exchange for the claims of the Affected Creditors.
(ii): Reflects elimination on settlement of the unamortized balance of debt issuance costs related to the Senior Notes.
(iii): Reflects the reversal of accrued interest and the foreign exchange translation impact on the Senior Notes from October 15, 2002 to March 31, 2003. The CCAA proceedings did not allow for principal and interest payments to be made on Senior Notes without Court approval or until the Plan was implemented. Accordingly, while the Predecessor continued to accrue for interest expense on the Senior Notes until March 31, 2003, no interest or penalties accrued on the claims of the Affected Creditors from and after October 15, 2002. The interest accrued by the Predecessor was reversed on the implementation of the Plan on April 1, 2003.
(iv): Reflects elimination on settlement of deferred gains on foreign currency derivative contracts related to the Senior Notes.
(v): Under the Plan, the existing Class A Voting Shares, Class B Non-Voting Shares and Preferred Shares of the Predecessor and all issued and outstanding warrants and options were cancelled without payment or consideration.
(vi): The net effect of adjustments (i) to (v) was an increase to shareholders' equity (deficiency) of $5.2 billion.

Fresh start adjustments:

(vii): Under fresh start accounting, all assets and liabilities were revalued at estimated fair values and the Company's surplus was eliminated. The carrying amounts of accounts receivable, accounts payable and accrued liabilities approximated fair value given their short term to maturity after adjustments for changes in estimates relating to resolution of contingencies, including legal claims, customer disputes and supplier contract negotiations. Other long-term liabilities, representing rights-of-way and network access contracts, were fair-valued based upon current market rates for such contracts. The fair value of the pension liability was determined by an independent actuary. The fair value of property, plant and equipment was calculated as the excess of the Equity Value and fair value of the liabilities over the fair value of the remaining assets. The Company hired an independent valuation expert to assist management in determining that the fair value of property, plant and equipment was not lower than the excess calculated above.

2. Significant accounting policies:

The accompanying consolidated financial statements are prepared in accordance with accounting principles generally accepted in Canada which, in the case of the Company, conform, in all material respects, with those in the United States, except as outlined in note 21.

The consolidated financial statements include all assets and liabilities of the Company and its majority-owned subsidiaries. The principal subsidiaries of the Company include Allstream Limited, Allstream Corp. and Allstream Fiber U.S., Inc. All intercompany transactions and balances have been eliminated on consolidation.

The Company's significant accounting policies are as follows:

(a): Cash and cash equivalents:

Cash equivalents consist of investments in money market instruments with a maturity at the date of purchase of less than three months. Cash and cash equivalents are recorded at cost, which approximates current market value.

36 Allstream Inc. 2003 Annual Report

(b): Revenue recognition:

The Company derives its revenue primarily from data, local, Internet and information technology services and long-distance products and services. Products and services are sold either stand-alone or together as a multiple service arrangement or a bundled solution. Components of multiple service arrangements are separately accounted for provided the elements have stand-alone value to the customer and the fair value of any undelivered elements can be objectively and reliably determined. The Company recognizes revenue once persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, fees are fixed or determinable and collectability is reasonably assured. Estimated sales rebates are recorded as a reduction of revenue in the period incurred.

Revenue on long-distance and other usage-based products and services is recognized based upon minutes of traffic carried. Revenue on local, data, internet, IT services and other products and services is recognized as the services are provided in accordance with contract terms, including any customer acceptance provisions. Revenue from technical support and maintenance is recognized over the term of the contract, during which the services are provided.

The Company has certain indefeasible rights-of-use agreements ("IRUs") pursuant to which the Company leases fibre and infrastructure to other telecommunication service providers. Upfront payments are deferred and recognized over the terms of the agreements, unless the criteria for sales-type leasing accounting are met.

(c): Property, plant and equipment:

Property, plant and equipment as of April 1, 2003 are recorded under the provisions of fresh start accounting as described in note 1(vii). Property, plant and equipment additions after April 1, 2003 are recorded at cost. Included in telecommunications facilities and equipment are costs incurred in developing new networks or expanding existing networks, such as costs of acquiring rights-of-way and network design. Construction costs related to telecommunications facilities and equipment that are installed on rights-of-way granted by others are capitalized and depreciated over the lives of the rights-of-way. Direct labour costs incurred to develop or construct network assets and internal-use software are capitalized. A portion of indirect labour and overhead costs incurred for the development of network assets is also capitalized. Interest on debt incurred to acquire property, plant and equipment is capitalized on assets under construction for more than three months at the Company's weighted average cost of debt. Telecommunications facilities and equipment are depreciated once the network is put in service.

Depreciation is computed using the straight-line method over the estimated useful lives of the assets as follows:

Telecommunications facilities and equipment		3 - 20 years
Buildings		13 - 40 years
Other property, plant and equipment		4 - 40 years
Equipment under capital leases		3 - 15 years
Application software		1 - 7 years
Leasehold improvements		Term of lease

Property, plant and equipment associated with the Company's network is subject to technological risks and market changes due to new products and services and changing customer demands. These changes may result in changes to the estimated useful lives of these assets.

Allstream Inc. 2003 Annual Report 37

(d): Impairment of long-lived assets:

The carrying amount of long-lived assets to be held and used is reviewed for impairment on an ongoing basis whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. An impairment is recognized when the carrying amount of an asset to be held and used exceeds the projected undiscounted future net cash flows expected from its use and disposal, and is measured as the amount by which the carrying amount of the asset exceeds its fair value.

(e): Foreign currency translation:

Foreign currency-denominated monetary items are translated into Canadian dollars at the exchange rates prevailing at the balance sheet date. Foreign currency-denominated non-monetary items are translated at the historical exchange rates. Transactions included in operations are translated at the average exchange rates for the period. Translation gains or losses are reflected in the consolidated statement of operations in the period in which they occur.

(f): Long-term investments:

The Company accounts for investments in which it exercises significant influence using the equity method. Other investments are accounted for at cost. The investments are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable, and a provision for loss in value is recorded when a decline in value below the carrying amount is considered to be other than temporary.

(g)

Employee benefit plans:

(i): Retirement benefits:

The Company recognizes the costs of retirement benefits and post-employment benefits over the period in which employees render services in return for the benefits. The costs of defined benefit pensions and other retirement benefits earned by employees are actuarially determined using the projected benefit method prorated on credited service and management's best estimate of expected plan investment performance, salary escalation and retirement ages of employees. Changes in these assumptions could impact future pension expense. For the purpose of calculating the expected return on plan assets, those assets are valued using a market-related value. Past service costs from plan amendments are amortized on a straight-line basis over the average remaining service period of employees active at the date of amendment, except for amendments to the post-retirement medical and dental benefits programs. The average remaining life expectancy of former employees is used for the post-retirement medical and dental benefits programs as no new members are allowed to join these plans. The excess of the cumulative unrecognized net gains (loss) over 10% of the greater of the benefit obligation and the market-related value of plan assets at the beginning of the year is amortized over the average remaining service period of active employees, except for the post-retirement medical and dental benefits programs where the average remaining life expectancy of former employees is used in the determination of the amortization period.

When the restructuring of a benefit plan gives rise to both a curtailment and a settlement of obligations, the curtailment is accounted for prior to the settlement.

38 Allstream Inc. 2003 Annual Report

(ii): Stock-based compensation:

The Company accounts for stock-based compensation in accordance with HB 3870, Stock-based Compensation and Other Stock-based Payments, which requires that a fair value-based method of accounting be applied to all stock-based payments to non-employees and to employee awards that are direct awards of stock, awards that call for settlement in cash or other assets, or are stock appreciation rights that call for settlement by the issuance of equity instruments.

HB 3870 permits the Company to treat employee stock options as capital transactions (the settlement method) until January 1, 2004. Effective on this date, the standard requires that all stock-based compensation payments to both employees and non-employees be accounted for using the fair value method. The Company will apply the new standard retroactively without restatement of prior periods. Consequently, opening deficit as at January 1, 2004 will be increased to reflect the expensing of the fair value of $3.1 million for awards granted on or after April 1, 2003.

Risk-free interest rate (%)		3.43
Expected volatility (%)		90.35
Expected life (in years)		4
Expected dividends		—

The Black-Scholes option pricing model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. Option pricing models require estimates, which are highly subjective, including expected volatility of the underlying stock. The Company currently estimates its volatility based on the historical share price volatility of comparable companies over the same period as the expected life of the option, as the Company does not have sufficient trading history itself. Changes in assumptions can materially affect estimates of fair values.

Allstream Inc. 2003 Annual Report 39

The pro forma impact on net income and earnings per share if the Company had accounted for employee stock options under the fair value method is as follows for the period:

Net income (as reported)			$	65,562
Stock-based compensation expense				(3,128	)

Net income (pro forma)			$	62,434

Pro forma weighted average number of common shares outstanding (in thousands):
	Basic			19,782
	Diluted			19,782

Earnings per share:
	As reported:
		Basic	$	3.31
		Diluted		3.29
	Pro forma:
		Basic		3.16
		Diluted		3.16

Stock-based awards that are settled in cash or may be settled in cash at the option of employees or directors are recorded as liabilities. The measurement of the liability and compensation cost for these awards is based on the intrinsic value of the award, and is recorded into operating income over the vesting period of the award. Changes in the Company's payment obligation subsequent to vesting of the award and prior to the settlement date are recorded in operating income in the period incurred. The payment amount is established for Share Appreciation Rights ("SARs") on the date of exercise of the award by the employee; for Restricted Share Units ("RSUs"), the vesting date of the award; and for Deferred Share Units ("DSUs"), the later of the date of termination of employment or directorship.

The Company's contribution to the Employee Share Ownership Plan ("ESOP") is recorded as compensation expense in the period the obligation to contribute is incurred.

(h): Income taxes:

The Company uses the asset and liability method of accounting for income taxes. Future income tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. When necessary, a valuation allowance is recorded to reduce future income tax assets to an amount where realization is more likely than not. Future income tax assets and liabilities are measured using enacted or substantively enacted tax laws and rates in effect for the period in which those temporary differences are expected to be recovered or settled. The effect on future income tax assets and liabilities of a change in tax laws and rates is recognized as part of the provision for income taxes in the period that includes the enactment date (or the period in which the changes in rates are substantively enacted).

40 Allstream Inc. 2003 Annual Report

(i): Earnings per common share:

The Company uses the treasury stock method of calculating diluted earnings per share. The treasury stock method includes only those unexercised options where the average market price of the common shares during the period exceeds the exercise price of the options. In addition, this method assumes that the proceeds would be used to purchase common shares at the average market price during the period.

(j): Use of estimates:

The preparation of financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the period. Significant estimates are used in, but not limited to, determining the recoverability of long-lived assets, the estimated useful lives of property, plant and equipment, the valuation of accounts receivable, the measurement of income tax valuation allowances, pension and other post-retirement benefits, capitalized labour and overhead, stock-based compensation expense, the accruals for the cost of carrier services and the recording of lease exit costs. Actual results could differ from those estimates.

(k)

Recent pronouncements:

(i): Effective January 1, 2004, the Company will adopt retroactively with restatement, HB 3110, Asset Retirement Obligations. The Section establishes standards for the recognition, measurement and disclosure of liabilities for statutory, contractual or legal obligations, when incurred, associated with the retirement of property, plant and equipment when those obligations result from the acquisition, construction, development or normal operation of the assets. Retirement includes the sale, abandonment, recycling or other disposal of an asset but not its temporary idling. The obligations are measured initially at fair value (using the present value of future cash flows discounted at a credit-adjusted risk-free rate of interest) in the period in which it is incurred. Upon initial recognition of a liability for an asset retirement obligation, a corresponding asset retirement cost is added to the carrying amount of the related asset. Following the initial recognition of an asset retirement obligation, the carrying amount of the liability is increased for the passage of time and adjusted for revisions to the amount or timing of the underlying cash flows needed to settle the obligation. The cost is amortized into income subsequently on the same basis as the related asset. The new standards are consistent with U.S. GAAP requirements under Statement of Financial Accounting Standards ("SFAS") No. 143, except that SFAS No. 143 is effective for U.S. GAAP as of January 1, 2003 (note 21).
(ii): In December 2001, the CICA issued Accounting Guideline 13, Hedging Relationships ("AcG-13"). AcG-13 establishes new criteria for hedge accounting and will apply to all hedging relationships in effect for the Company's fiscal year commencing on January 1, 2004 under Canadian GAAP. To qualify for hedge accounting, consistent with U.S. GAAP, the hedging relationship must be appropriately documented at the inception of the hedge and there must be reasonable assurance, both at the inception and throughout the term of the hedge, that the hedging relationship will be effective. Effectiveness requires a high correlation of changes in fair values or cash flows between the hedged item and the hedge. The adoption of this standard is not expected to have an impact on the consolidated financial statements.
(iii): In June 2003, the CICA issued Accounting Guideline AcG-15, Consolidation of Variable Interest Entities "VIEs." VIEs are entities that have insufficient equity and/or their equity investors lack one or more specified essential characteristics of a controlling financial interest. The guideline provides specific guidance for determining when an entity is a VIE and who, if anyone, should consolidate the VIE. The guideline is effective on a prospective basis for the Company's 2005 fiscal year. The Company is currently assessing the impact of adoption of AcG-15.

Allstream Inc. 2003 Annual Report 41

(iv): In July 2003, the CICA issued HB 1100, Generally Accepted Accounting Principles ("GAAP"). This section establishes standards for financial reporting in accordance with Canadian GAAP. It describes what constitutes Canadian GAAP and its sources. This section also provides guidance on sources to consult when selecting accounting policies and determining appropriate disclosures when the primary sources of Canadian GAAP are silent. This standard is effective for the Company's 2004 fiscal year. The adoption of this standard is not expected to have a material impact on the consolidated financial statements.

3. Dispositions:

On July 2, 2003, the Company completed the previously announced sale of its subsidiaries, Contour Telecom Inc. and Argos Telecom Inc., to YAK Communications (Canada) Inc. for approximately $8.0 million in cash.

The disposition generated a gain on the sale of $0.4 million which was calculated as follows:

Proceeds from disposition		$	8,037
Less:
	Intangible assets		5,540
	Net assets, other than intangibles		1,700
	Disposition costs		367

			7,607

Gain on sale		$	430

4. Cash and cash equivalents:

Cash on deposit:
	Canadian dollar	$	13,080
	U.S. dollar		609
Short-term investments, at rates of interest varying between 0.87% and 2.84%:
	Canadian dollar		328,640
	U.S. dollar		3,405

		$	345,734

5. Property, plant and equipment:

	Cost		Accumulated depreciation		Net book value
Telecommunications facilities and equipment	$	433,413	$	36,762	$	396,651
Land		1,754		—		1,754
Buildings		34,989		1,756		33,233
Other property, plant and equipment		84,386		18,207		66,179
Equipment under capital leases		5,499		944		4,555
Application software		55,319		18,963		36,356
Leasehold improvements		5,487		861		4,626

	$	620,847	$	77,493	$	543,354

As of December 31, 2003, property, plant and equipment includes $15.5 million of property, plant and equipment under construction that is not in service and, accordingly, is not being depreciated.

42 Allstream Inc. 2003 Annual Report

6. Long-term investments:

Fixed Wireless Venture (a)	$	5,000
Other investments		709

	$	5,709

(a): The Company has entered into a venture with Inukshuk Internet Inc., a wholly owned subsidiary of Microcell Telecommunications Inc., and NR Communications, LLC to build a Multipoint Communications System network to offer high speed internet, IP-based voice and local networking services. The companies have signed a Unanimous Shareholders' Agreement ("Shareholders' Agreement") in which the companies agree to fund start-up activities to June 30, 2004. As part of the Shareholders' Agreement, the Company is obligated to contribute $5.0 million in cash and contributed services to fund start-up activities. As of December 31, 2003, the Company has contributed $100,000 of its obligation to the venture.

If all parties are in agreement to proceed on June 30, 2004, the parties will contribute a combination of cash, assets and services to the venture, representing a total value of $135 million. The Company's portion will be $45 million in aggregate, comprised of cash and contributed services.

7. Other assets:

Restricted cash	$	15,588
Other		4,958

	$	20,546

The restricted cash is held in trust and $14.0 million is held as further protection for the directors and officers of the Predecessor with respect to their potential personal liability for certain statutory liabilities. The restrictions will terminate upon the earlier of (i) December 31, 2008 and (ii) three years from the date of the last claim being conclusively resolved. The remaining $1.6 million represents cash segregated as collateral against outstanding letters of credit of the same amount. The cash remains restricted until the letters of credit are cancelled or expired.

8. Accounts payable and accrued liabilities:

Accrued liabilities and trade payables	$	104,324
Carrier costs		53,998
Commodity and other taxes		14,645
Personnel costs		10,772
Accrued pension contributions (note 11(b))		10,729
Provision for restructuring (note 16)		4,048
Other		4,848

	$	203,364

Allstream Inc. 2003 Annual Report 43

9. Capital lease obligations:

The following is a schedule, by year, of the future minimum lease payments for capital leases, together with the balance of the obligation, as at December 31, 2003:

2004	$	6,018
2005		1,879
2006		1,850
2007		1,850
2008		1,850
2009 and thereafter		16,650

Total minimum lease payments		30,097
Less imputed interest at rates varying from 7.5% to 11.3%		9,257

Balance of the obligations		20,840
Less current portion		5,222

	$	15,618

Interest expense on capital leases totaled $1.2 million for the period.

10. Other long-term liabilities:

Deferred revenue	$	13,065
Rights-of-way and network access contracts liability (note 1(vii))		12,450
Other post-retirement benefit obligations (note 11(b))		11,549
Provision for restructuring (note 16)		5,764
Liability for stock-based compensation (notes 13(a)(i) and 13(c))		4,413
Other		3,750

	$	50,991

11. Employee benefits:

(a): The Company's defined contribution plan expense for the period was $2.3 million.
(b): The Company's net benefit plan expense for the period is as follows:

	Pension benefit plans			Other benefit plans
Current service cost	$	5,360		$	120
Interest cost		25,588			563
Expected return on plan assets		(22,779	)		—

Net benefit plan expense	$	8,169		$	683

44 Allstream Inc. 2003 Annual Report

The average remaining service periods of the active employees covered by the pension plans range from 11 to 14 years.

The average remaining service period of the active employees covered by the post-retirement life insurance program is 13 years.

The average remaining life expectancy of the former employees covered by the post-retirement medical and dental insurance programs is 15 years.

Information about the Company's defined benefit and other retirement benefit plans as at December 31, 2003, in aggregate, is as follows:

		Pension benefit plans			Other benefit plans
Accrued benefit obligation:
	Balance, beginning of period	$	520,285		$	11,420
	Interest cost		25,588			563
	Actuarial loss		48,081			941
	Current service cost		5,360			120
	Employees' contributions		1,899			—
	Benefits paid		(30,805	)		(554	)

Balance, end of period		$	570,408		$	12,490

		Pension benefit plans			Other benefit plans
Plan assets:
	Fair value, beginning of period	$	400,109		$	—
	Actual return on plan assets		81,574			—
	Employer contributions		21,850			—
	Accrued employer contributions		10,729			—
	Employees' contributions		1,899			554
	Benefits paid		(30,805	)		(554	)

Fair value, end of period		$	485,356		$	—

Funded status — plan deficit		$	(85,052	)	$	(12,490	)
Unrecognized actuarial loss (gain)			(10,714	)		941

Accrued benefit liability		$	(95,766	)	$	(11,549	)

The accrued benefit liability for other benefit plans is included in other long-term liabilities (note 10).

The significant actuarial assumptions adopted in measuring the Company's accrued benefit obligations are as follows (weighted average assumptions as of December 31, 2003):

	Pension benefit plans	Other benefit plans
Discount rate	6.00%	6.00%
Expected long-term rate of return on plan assets	7.50%	—
Rate of compensation increase	3.50%	—

(c): Funding commitment:

At December 31, 2003, the Company had unfunded solvency deficits under its defined benefit pension plans of approximately $101.8 million. The Company is required to fund this deficit over the next four years.

Allstream Inc. 2003 Annual Report 45

12. Share capital:

(a): Authorized:

The Company's authorized capital consists of an unlimited number of Class A Voting Shares and Class B Limited Voting Shares (collectively, the "Shares"). The two classes of Shares were created to ensure compliance with the foreign ownership restrictions in the Telecommunications Act (Canada) (the "Telecommunications Act") and the regulations thereunder. Class A Voting Shares participate equally with the Class B Limited Voting Shares with respect to the declaration of any dividends or distributions if, as and when declared by the board. Holders of Class A Voting Shares are entitled to receive the remaining assets of the Company on its winding-up or dissolution in equal amounts, share for share, with the holders of Class B Limited Voting Shares.

Class A Voting Shares:

Class A Voting Shares are convertible, at the option of the holder, at any time, into Class B Limited Voting Shares on a one-for-one basis. To ensure compliance with the foreign ownership restrictions contained in the Telecommunications Act and the regulations thereunder, for so long as those restrictions pertain, the directors of the Company shall have the right to sell the Class A Voting Shares of a holder thereof who is not a Canadian (as such term is defined in the Telecommunications Act), subject to the provisions of the CBCA and the Telecommunications Act. Holders of Class A Voting Shares are entitled to receive notice of and attend to vote at all meetings of the shareholders of the Company, except at a meeting at which holders of a specified class or series (other than the Class A Voting Shares) are entitled to vote separately as a class as provided in the CBCA or the Articles of the Company. Holders of Class A Voting Shares are entitled to elect five of the nine members to the board, subject to increase in accordance with the Company's Articles, commencing at such time as holders of the Class B Limited Voting Shares hold less than 50% of the Company's outstanding equity.

Class B Limited Voting Shares:

Class B Limited Voting Shares are convertible automatically upon the full or partial removal of foreign ownership restrictions within the Telecommunications Act, into Class A Voting Shares on a one-for-one basis to the extent not otherwise restricted by law, provided the conversion right is available on a pro rata basis to all holders of Class B Limited Voting Shares in the case of a partial removal. The Class B Limited Voting Shares may also be exchanged for Class A Voting Shares on a one-for-one basis, at the option of the holder in certain other limited circumstances, if the holder submits a Canadian residency declaration.

Holders of Class B Limited Voting Shares are entitled to elect four of the nine members of the board, subject to reduction in accordance with the Company's Articles commencing at such time as the holders of the Class B Limited Voting Shares hold less than 50% of the Company's outstanding equity. The number of directors elected by holders of Class B Limited Voting Shares will be reduced in accordance with the percentage of total equity held by holders of Class B Limited Voting Shares in accordance with the Articles and the holders of the Class A Voting Shares will correspondingly acquire the entitlement to elect additional directors. Class B Limited Voting Shares are entitled to vote as a separate class in limited circumstances as described in the Articles or where required by the CBCA.

Shareholder Rights Plan:

The Company has established a Shareholder Rights Plan (the "Rights Plan") to ensure, to the extent possible, that all shareholders will be treated equally and fairly in connection with any take-over offer for the Company. The Rights Plan is triggered when a person acquires beneficial ownership of a minimum of either (i) 10% of the outstanding Class A Voting Shares (or such higher amount as may be determined by the Board of Directors, provided such amount does not exceed 20% of the outstanding Class A Voting Shares), or (ii) 20% of the aggregate outstanding Shares, other than under certain conditions. The initial lower threshold for bids for Class A Voting Shares recognizes the restriction on non-Canadian holders acquiring additional Class A Voting Shares due to ownership restrictions under the Telecommunications Act.

46 Allstream Inc. 2003 Annual Report

The Rights Plan is designed to encourage any potential acquirer to negotiate directly with the Company's Board of Directors, to provide increased assurance that a potential acquirer would pay an appropriate control premium in connection with any acquisition of the Company, for the benefit of all shareholders.

(b): On December 9, 2003, the Company's Board of Directors declared a special dividend of $3.50 per share on the issued and outstanding Class A Voting Shares and Class B Limited Voting Shares. This special dividend was paid on January 6, 2004 to holders of record at the close of business on December 19, 2003. The total dividend paid was $69.4 million.
(c): Shares held in escrow:

As described in note 1(i), in accordance with the provisions of the Plan, each Affected Creditor was to receive a pro rata share of the cash distribution of $233 million and 100% of the equity of the Company. If an Affected Creditor disputed the claim amount for distribution purposes at the Plan Implementation Date, the Company issued the number of Class B Limited Voting Shares and transferred the amount of cash that the Affected Creditor would have otherwise received into an escrow account with the transfer agent pending final adjudication or settlement of the dispute. Upon settlement of the dispute, any shares not distributed to the Affected Creditor are returned by the transfer agent to the Company for cancellation and deemed not to have been issued as at the Plan Implementation Date. Any cash not distributed to the Affected Creditors upon settlement of the disputed claim will be redistributed pro rata to all Affected Creditors.

During the period, 241,000 Class B Limited Voting Shares were issued to the escrow account. Upon settlement of disputed claims, as described above, 24,000 of such shares were released from the escrow account, and 176,000 shares were cancelled. As of December 31, 2003, 41,000 Class B Limited Voting Shares remain in escrow.

13. Stock-based compensation plans:

(a): Management Incentive Plan:

The Company has established and the board administers, a Management Incentive Plan permitting the grant of RSUs, SARs, stock options ("Options"), and other share-based awards to management employees of the Company. An aggregate of 2,000,000 Shares have been reserved for issuance under the Management Incentive Plan.

RSUs, SARs and Options granted under the Management Incentive Plan are non-assignable, except as provided therein and SARs and Options expire not later than 10 years from the date of grant.

(i): Restricted Share Units:

Under the Management Incentive Plan, certain employees may receive an award in the form of an RSU, which generally vest at the end of three years. Stock-based compensation, representing the underlying value of the award, is recognized on a straight-line basis over the three-year vesting period, at which time, the RSUs are settled by the delivery of shares to the participant or, at the participant's option, the delivery of the cash equivalent market value of the shares determined by the average closing price of the shares for the five trading days immediately prior to the date of vesting. As at December 31, 2003, there were 229,244 RSUs awarded and outstanding, of which 144 RSUs were vested. Compensation expense recorded during the period for RSUs totalled $4.1 million and is recorded in selling, general and administration expenses.

Allstream Inc. 2003 Annual Report 47

(ii): Share Appreciation Rights:

SARs grants are settled by the delivery of a cash payment equal to the difference between the fair market value of the underlying shares upon exercise and the fair value at the date of grant, multiplied by the number of shares upon which a SAR is based. The board, at its discretion, may elect to have the Company deliver the underlying shares, cash or a combination of underlying shares and cash. SARs granted in conjunction with the granting of Options have the same terms for vesting as the Options to which they relate. Otherwise, each SAR grant vests as to one-third each on the date of grant, and on the first and second anniversaries of the date of grant. SAR grants are exercisable over a maximum 10-year term. As at December 31, 2003, there are no SARs awarded and outstanding.

(iii): Stock options:

The number of shares reserved for issuance in the aggregate to any one eligible person pursuant to the Management Incentive Plan shall not exceed 5% of the aggregate outstanding Shares. Each Option is exercisable into one Class A Voting Share or Class B Limited Voting Share (as specified in the grant) of the Company, at a price no less than the closing price of such class of shares, on the day immediately preceding the grant date and generally vest over three years.

The following table summarizes the Company's Options outstanding at December 31, 2003:

	Number of options		Exercise price per share			Weighted average exercise price
Outstanding, April 1, 2003	—		$	—		$	—
Granted	672,000			36.05 - 67.79			37.49
Cancelled	(99,780	)		(36.05	)		(36.05	)
Exercised	—			—			—

Outstanding, December 31, 2003	572,220			36.05 - 67.79			37.74

The following table summarizes information concerning options outstanding at December 31, 2003:

	Options outstanding
Range of exercise price	Number of options	Weighted average remaining contractual life (years)	Weighted average exercise price
$36.05	528,720	4.3	$	36.05
$52.38 — $67.79	43,500	4.8		58.26

	572,220	4.3		37.74

Exercisable, end of year	720	0.7	$	36.05

48 Allstream Inc. 2003 Annual Report

(b): Employee Share Ownership Plan:

The Board approved an ESOP, effective July 2003. All permanent full-time salaried and sales employees and all bargaining unit employees, including permanent and temporary, full and part-time, are eligible. The maximum contribution level is 8% of base pay for salaried and bargaining unit employees or target income for employees on sales commission. Allstream will match 25% of each participating employee's contributions with a cash contribution on a quarterly basis. Upon attainment of certain Company targets, the Company will contribute an additional 25% match. This amount will be payable to a trustee on behalf of active employees as of December 31 of each year and will be paid on the date the annual variable pay is paid. The funds are used by the trustee to acquire the Company's shares on the open market. Compensation expense recorded during the period under the ESOP plan was $1.4 million.

(c): Director Compensation Plan:

Outside members of the Company's Board of Directors may elect annually to receive all or a portion of their compensation in the form of DSUs, the number of which is determined by the market price of the Company's Shares at the time of payment of the director's annual retainer fees. Additional DSUs are granted when dividends are paid. Upon termination of board service, the cash value to be paid for the DSUs is determined by the average closing price of the Shares for the five trading days immediately prior to the date of termination of board service. In the period ended December 31, 2003, 4,411 DSUs have been granted, are outstanding and are fully vested. Compensation expense recorded during the period under the Director Compensation Plan was $0.3 million.

14. Earnings per share:

Numerator:		$	65,562
Denominator:
	Basic weighted average number of shares outstanding (in thousands)		19,782
Effect of dilutive securities:
	Employee stock options		169

Diluted weighted average number of shares outstanding (in thousands)			19,951

During the period, 21,000 employee stock options were excluded from the calculation of diluted earnings per share as they were anti-dilutive. These options could be dilutive in the future.

Allstream Inc. 2003 Annual Report 49

15. Income taxes:

The Company uses the asset and liability method of accounting for income taxes. The tax effects of temporary differences that give rise to significant portions of future income tax assets and liabilities are as follows:

		As at December 31, 2003
Future tax assets:
	Operating loss carryforwards	$	1,088,701
	Property, plant and equipment		26,454
	Restructuring costs		17,197
	Accrued pension liability		37,713
	Other		26,773

	Total future tax assets		1,196,838
Valuation allowance			(1,196,838	)

Net future income tax assets		$	—

The implementation of the Plan and certain related transactions resulted in a forgiveness of indebtedness of approximately $3.9 billion for income tax purposes. The forgiven amount was applied to reduce non-capital losses of approximately $769 million and approximately $3.1 billion of capital losses available to the Company. The capital losses arose on an acquisition of control of the Predecessor that occurred on the implementation of the Plan.

Following the implementation of the Plan, the remaining non-capital tax losses of the Predecessor are available to reduce taxable income of the Company. The use of these losses will generally be restricted in future years to profits from the Predecessor's business that gave rise to the losses, and profits from similar businesses. As the Predecessor incurred significant losses and did not have a history of operating income, a full valuation allowance was recorded to reduce future income tax assets to nil upon fresh start accounting.

When the tax benefits of the future income tax asset is subsequently realized, the benefit is recorded as a capital transaction and is included in contributed surplus. The benefit of the Predecessor's future tax assets utilized and recorded by the Company in contributed surplus during the period amounted to $46.7 million.

The reconciliation of the provision for income taxes to amounts computed by applying combined federal and provincial tax rates to income before provision for income taxes is as follows:

Computed at combined statutory rate		$	41,462
Tax effect of:
	Expenses not deductible for income tax purposes		612
	Large Corporations Tax		1,386
	Effect of increase in enacted tax rates		(132,835	)
	Change in valuation allowance		136,995
	Other		568

			6,726

		$	48,188

50 Allstream Inc. 2003 Annual Report

The effect of the increase in enacted tax rates of $132.8 million is due to the revaluation of the Company's future tax assets for an increase in provincial corporate income tax rates. The change in income tax rates increases the benefit of utilizing these tax losses in future periods. However, the increased future tax asset arising from this change has been offset by a valuation allowance, as management believes it is more likely than not that this asset will not be realized.

At December 31, 2003, the Company has the following non-capital losses available to reduce future years' taxable income, which expire as follows:

2004	$	54,412
2005		101,929
2006		526,931
2007		499,461
2008		234,286
2009		1,639,296
2010		16,467

	$	3,072,782

16. Workforce reduction and provision for restructuring:

		April 1, 2003		Payments			Accretion expense		December 31, 2003
Provision for restructuring:
	Workforce reduction	$	7,841	$	(5,352	)	$	—	$	2,489
	Facilities consolidation		9,956		(3,048	)		415		7,323

		$	17,797	$	(8,400	)	$	415	$	9,812

In 2002, the Predecessor implemented a cost reduction initiative to bring the Predecessor's cost structure in line with its current and projected revenue base. This cost reduction initiative included both employee severance costs and facilities consolidation costs. The remaining balances at December 31, 2003 represent salary continuance payments in accordance with employee severance agreements and future payments to be made to landlords as a result of facilities consolidation activities.

The provision for restructuring comprises $4.0 million included in accrued liabilities and $5.8 million included in other long-term liabilities.

17. Financial instruments:

(a): Fair values of financial assets and liabilities:

The fair values of cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities approximate their carrying values due to the short-term nature of these instruments.

(b): Foreign currency risk:

The Company is exposed to foreign currency fluctuations on its U.S. dollar-denominated cash and cash equivalents, accounts receivable and accounts payable. The foreign exchange gain for the period of $3 million is recorded in selling, general and administration expenses.

Allstream Inc. 2003 Annual Report 51

(c): Interest rate risk:

The following table summarizes the Company's exposure to interest rate risk.

			Fixed interest rate maturing within
	Floating rate		1 year		1 - 5 years		After 5 years		Non-interest bearing
Financial assets
Cash and cash equivalents	$	345,734	$	—	$	—	$	—	$	—
Accounts receivable		—		—		—		—		120,598
Financial liabilities
Current liabilities		—		—		—		—		272,853
Capital leases		—		5,222		5,121		10,497		—

(d): Credit risk:

The Company's financial instruments that are exposed to credit risk are cash and cash equivalents and accounts receivable. Cash and cash equivalents consist of investments in highly liquid, highly secure money market instruments, which are on deposit at major financial institutions. Credit risk with respect to accounts receivable is limited due to the large number of customers to which the Company provides services.

18. Segmented information:

The Company currently operates in one operating segment, the telecommunications industry in Canada. The Company offers a number of products and services, delivered through its integrated network and solutions support infrastructure, sold by a national sales force, agents and telemarketers, and provisioned by one operations group. The Company makes decisions and evaluates financial performance primarily based on product and services revenue.

Revenue by product and services is as follows:

Data	$	307,445
Local		162,906
Internet and IT services		127,935
Other		10,289

		608,575
Long distance		339,221

	$	947,796

During the period, no customers of the Company individually represented more than 10% of the Company's revenue.

52 Allstream Inc. 2003 Annual Report

19. Change in non-cash working capital:

Accounts receivable	$	23,291
Other current assets		22
Other assets		(1,644	)
Accounts payable		12,816
Accrued liabilities		(8,288	)
Income taxes payable		(368	)
Other long-term liabilities		(2,698	)

	$	23,131

20. Supplemental cash flow information:

Supplemental cash flow information:
	Interest paid	$	251
	Income taxes paid		4,615
Supplemental disclosure of change in non-cash financing and investing activities:
	Accrued liabilities and accounts payable incurred for the acquisition of property, plant and equipment		20,110
	Accrued liabilities incurred for the investment in the venture with Inukshuk Internet Inc. and NR Communications, LLC		4,900

Allstream Inc. 2003 Annual Report 53

21. Reconciliation to accounting principles generally accepted in the United States:

The Company's consolidated financial statements have been prepared in accordance with accounting principles generally accepted in Canada ("Canadian GAAP") which, in the case of the Company, conform in all material respects with those in the United States ("U.S. GAAP"), except as outlined below:

(a): Consolidated statements of operations and comprehensive income and consolidated balance sheet:

The application of U.S. GAAP would have the following effect on income for the period and basic and diluted earnings per common share as reported:

Net income, Canadian GAAP		$	65,562
Depreciation (a)(ii)			(2,299	)
Accretion expense (a)(ii)			(595	)

Net income and comprehensive income, U.S. GAAP		$	62,668

Earnings per common share under U.S. GAAP:
	Basic	$	3.17
	Diluted		3.14

Weighted average number of common shares outstanding (in thousands):
	Basic		19,782
	Diluted		19,951

The cumulative effect of these adjustments on shareholders' equity is as follows:

Shareholders' equity in accordance with Canadian GAAP	$	623,892
Depreciation (a)(ii)		(2,299	)
Accretion expense (a)(ii)		(595	)

Shareholders' equity in accordance with U.S. GAAP	$	620,998

The following table indicates the differences between the amounts of consolidated balance sheet items determined in accordance with Canadian and U.S. GAAP:

	U.S. GAAP			Canadian GAAP			Difference
Assets
Property, plant and equipment	$	550,222		$	543,354		$	6,868
Liabilities and Shareholders' Equity
Other long-term liabilities		60,753			50,991			9,762
Deficit		(6,717	)		(3,823	)		(2,894	)

54 Allstream Inc. 2003 Annual Report

(i): Consolidated statement of cash flows:

Canadian GAAP permits the disclosure of a subtotal of the amount of funds provided by (used in) operations before change in non-cash working capital items in the consolidated statement of cash flows. U.S. GAAP does not permit this subtotal to be included.

(ii): Asset retirement obligations:

The Company adopted SFAS No. 143 for U.S. GAAP purposes on April 1, 2003, in conjunction with its adoption of fresh start accounting. SFAS No. 143 requires entities to record the fair value of a liability for an asset retirement obligation in the period in which the legal or contractual removal obligation is incurred. The associated asset retirement costs are capitalized as part of the carrying amount of the long-lived asset and depreciated over the asset's estimated useful life.

The Company has asset retirement obligations related to a number of asset categories, including:

•: Fibre — located underground or on poles, where the Company may be obligated to remove the fibre and/or related equipment if the underlying rights-of-way is terminated or if the Company chooses to decommission the assets;
•: Microwave towers and buildings/structural accesses — removal of equipment and related accesses to the sites; and
•: Leased facilities — restoration of certain leased premises to their original state upon exit.

Significant assumptions are required to estimate the fair value of asset retirement obligations, primarily related to the amount and timing of cash flows required to satisfy the Company's future legal obligation, the probability of being required to retire the asset, and the appropriate discount rate to present value the future cash flows. Actual results that differ from the estimates used will impact future results of operations and the financial position of the Company.

The undiscounted amount of the estimated cash flows required to settle the obligation is $14.9 million. The present value of the asset retirement obligation was calculated using a credit adjusted discount rate of 8.7% over periods ranging from 2 to 38 years.

The following is a reconciliation of the significant changes in the asset retirement obligation during the period:

Asset retirement obligation liability, April 1, 2003	$	9,167
Accretion expense		595

December 31, 2003	$	9,762

Allstream Inc. 2003 Annual Report 55

(iii): Stock-based compensation expense:

Effective April 1, 2003, the Company adopted the disclosure provisions of SFAS No. 148, Accounting for Stock-Based Compensation — Translation and Disclosure ("SFAS No. 148"). This statement amends SFAS No. 123, Accounting for Stock-Based Compensation ("SFAS No. 123"), to provide for alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. As allowed by SFAS No. 148, the Company has chosen to continue to account for compensation cost associated with its employee stock option plan in accordance with the intrinsic value method prescribed by APB No. 25, Accounting for Stock Issued to Employees ("APB No. 25"), adopting the disclosure only provisions of SFAS No. 123. Under this method, no compensation expense is recorded if stock options are granted at an exercise price equal to the fair market value of the Company's stock on the grant date. The accounting for cash settled RSUs and DSUs under the intrinsic method is consistent with the Company's accounting policy under Canadian GAAP. As option grants during the year had an exercise price equal to fair value and no modification to terms occurred during the year, stock-based compensation expense recorded under the intrinsic value method was consistent with Canadian GAAP. Effective January 1, 2004, the Company will adopt fair value accounting for all employee awards. The impact is consistent with Canadian GAAP, as described in note 2(g)(ii), except that under U.S. GAAP, any transitional charge is recognized in earnings as a cumulative effect of a change in accounting principles.

Had the Company adopted the fair value method to account for stock options under SFAS No. 123, income attributable to common shareholders and basic and dilutive earnings per share would have been as indicated below:

Income attributable to common shareholders, as reported — U.S. GAAP			$	62,668
Deduct total stock-based employee compensation expense determined under fair value-based method for all awards				(3,128	)

Income attributable to common shareholders, pro forma — U.S. GAAP			$	59,540

Pro forma weighted average number of common shares outstanding (in thousands):
	Basic			19,782
	Diluted			19,782

Earnings per share:
	As reported:
		Basic	$	3.17
		Diluted		3.14
	Pro forma:
		Basic		3.01
		Diluted		3.01

The assumptions used to value stock option grants for the purposes of the SFAS 123 pro forma disclosure are consistent with Canadian GAAP as noted in note 2(g)(ii).

56 Allstream Inc. 2003 Annual Report

(b)

Other disclosures:

(i): Accounts receivable are net of an allowance for doubtful accounts of $14.3 million at December 31, 2003.
(ii): Recently issued accounting standards:

In November 2002, the FASB issued Interpretation No. 45, Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others ("FIN 45"), which requires certain disclosures of obligations under guarantees. The disclosure requirements of FIN 45 are included in note 22 (b)(ii). Effective 2003, FIN 45 also requires the recognition of a liability by a guarantor at the inception of certain guarantees entered into or modified after December 31, 2002, based on the fair value of the guarantee. The adoption of this standard did not have a material impact on the consolidated financial statements.

In November 2002, the Emerging Issues Task Force reached a consensus on Issue 00-21, addressing how to account for revenue arrangements that involve the delivery or performance of multiple products, services, and/or rights to use assets. Revenue arrangements with multiple deliverables are divided into separate units of accounting if the deliverables in the arrangement meet the following criteria: (a) the delivered item has value to the customer on a stand-alone basis; (b) there is objective and reliable evidence of the fair value of undelivered items; and (c) delivery of any undelivered item is probable. Arrangement consideration should be allocated among the separate units of accounting based on their relative fair values, with the amount allocated to the delivered item being limited to the amount that is not contingent on the delivery of additional items or meeting other specified performance conditions. The adoption of this standard on April 1, 2003 did not have a material impact on the consolidated financial statements.

In January 2003, the FASB issued Interpretation No. 46, Consolidation of Variable Interest Entities, An Interpretation of ARB No. 51. This Interpretation addresses the consolidation by business enterprises of variable interest entities, as defined in the Interpretation. The Interpretation applied immediately to variable interests in variable interest entities created after January 31, 2003, and to variable interests in variable interest entities obtained after January 31, 2003. In December 2003, the FASB issued FASB Interpretation No. 46R, Consolidation of Variable Interest Entities Revised. FIN 46R modifies the scope exceptions provided in FIN 46. Entities would be required to replace FIN 46 provisions with FIN 46R provisions for all newly created post-January 31, 2003 entities as of the end of the first interim or annual reporting period ending after March 15, 2004. The application of these Interpretations did not have a material effect on the consolidated financial statements.

Allstream Inc. 2003 Annual Report 57

22. Commitments and contingencies:

(a)

Contractual commitments:

(i): Operating leases, capital purchase commitments and supply contracts:

Under the terms of its operating lease agreements for fibre optics maintenance, operating facilities, equipment rentals and capital purchase commitments under supply contracts and customer contracts, the Company is committed to make the following payments for the years ending December 31, as follows:

2004	$	153,809
2005		100,638
2006		69,255
2007		59,696
2008		52,450
Thereafter		232,945

	$	668,793

(ii): Other:

As described in note 11(c), the Company is required to fund certain solvency deficits under its defined benefit pension plans. As described in note 6, the Company has commitments in connection with an investment.

(b)

Contingent liabilities:

(i): Litigation:

(ii): Guarantees:

Effective January 1, 2003, the Company adopted AcG-14, Disclosure of Guarantees, which requires a guarantor to disclose certain information about guarantees it has provided. In addition to the above commitments and contingencies, the Company has also provided routine indemnifications, whose terms range in duration and often are not explicitly defined. These indemnifications relate to numerous matters, as described below.

The Company has provided intellectual property indemnifications, which are customary in the industry and have indefinite terms and require the Company to compensate other parties for certain damages or costs incurred as a result of third party intellectual property claims arising from certain transactions. The nature of intellectual property indemnifications prevents the Company from making reasonable estimates of the maximum liability arising therefrom. Historically, the Company has not made significant payments related to these indemnifications.

In addition, the Company has provided indemnifications under certain supplier agreements with other telecommunications providers and municipalities pursuant to the provision of the Company's services. These indemnifications relate to claims made by third parties (including customers) in connection with the use of the Company's services and related equipment.

The Company has indemnified a third party in connection with a marketing agreement, and has determined that the potential maximum loss is not significant. The Company has also indemnified certain financial advisors regarding liability they may incur as a result of their activity as advisors to the Company or the Company's noteholders arising out of the Company's restructuring in 2003.

58 Allstream Inc. 2003 Annual Report

In connection with certain dispositions of assets or businesses, the Company may be required to pay counterparties for costs and losses incurred as a result of breaches of representations and warranties, or damages to property or buildings, environmental liabilities and changes in the interpretation of laws or regulations (including tax laws).

The maximum amount of these indemnifications cannot be reasonably estimated due to the uncertain nature of such indemnities. The difficulty in assessing the amount of the liability results primarily from the inability in determining how the law will apply to such provisions and the lack of limitations on potential liability. Historically, the Company has not made significant payments related to these indemnifications.

The Company continues to monitor the conditions that are subject to guarantees and/or indemnifications to identify whether it is probable that a loss has occurred, and would recognize any such losses under any guarantees and indemnifications when those losses are estimable.

(c): Letters of credit:

In the normal course of business, the Company obtains letters of credit in compliance with its rights-of-way agreements with various municipalities and utility companies. In general, the terms of the letters of credit permit the municipality or the utility company to draw on the letters of credit to recover any losses incurred under the rights-of-way agreement, as defined. As at December 31, 2003, the Company had letters of credit outstanding of $1.6 million with nil drawn.

Allstream Inc. 2003 Annual Report 59

corporate governance

The Company is committed to implementing a culture of corporate governance consistent with its legal requirements and high ethical standards, including the initiatives outlined in the Message from the Chairman. As a result of restructuring, the Company emerged on April 1, 2003, with new shareholders (the former creditors) and a new Board of Directors. The Board and its Committees are striving to create a model corporate governance value added structure. To this end, the Board has approved an Ethics and Integrity Program within the Company that includes a program to ensure employees have read and understood the Company's Code of Conduct. Since the Board has only been functioning since April 1, 2003, some aspects of good governance are in the process of unfolding.

The Board is responsible for the overall stewardship of the Company. The Board oversees the conduct of the business and affairs of the Company through reviewing and approving the Company's strategic and business plans taking into account the opportunities and risks of the business and the operational, capital and financial plans for the coming year. The Board assesses any risks which might prevent the Company from meeting its business objectives including strategic plans, the quality of the people to execute those plans and excellence in operations, human resource development and succession planning. While the management of the business is delegated to the C.E.O., the Board expects management to manage the Company's business in accordance with the plans in a prudent manner and with the goal of enhancing shareholder value.

The Board has established Audit, Human Resources and Compensation, and Governance Committees to assist the Board in carrying out its responsibilities. Each Committee consists of five directors, all of whom are unrelated directors. The Board and Committee Charters and the Company's Code of Conduct are available at www. allstream.com.

60 Allstream Inc. 2003 Annual Report

board of directors

Purdy Crawford⁽²⁾⁽³⁾
Chairman and Director

John T. McLennan
Vice Chairman,
Chief Executive Officer and Director

Gerald Beasley⁽¹⁾
Director

William A. Etherington⁽¹⁾⁽²⁾
Director

Deryk I. King⁽²⁾⁽³⁾
Director

Ian D. Mansfield^(1)(2)(3)
Director

Ian M. McKinnon⁽²⁾⁽³⁾
Director

Jane Mowat⁽¹⁾
Director

Daniel F. Sullivan⁽¹⁾⁽³⁾
Director

(1): Member of Audit Committee
(2): Member of Corporate Governance and Nominating Committee
(3): Member of Human Resources and Compensation Committee

leadership team

John T. McLennan
Vice Chairman and
Chief Executive Officer

John A. MacDonald
President and Chief Operating Officer

David A. Lazzarato
Executive Vice President and
Chief Financial Officer

Tal Bevan
Executive Vice President, Sales

Harold Giles
Executive Vice President,
Leadership Resources and Development

Mike Kologinski
Executive Vice President, Marketing

Judy McLeod
Executive Vice President,
Customer Operations

Dean Prevost
Executive Vice President and President,
IT Services

Henry C. Yip
Executive Vice President,
Network Services

Scott L. Ewart
Senior Vice President,
General Counsel and Secretary

Ron McKenzie
Senior Vice President,
Strategy and Corporate Development

Chris Peirce
Senior Vice President,
Regulatory and Government Affairs

Brock Robertson
Senior Vice President,
Treasury and Investor Relations

Don Welham
Vice President, Controller

Allstream Inc. 2003 Annual Report 61

corporate information

Principal executive offices	Transfer agent	Investors and analysts
*Allstream Inc.*	*CIBC Mellon*	*Allstream Inc., Investor Relations*
200 Wellington Street West, 16th Floor Toronto, Ontario, Canada M5V 3G2 Tel: 416-345-2000 Web: www.allstream.com Shareholder information and assistance Tel: 888-311-1154 For general company information and news releases: Web: www.allstream.com/investor/ index.html	320 Bay Street, P.O. Box 1 Toronto, Ontario, Canada M5H 4A6 Tel: 800-387-0825 or 416-643-5500 Web: www.cibcmellon.com Email: inquiries@cibcmellon.com Auditors *KPMG, LLP* Yonge Corporate Centre 4100 Yonge Street, Suite 200 Toronto, Ontario, Canada M2P 2H3	200 Wellington Street West, 16th Floor Toronto, Ontario, Canada M5V 3G2 Brock Robertson Senior Vice President, Treasury and Investor Relations Tel: 416-345-3125 Email: brock.robertson@allstream.com Dan Coombes Director, Investor Relations Tel: 416-345-2326 Email: dan.coombes@allstream.com

62 Allstream Inc. 2003 Annual Report

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EX-99.2 4 a2132723zex-99_2.htm CONSOLIDATED FINANCIAL STATEMENTS OF AT&T 2002
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Consolidated Financial Statements
(Expressed in Canadian dollars)

AT&T CANADA INC.

Years ended December 31, 2002, 2001 and 2000

auditors' report to the shareholders

We have audited the consolidated balance sheets of AT&T Canada Inc. as at December 31, 2002 and 2001 and the consolidated statements of operations and deficit and cash flows for each of the years in the three-year period ended December 31, 2002. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with Canadian generally accepted auditing standards. Those standards require that we plan and perform an audit to obtain reasonable assurance whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.

In our opinion, these consolidated financial statements present fairly, in all material respects, the financial position of the Company as at December 31, 2002 and 2001 and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2002 in accordance with Canadian generally accepted accounting principles.

/s/ KPMG LLP

Chartered Accountants

Toronto, Canada
January 31, 2003, except as
to notes 1, 8 and 25, which are
as of February 25, 2003

comments by the auditors for u.s. readers on canada-u.s. reporting differences

In the United States, reporting standards for auditors require the addition of an explanatory paragraph (following the opinion paragraph) when the financial statements are affected by conditions and events that cast substantial doubt on the Company's ability to continue as a going concern, such as those described in note 1 to the consolidated financial statements. Our report to the shareholders, dated January 31, 2003, except as to notes 1, 8 and 25, which are as of February 25, 2003, is expressed in accordance with Canadian reporting standards, which do not permit a reference to such conditions and events in the auditors' report when these are adequately disclosed in the financial statements.

In addition, in the United States, reporting standards for auditors require the addition of an explanatory paragraph (following the opinion paragraph) when there is a change in accounting principles that has a material effect on the comparability of the Company's financial statements, such as the change described in note 2(e) to the consolidated financial statements. Our report to the shareholders dated January 31, 2003, except as to notes 1, 8 and 25, which are as of February 25, 2003, is expressed in accordance with Canadian reporting standards, which do not require a reference to such a change in accounting principles in the auditors' report when the change is properly accounted for and adequately disclosed in the financial statements.

/s/ KPMG LLP

Chartered Accountants

Toronto, Canada
January 31, 2003, except as
to notes 1, 8 and 25, which are
as of February 25, 2003

consolidated balance sheets

(In thousands of Canadian dollars)
December 31, 2002 and 2001

			2002			2001
						(Restated note 2(g))
Assets
Current assets:
	Cash and cash equivalents (note 4)		$	420,542		$	537,294
	Accounts receivable (note 7(b))			166,434			70,640
	Other current assets			23,045			14,154

				610,021			622,088
Property, plant and equipment (note 5)				952,699			2,180,773
Goodwill (note 6)				—			1,639,065
Other intangible assets (note 6)				7,565			14,531
Deferred pension asset (note 16)				60,430			45,174
Deferred foreign exchange				—			144,287
Other assets, net (note 7)				56,985			117,707

			$	1,687,700		$	4,763,625

Liabilities and Shareholders' Deficiency
Current liabilities:
	Liabilities not subject to compromise:
		Accounts payable	$	45,802		$	63,291
		Accrued liabilities		234,549			267,229
		Accrued interest payable		—			70,004
		Income taxes payable		7,056			5,584
		Current portion of capital lease obligations (note 9)		3,952			1,930
	Liabilities subject to compromise (note 8)			4,719,591			—

				5,010,950			408,038
Long-term debt (note 8)				—			4,655,077
Long-term portion of capital lease obligations (note 9)				16,601			17,661
Other long-term liabilities				47,547			45,110
Deferred foreign exchange (note 17(b))				106,617			29,445
Shareholders' deficiency (note 10):
	Common shares			1,393,994			1,133,664
	Warrants			496			709
	Deficit			(4,888,505	)		(1,526,079	)

				(3,494,015	)		(391,706	)

			$	1,687,700		$	4,763,625

Reorganization proceedings and basis of presentation (note 1)
Reconciliation to accounting principles generally accepted in the United States (note 23)
Commitments and contingencies (note 24)
Subsequent events (note 25)

See accompanying notes to consolidated financial statements.

On behalf of the Board:

/s/ PURDY CRAWFORD Purdy Crawford	Director	/s/ JAMES J. MEENAN James J. Meenan	Director

consolidated statements of operations and deficit

(In thousands of Canadian dollars, except per share amounts)
Years ended December 31, 2002, 2001 and 2000

		2002			2001			2000
					(Restated — note 2(g))
Revenue		$	1,488,145		$	1,544,721		$	1,505,378
Expenses:
	Service costs		931,949			1,005,790			1,034,860
	Selling, general and administrative		333,004			385,966			411,947
	Workforce reduction and provision for restructuring (note 12)		87,069			21,901			(10,249	)
	Write-down of property, plant and equipment and goodwill (notes 5 and 6)		1,203,196			—			—
	Depreciation and amortization		273,142			465,600			402,551

			2,828,360			1,879,257			1,839,109

Loss from operations			(1,340,215	)		(334,536	)		(333,731	)
Other income (expense):
	Interest income		9,193			19,134			17,243
	Interest expense		(431,625	)		(401,114	)		(319,046	)
	Foreign exchange loss		(41,126	)		(10,097	)		—
	Reorganization expenses (note 14)		(7,065	)		—			—
	Write-down of long-term investments and other assets (note 7(c))		(11,855	)		—			—
	Other (note 13)		(2,225	)		(10,797	)		13,739

			(484,703	)		(402,874	)		(288,064	)

Loss before minority interest and income taxes			(1,824,918	)		(737,410	)		(621,795	)
Minority interest			—			—			104,274
Income taxes (note 15)			6,741			7,965			5,686

Loss for the year			(1,831,659	)		(745,375	)		(523,207	)
Deficit, beginning of year:
	As previously reported		(1,513,805	)		(780,704	)		(257,497	)
	Adjustment for change in accounting policy for foreign exchange (note 2(g))		(12,274	)		—			—

	As restated		(1,526,079	)		(780,704	)		(257,497	)
Adjustment for change in accounting policy for goodwill (note 2(e))			(1,530,767	)		—			—

Deficit, end of year		$	(4,888,505	)	$	(1,526,079	)	$	(780,704	)

Basic and diluted loss per common share (note 2(j))		$	(17.95	)	$	(7.57	)	$	(5.48	)

Weighted average number of common shares outstanding (in thousands)			102,047			98,406			95,561

See accompanying notes to consolidated financial statements.

consolidated statements of cash flows

(In thousands of Canadian dollars)
Years ended December 31, 2002, 2001 and 2000

			2002			2001			2000
						(Restated — note 2(g))
Cash provided by (used in):
Operating activities:
	Loss for the year		$	(1,831,659	)	$	(745,375	)	$	(523,207	)
	Adjustments required to reconcile loss to cash flows from operating activities:
		Depreciation and amortization		273,142			465,600			402,551
		Write-down of property, plant and equipment and goodwill (notes 5 and 6)		1,203,196			—			—
		Write-down of long-term investments and other assets (note 7(c))		11,855			—			—
		Accretion of Senior Discount Note interest		156,855			145,148			125,916
		Amortization of debt issuance costs		10,807			15,661			16,248
		Amortization of deferred gain on termination of cross-currency swaps and forward contracts (note 17(b))		(16,232	)		(4,264	)		—
		Loss (gain) on sale of investments		1,502			8,894			(13,011	)
		Minority interest		—			—			(104,274	)
		Deferred pension charge (note 16(a))		8,661			5,074			2,690
		Change in pension plan valuation allowance (note 16(a))		—			(31,934	)		2,937
		Unrealized foreign exchange loss		59,844			12,275			—
		Other		(1,422	)		3,577			2,012

				(123,451	)		(125,344	)		(88,138	)
	Change in non-cash working capital (note 20)			(24,308	)		183,636			(80,411	)

	Net cash generated by (used in) operating activities			(147,759	)		58,292			(168,549	)
Investing activities:
	Acquisitions, net of cash or bank indebtedness acquired			—			(43,410	)		(197,867	)
	Dispositions of investments, net of disposition costs			2,200			3,580			17,656
	Additions to property, plant and equipment			(143,865	)		(419,173	)		(560,404	)
	Reductions (additions) to other assets			1,355			236			(1,164	)
	Decrease to restricted investments			—			—			42,429

	Net cash used in investing activities			(140,310	)		(458,767	)		(699,350	)
Financing activities:
	Issue of share capital, net of issuance costs			259,022			48,243			35,206
	Termination of cross-currency swaps and forward contracts (note 17(b))			85,504			150,664			—
	Draw from (repayment of) credit facility, net			(170,000	)		(100,000	)		270,000
	Issues of long-term debt			—			781,959			355,912
	Debt issue and credit facility costs			(1,304	)		(6,230	)		(5,234	)
	Decrease in other long-term liabilities			(1,694	)		(5,054	)		(5,935	)
	Repayment of capital lease			(279	)		(1,695	)		(2,981	)

	Net cash generated by financing activities			171,249			867,887			646,968
Effect of exchange rate changes on cash				68			1,295			187

Increase (decrease) in cash and cash equivalents				(116,752	)		468,707			(220,744	)
Cash and cash equivalents, beginning of year				537,294			68,587			289,331

Cash and cash equivalents, end of year			$	420,542		$	537,294		$	68,587

Supplemental cash flow information (note 21)

See accompanying notes to consolidated financial statements.

notes to consolidated financial statements

(Tabular amounts in thousands of Canadian dollars, except per share amounts)
Years ended December 31, 2002, 2001 and 2000

AT&T Canada Inc. (the "Company") is a holding company, which engages in the telecommunications business in Canada through its subsidiaries, the most significant of which is its 69% owned operating subsidiary, AT&T Canada Corp. The Company's activities in the telecommunications business consist primarily of the development and construction of telecommunications networks for the provision of local and data services, internet and IT services and long-distance services to businesses in Canada.

On October 8, 2002, all of the Company's Class A Voting Shares and Class B Non-Voting Shares, not already owned by AT&T Corp., were purchased by Brascan Financial Corporation and CIBC Financial Partners (the "Back-end"). As a result, the publicly traded Class B Deposit Receipts were de-listed by The Toronto Stock Exchange (the "TSX") and NASDAQ and are no longer publicly traded.

1. Reorganization proceedings and basis of presentation:

(a): Reorganization proceedings:

On October 15, 2002 (the "Commencement Date"), the Company and certain of its subsidiaries, namely AT&T Canada Corp., AT&T Canada Telecom Services Company, AT&T Canada Fibre Canada Company, MetroNet Fibre US Inc., MetroNet Fibre Washington Inc. and Netcom Canada Inc. (collectively, the "AT&T Canada Companies"), voluntarily filed an application for creditor protection under the Companies' Creditors Arrangement Act ("CCAA") with the Ontario Superior Court of Justice, Toronto, Ontario, Canada (the "Court") and obtained an order from the Bankruptcy Court in the Southern District of New York (the "U.S. Court") under Section 304 of the U.S. Bankruptcy Code to recognize the CCAA proceedings in the United States. On January 22, 2003, the AT&T Canada Companies filed a Consolidated Plan of Arrangement and Reorganization (the "Plan") and related Management Information Circular with the Court. The purpose of the Plan is to restructure the balance sheet and equity of the AT&T Canada Companies, provide for the compromise, settlement and payment of liabilities of certain creditors of the AT&T Canada Companies and to simplify the operating corporate structure of the AT&T Canada Companies. The Plan provides for, amongst other things:

(i): transactions that will result in a corporate structure with a new parent company ("New AT&T Canada"), which will own the existing holding company, AT&T Canada Inc. and a wholly owned operating subsidiary ("New OpCo"), which will be created as a consequence of the amalgamation of certain of the existing subsidiaries of AT&T Canada Inc.;
(ii): the cancellation of all existing outstanding equity, including warrants and share purchase options of AT&T Canada Inc. and AT&T Canada Corp. for no consideration (notes 10 and 11); and
(iii): the exchange and compromise of the senior notes of the Company (the "Senior Notes") and certain other affected claims ("Affected Creditors") for a combination of cash, which will not be less than $200 million, and 100% of the equity of New AT&T Canada upon emergence from CCAA.

On February 20, 2003, the Plan was approved by the holders of the Senior Notes ("Noteholders"), and other affected creditors. On February 25, 2003, the Court issued an order sanctioning the Plan and the U.S. Court issued an order recognizing and enforcing the Court's sanction order.

As a wholly owned subsidiary of AT&T Canada Inc., New OpCo will carry on the businesses formerly conducted by each of the Canadian AT&T Canada Companies. In effect, after the reorganization under the Plan, AT&T Canada Inc. will operate through one Canadian subsidiary instead of seven Canadian operating subsidiaries and AT&T Canada Inc. will become the wholly owned subsidiary of New AT&T Canada, whose principal asset consists of its ownership of all of the common shares of AT&T Canada Inc. Following the implementation of the Plan, the business and operations of AT&T Canada Inc. will not undergo any change as a result of New AT&T Canada becoming the top company in the corporate structure.

The completion of the Plan and emergence from the CCAA proceedings ("Plan Implementation Date") is subject to a number of conditions, including that an appeal period of the Court's approval has expired with either no appeal commenced or a final determination made by the Court, and the receipt of certain exemption orders from securities regulatory authorities in Canada to provide that the shares of New AT&T Canada (the "New Shares") issued under the Plan will be freely tradeable, and the listing of the New Shares on the TSX.

Two of the Company's wholly owned subsidiaries, Contour Telecom Inc. and Montage.DMC eBusiness Services, Inc., were excluded from the CCAA proceedings. Together, these entities generated less than 5% of consolidated revenues in 2002 and 2001 (2000 — 5%), and were an insignificant component of consolidated net loss and the Company's financial position for each of the years presented.

(b): Basis of presentation:

The consolidated financial statements have been prepared on a going concern basis in accordance with Canadian generally accepted accounting principles ("GAAP"). The going concern basis of presentation assumes that the Company will continue in operation for the foreseeable future and will be able to realize its assets and discharge its liabilities and commitments in the normal course of business. There is doubt about the appropriateness of the use of the going concern assumption in the preparation of the consolidated financial statements because of the circumstances of the CCAA reorganization proceedings and circumstances giving rise to this event, including the Company's long-term debt which is in default. There can be no assurances that the Plan will be implemented as contemplated and that the Company will emerge from the CCCA proceedings. Also, there can be no assurances that even if the Plan is implemented, the Company will be a going concern post-emergence.

The consolidated financial statements do not reflect significant adjustments that would be necessary in the carrying amount of assets and liabilities, the reported revenue and expenses, and the balance sheet classifications used if the going concern basis was not appropriate. The appropriateness of the going concern basis is dependent upon, among other things, implementation of the Plan, future profitable operations and the Company's ability to generate sufficient cash from operations and from financing arrangements to meet its obligations.

If the Plan is implemented, New AT&T Canada will be required to perform a comprehensive revaluation of its balance sheet under the provisions of The Canadian Institute of Chartered Accountants ("CICA") Handbook Section ("HB") 1625, "Comprehensive Revaluation of Assets and Liabilities" ("fresh start accounting"). Under fresh start accounting, the Company's assets and liabilities will be recorded at management's best estimate of their fair values. The reported amounts in the accompanying consolidated financial statements could materially change, because they do not give effect to adjustments to the carrying amount of assets and liabilities that may ultimately result from the adoption of fresh start accounting to reflect assets and liabilities at their fair values. In particular, it is expected that there will be significant differences (either positive or negative) between the fair value and carrying amount as a result of fresh start accounting in the following areas: capital assets, deferred pension asset and long-term liabilities.

2. Significant accounting policies:

The consolidated financial statements include all assets and liabilities of the Company and its majority-owned subsidiaries. All intercompany transactions and balances have been eliminated on consolidation.

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the year. Actual results could differ from those estimates.

Significant estimates are used in determining, but not limited to, the recoverability of capital assets, allowance for doubtful accounts, provisions for workforce reduction and restructuring, provisions for contingent liabilities, liabilities subject to compromise, and income tax valuation allowances. Assessments of the recoverability of capital assets require estimates of useful lives, future cash flows, discount rates and terminal values. Management develops cash flow projections using assumptions that reflect the Company's planned courses of action and management's best estimate of the most probable set of economic conditions. When assessing the reasonableness of the assumptions, current information, currently prevailing economic conditions and trends are considered. Liabilities subject to compromise under the CCAA proceedings have been estimated based upon the Court-approved process to prove, administer and adjudicate claims. The claims of Noteholders have been determined in accordance with such process. Claims of other affected creditors and the amount recorded as liabilities have been estimated using the information provided by the Affected Creditors and management's assessment of the merits of the claims. Actual results may be materially different from assumptions used.

The Company's significant accounting policies are as follows:

(a): Cash and cash equivalents:

(b): Revenue recognition:

The Company derives its revenue primarily from data, local, internet and IT services and long-distance products and services. Products and services are sold either standalone or together as a multiple service arrangement or bundled solution. Components of multiple service arrangements are separately accounted for provided the elements have standalone value to the customer and the fair value of any undelivered elements can be reliably determined. The Company recognizes revenue once evidence of an arrangement exists, delivery has occurred, fees are fixed or determinable and collectability is probable.

(c): Accounts receivable securitization:

The Company accounts for the transfer of receivables according to Accounting Guideline ("AcG") AcG-12, "Transfer of Receivables." The Company recognizes gains or losses on the transfer of receivables that qualify as sales and retains a subordinated retained interest in the accounts receivable transferred and ongoing servicing responsibilities. Losses on the sale of accounts receivable are recorded in the consolidated statements of operations and deficit at the date of sale.

The amount of the losses depends in part on the carrying amount of the accounts receivable involved in the transfer, allocated between the accounts receivable sold and the Company's retained interest based on their relative fair value at the date of the transfer. The Company measures fair value based on the expected future cash receipts to be realized using management's best estimates of key assumptions for credit and dilution losses, collection term of the accounts receivable and the trust's contracted return.

Any subsequent decline in the value of the retained interest other than a temporary decline, will be recorded in income.

(d): Property, plant and equipment:

Property, plant and equipment are recorded at cost. Included in telecommunications facilities and equipment are costs incurred in developing new networks or expanding existing networks, such as costs of acquiring rights-of-way and network design. Construction costs related to telecommunications facilities and equipment that are installed on rights-of-way granted by others are capitalized and depreciated over the lives of the rights-of-way. Interest is capitalized on assets under construction for more than three months at the Company's weighted average cost of debt. Telecommunications facilities and equipment are depreciated once the network is put in service.

Depreciation is computed using the straight-line method over the estimated useful lives of the assets as follows:

Telecommunications facilities and equipment		3 - 20 years
Buildings		13 - 40 years
Other capital assets		4 - 40 years
Equipment under capital leases		3 - 15 years
Application software		1 - 7 years
Leasehold improvements		Term of lease

The carrying amount of property, plant and equipment is reviewed for impairment on an ongoing basis whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. If the total of the expected future undiscounted cash flows is less than the carrying amount of the asset, a loss is recognized for the difference between the expected future undiscounted cash flows and carrying amount of the asset.

(e): Business combinations, goodwill and other intangible assets:

Effective January 1, 2002, the Company adopted HB 3062, "Goodwill and Other Intangible Assets," and HB 1581, "Business Combinations." The new standards mandate the purchase method of accounting for business combinations and require that goodwill and indefinite-life intangible assets no longer be amortized but tested for impairment at least annually. The standards also specify criteria that intangible assets must meet to be recognized and reported apart from goodwill.

The Company has adopted these new standards as at January 1, 2002 and discontinued amortization of all existing goodwill. Goodwill is allocated to reporting units and any potential goodwill impairment is identified by comparing the carrying value of a reporting unit with its fair value. If any potential impairment is indicated, then it is quantified by comparing the carrying value of goodwill to its fair value, based on the fair value of the assets and liabilities of the reporting unit. HB 3062 requires completion of a transitional goodwill impairment evaluation within six months of adoption.

Under HB 3062, any transitional impairment loss is recognized as a charge to opening deficit at January 1, 2002. In 2002, the Company completed its transitional goodwill impairment test and determined that unamortized goodwill of $1,530.8 million, as at January 1, 2002, was impaired under the fair value approach. This amount was charged to opening deficit with a corresponding reduction in goodwill (note 6).

Intangible assets that have definite lives are amortized over their estimated useful lives. Intangible assets are tested for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. If the total of the expected future undiscounted cash flows is less than the carrying amount of the asset, a loss is recognized for the difference between the expected future undiscounted cash flows and the carrying amount of the asset.

The following presents the effects on the year ended December 31, 2001 and 2000 as if the Company had retroactively adopted the change in accounting policy for non-amortization of goodwill discussed above:

	2001			2000
Reported loss for the year	$	(745,375	)	$	(523,207	)
Add back: goodwill amortization		109,186			94,427

Adjusted loss for the year	$	(636,189	)	$	(428,780	)

Reported basic and diluted loss per share	$	(7.57	)	$	(5.48	)
Add back: goodwill amortization		1.11			0.99

Adjusted basic and diluted loss per share	$	(6.46	)	$	(4.49	)

Prior to the adoption of HB 3062, goodwill and other intangible assets recorded at the date of acquisition were amortized on a straight-line basis over their estimated useful lives of 5 to 25 years. Goodwill and other intangible assets were reviewed for impairment whenever events or changes in circumstances indicated that the carrying amount may not be recoverable. If the total of the expected future undiscounted cash flows was less than the carrying amount of the asset, a loss was recognized for the difference between the expected future undiscounted cash flows and the carrying amount of the asset.

(f): Debt issuance costs:

Debt issuance costs are amortized on a straight-line basis over the terms of the related debt financing.

(g): Foreign currency translation and hedging relationships:

Foreign currency-denominated monetary items are translated into Canadian dollars at the exchange rate prevailing at the balance sheet date. Foreign currency-denominated non-monetary items are translated at the historical exchange rate. Transactions included in operations are translated at the average exchange rate for the period. Translation gains or losses are reflected in the consolidated statements of operations in the period in which they occur.

Effective January 1, 2002, the Company adopted amended HB 1650, "Foreign Currency Translation," which eliminates the deferral and amortization of foreign currency translation gains and losses on long-term monetary items with a fixed or ascertainable life. Exchange gains and losses on long-term monetary items are included in income.

At December 31, 2001, the Company had approximately $12.3 million (2000 — nil) of unamortized foreign exchange losses related to long-term debt. Upon adoption, deferred foreign exchange has been reduced by this amount, with a corresponding increase in opening deficit as of January 1, 2002. HB 1650 also requires restatement of prior periods, the effect of which was to increase the reported loss and loss per share for the year ended December 31, 2001 by $12.3 million (2000 — nil) and $(0.12) (2000 — nil), respectively.

The Company hedges its exposure to foreign currency exchange rate risk on long-term debt from time to time, by designating existing foreign currency-denominated monetary assets as hedge instruments and, through the purchase of currency options, cross-currency swaps and forward exchange contracts. The Company accounts for these financial instruments as hedges and, as a result, foreign exchange gains and losses on hedge instruments are recorded in the same period as the corresponding gains and losses on the related long-term debt. Premiums paid to acquire currency options, cross-currency swaps and forward exchange contracts are deferred and amortized on a straight-line basis over the terms of the instruments. Changes in fair values of derivative instruments not designated as hedging instruments and ineffective portion of hedges, if any, are recognized in earnings in the current year.

The Company's policy is to formally designate each derivative financial instrument as a hedge of a specifically identified debt instrument. The Company believes the derivative financial instruments are effective as hedges, both at inception and over the term of the instrument.

Gains and losses on terminations of foreign currency derivative agreements are deferred under other current, or non-current, assets or liabilities on the balance sheet and amortized to foreign exchange gain (loss) over the remaining term of the underlying debt for which these derivative instruments were designated as cash flow hedges. In the event of early extinguishment of the related debt obligation, any realized or unrealized gain or loss from the derivative would be recognized in the consolidated statements of operations at the time of extinguishment.

(h)

Employee benefit plans:

(i): Retirement benefits:

The Company recognizes the costs of retirement benefits and post-employment benefits over the period in which employees render services in return for the benefits. The costs of defined benefit pensions and other retirement benefits earned by employees are actuarially determined using the projected benefit method prorated on credited service and management's best estimate of expected plan investment performance, salary escalation and retirement ages of employees. Changes in these assumptions could impact future pension expense. For the purpose of calculating the expected return on plan assets, those assets are valued using a market-related value. Past service costs from plan amendments are amortized on a straight-line basis over the average remaining service period of employees active at the date of amendment, except for amendments to the post-retirement medical and dental benefits programs. The average remaining life expectancy of former employees is used for the post-retirement medical and dental benefits programs as no new members are allowed to join these plans. The excess of the cumulative unrecognized net gains (loss) over 10% of the greater of the benefit obligation and the market-related value of plan assets is amortized over the average remaining service period of active employees, except for the post-retirement medical and dental benefits programs where the average remaining life expectancy of former employees is used in the determination of the amortization period.

When the restructuring of a benefit plan gives rise to both a curtailment and a settlement of obligations, the curtailment is accounted for prior to the settlement.

(ii): Stock-based compensation:

Effective January 1, 2002, the Company adopted HB 3870, "Stock-based Compensation and Other Stock-based Payments," which requires that a fair value-based method of accounting be applied to all stock-based payments to non-employees and to employee awards that are direct awards of stock, awards that call for settlement in cash or other assets, or are stock appreciation rights that call for settlement by the issuance of equity instruments. HB 3870 permits the Company to continue its existing policy of treating all other employee and director stock options as capital transactions (the settlement method), but requires pro forma disclosure of net earnings and per share information as if the Company had accounted for these stock options under the fair value method (note 11).

HB 3870 requires disclosure of the pro forma effect of awards granted after January 1, 2002. The Company has elected to include the pro forma effect of awards granted prior to January 1, 2002 in its disclosures. The fair value of stock options issued in the period is determined using the Black-Scholes option-pricing model for purposes of the pro-forma disclosures, and is allocated to compensation cost on a straight-line basis over the vesting period of the award. The adoption of the new section did not impact the consolidated financial statements.

(iii): Employee Share Ownership Plan:

Compensation expense is recognized for the Company's contributions to the Employee Share Ownership Plan. The Company's contributions are made through the issuance of Class B Non-Voting Shares from treasury.

(i): Income taxes:

The Company uses the liability method of accounting for income taxes. Future income tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. When necessary, a valuation allowance is recorded to reduce future income tax assets to an amount where realization is more likely than not. Future income tax assets and liabilities are measured using enacted or substantively enacted tax laws and rates in effect for the year in which those temporary differences are expected to be recovered or settled. The effect on future income tax assets and liabilities of a change in tax laws and rates is recognized as part of the provision for income taxes in the period that includes the enactment date (or the period in which the changes in rates are substantively enacted).

(j): Loss per common share:

Effective January 1, 2001, the Company adopted retroactively the treasury stock method of calculating diluted earnings per share in accordance with HB 3500. The treasury stock method includes only those unexercised options and warrants where the average market price of the common shares during the period exceeds the exercise price of the options and warrants. In addition, this method assumes that the proceeds would be used to purchase common shares at the average market price during the period.

The change in the method of calculation of loss per share did not impact basic and diluted loss per share for 2001 and 2000.

As a result of net losses for the years ended December 31, 2002, 2001 and 2000, respectively, the effect of converting stock options and warrants has not been included in the calculation of diluted loss per common share because to do so would be anti-dilutive.

(k)

Recent pronouncements:

(i): Effective January 1, 2003, the Company will adopt AcG-14, "Disclosure of Guarantees," which requires a guarantor to disclose significant information about guarantees it has provided, without regard to whether it will have to make any payments under the guarantees and in addition to the accounting and disclosure requirements of HB 3290, "Contingencies." The Guideline is generally consistent with disclosure requirements for guarantees in the United States (Financial Accounting Standard Board ("FASB") Interpretation No. 45) but, unlike the FASB's guidance, does not apply to product warranties and does not encompass recognition and measurement requirements. The Company has evaluated the impact of adoption of AcG-14 and the disclosures are included in note 23(b)(ii).
(ii): In December 2002, the CICA issued HB 3063, "Impairment or Disposal of Long-Lived Assets" and revised HB 3475, "Disposal of Long-Lived Assets and Discontinued Operations." These sections supersede the write-down and disposal provisions of HB 3061, "Property, Plant and Equipment" and HB 3475, "Discontinued Operations." The new standards are consistent with U.S. GAAP. HB 3063 establishes standards for recognizing, measuring and disclosing impairment of long-lived assets held-for-use. An impairment is recognized when the carrying amount of an asset to be held and used, exceeds the projected future net cash flows expected from its use and disposal, and is measured as the amount by which the carrying amount of the asset exceeds its fair value. HB 3475 provides specific criteria for and requires separate classification for assets held-for-sale and for these assets to be measured at the lower of their carrying amounts or fair value, less costs to sell. HB 3475 also broadens the definition of discontinued operations to include all distinguishable components of an entity that will be eliminated from operations. HB 3063 is effective for the Company's 2004 fiscal year, however, early application is permitted. Revised HB 3475 is applicable to disposal activities committed to by the Company after May 1, 2003, however, early application is permitted. The Company is currently evaluating the effect of the adoption of these standards on its financial position, results of operations and cash flows.

3. Acquisitions and dispositions:

Details of business acquisitions during 2001 and 2000 are as follows. Consideration was satisfied in cash unless otherwise noted below.

			2000
	2001 MONTAGE		2000
	2001 MONTAGE		Contour		Brak		Netcom		DMC
	(b)		(c)		(d)		(e)		(f)
Current assets	$	15,493	$	10,373	$	4,044	$	6,192	$	3,993
Capital assets		4,717		7,093		548		—		501
Other assets		—		694		990		5,545		—
Goodwill		51,029		70,032		29,554		66,892		92,309

		71,239		88,192		35,136		78,629		96,803
Current liabilities		11,869		11,337		4,708		11,157		1,308
Long-term debt		—		6,875		202		—		—

		11,869		18,212		4,910		11,157		1,308

Purchase price	$	59,370	$	69,980	$	30,226	$	67,472	$	95,495

(a): On May 1, 2001, the Company disposed of certain call centres. Proceeds on disposition were $3.6 million in cash. The disposition generated a loss on sale of $8.9 million.
(b): Acquisition of MONTAGE eIntegration Inc.:

On June 1, 2001, the Company acquired all of the issued and outstanding shares of MONTAGE eIntegration Inc. ("MONTAGE"). MONTAGE is a Canadian E-Business solutions integrator focused on transforming traditional organizations into connected enterprises through internet technologies. Consideration of $58.4 million was paid on closing, comprised of $13.7 million in cash and $44.7 million, represented by 967,355 Class B Non-Voting Shares of the Company. In addition, acquisition costs of $1.0 million were incurred. The vendors had the potential to earn up to an additional $30.0 million contingent upon the attainment by June 30, 2002 of certain specified performance targets. As determined at June 30, 2002, no additional consideration was earned.

(c): Acquisition of Contour Telecom Inc. (Canada) (formerly TigerTel Inc.):

On January 6, 2000, the Company acquired all of the issued and outstanding shares of Contour Telecom Inc. (Canada) (formerly TigerTel Inc. ("Contour")), a Canadian business telecommunications provider.

(d): Acquisition of Brak Systems Inc.:

On March 20, 2000, the Company acquired all of the issued and outstanding shares of Brak Systems Inc. ("Brak"), a Canadian internet security company.

(e): Acquisition of Netcom Canada Holding Inc.:

On April 10, 2000, the Company exercised its right to acquire the remaining 49% of issued and outstanding shares, not previously owned by the Company, of Netcom Canada Holding Inc. ("Netcom"), an internet service provider for U.S. $46.2 million (Cdn. $67.5 million) in cash.

(f): Acquisition of DMC Inc.:

On May 31, 2000, the Company acquired all of the issued and outstanding shares of DMC Inc. ("DMC"), a Canadian business specializing in the deployment of business-focused internet and E-Business strategies and solutions. Purchase consideration of $95.5 million, recorded at the date of acquisition, was funded by a combination of the issuance of 769,231 Class B Non-Voting Shares priced at market on date of acquisition and $50 million in cash.

(g): Shared Technologies of Canada:

On July 18, 2000, the Company reduced its ownership in Shared Technologies of Canada ("STOC") from 70% to 15%. Proceeds on disposition were $16.5 million: $13.6 million received in cash and a receivable of $2.9 million. STOC also repaid intercompany loans owing of $4.5 million. The disposition generated a gain on sale of $13.0 million before income taxes. During 2002, the Company disposed of its remaining 15% investment in STOC for net proceeds of $2.2 million (note 7(d)).

Unaudited pro forma consolidated financial information:

The following unaudited pro forma consolidated financial information reflects the acquisitions of Contour, Brak, Netcom, DMC and MONTAGE as if these transactions had occurred on January 1, 2000:

		2001			2000
		(Restated — note 2(g))
Revenue		$	1,568,655		$	1,560,729
Expenses:
	Service costs		1,020,851			1,068,704
	Selling, general and administrative expenses		395,208			430,368
Integration costs, provision for restructuring and workforce reduction			21,901			(10,249	)
Depreciation and amortization			470,309			422,780

Loss from operations			(339,614	)		(350,874	)
Other income (expense):
	Interest expense, net		(382,094	)		(302,064	)
	Foreign exchange loss		(10,097	)		—
	Other income (expense)		(6,989	)		13,874

			(399,180	)		(288,190	)
Loss before minority interest and income taxes			(738,794	)		(639,064	)
Minority interest			—			101,983
Income taxes			9,580			6,073

Loss for the year		$	(748,374	)	$	(543,154	)

Basic and diluted loss per common share		$	(7.60	)	$	(5.68	)

This financial information has not been adjusted to give effect to the dispositions of STOC and certain call centres on July 18, 2000 and May 1, 2001, respectively. The pro forma consolidated financial information has been provided for information purposes only and is not necessarily indicative of the results of operations that actually would have been achieved if the acquisitions had been completed on January 1, 2000, or that may be reported in the future.

4. Cash and cash equivalents:

		2002		2001
Cash on deposit:
	Canadian dollar	$	78,551	$	10,139
	U.S. dollar		4,827		214
Short-term investments, at rates of interest varying between 1.25% and 3.08%:
	Canadian dollar		309,436		481,434
	U.S. dollar		27,728		45,507

		$	420,542	$	537,294

5. Property, plant and equipment:

2002	Cost		Accumulated depreciation		Net book value
Telecommunications facilities and equipment	$	2,015,809	$	1,326,781	$	689,028
Land and buildings		147,554		96,257		51,297
Other capital assets		608,561		472,890		135,671
Equipment under capital leases		31,018		20,751		10,267
Application software		173,577		118,697		54,880
Leasehold improvements		31,317		19,761		11,556

	$	3,007,836	$	2,055,137	$	952,699

2001	Cost		Accumulated depreciation		Net book value
Telecommunications facilities and equipment	$	2,060,341	$	483,964	$	1,576,377
Land and buildings		169,516		41,601		127,915
Other capital assets		600,911		254,104		346,807
Equipment under capital leases		28,542		6,430		22,112
Application software		163,253		73,965		89,288
Leasehold improvements		31,115		12,841		18,274

	$	3,053,678	$	872,905	$	2,180,773

As of December 31, 2002, property, plant and equipment include $5.9 million (2001 — $16.9 million) of property, plant and equipment under construction that are not in service and, accordingly, have not been depreciated. Interest capitalized to property, plant and equipment during 2002 amounted to $0.3 million (2001 — $0.9 million) and has been calculated using the Company's weighted average cost of debt of 11.5% (2001 — 11.5%) applied to the monthly amount expended in networks in progress that are not in service.

In the second quarter of 2002, the Company assessed the carrying amounts of its long-lived assets for impairment. The assessment was performed due to regulatory decisions issued in the first half of 2002 affecting the Company's business plan, the deterioration of the economic environment and the substantial decline in market value of companies in the telecommunications services sector.

An impairment was assessed based on a comparison of the net recoverable amount, using projected future undiscounted cash flows, to the carrying amount of the long-lived assets. The impairment charge of $1,095.0 million for certain property, plant and equipment, predominately telecommunication facilities and equipment, was measured as the deficiency between the carrying amount and the net recoverable amount, and has been recorded as a charge to earnings and an increase in accumulated depreciation.

An additional assessment for impairment of the carrying values of the Company's long-lived assets was performed due to the brand transition and changes in ownership as contemplated in the Plan in the fourth quarter of 2002. It was determined based on this assessment that projected future undiscounted cash flows exceeded the carrying amount of the Company's property, plant and equipment, and there was no further impairment.

6. Goodwill and other intangible assets:

(a): Goodwill:

The change in the carrying amount of goodwill for the year ended December 31, 2002 is shown below:

		Balance, December 31, 2001			Transitional impairment			Impairment in 2002			Other			Balance, December 31, 2002
Goodwill		$	1,639,065		$	(1,530,767	)	$	(108,228	)	$	(70	)	$	—

Net goodwill as at December 31, 2001 consisted of cost of $1,913.2 million less accumulated amortization of $274.1 million.

In the second quarter of 2002, the Company completed its transitional goodwill impairment test as a result of adopting HB 3062, and determined that unamortized goodwill of $1,530.8 million as at January 1, 2002, was impaired under the fair value approach. The one-time transitional adjustment for the impairment assessment was charged to opening deficit with a corresponding reduction in goodwill. During the second quarter of 2002, the Company also performed an assessment for impairment of the carrying amount of its remaining goodwill due to the circumstances described in note 5. It was determined that the remaining unamortized goodwill of $108.2 million was also impaired under the fair value approach.

(b): Other intangible assets:

The following table summarizes the Company's other intangible assets for the year ended December 31:

2002	Cost		Accumulated amortization		Net book value
Customer lists	$	4,025	$	2,547	$	1,478
Right-of-way agreements		702		148		554
Ghz licenses		7,904		2,371		5,533
Non-compete agreements		33,633		33,633		—

	$	46,264	$	38,699	$	7,565

2001	Cost		Accumulated amortization		Net book value
Customer lists	$	4,016	$	937	$	3,079
Right-of-way agreements		702		111		591
Ghz licenses		7,904		1,581		6,323
Non-compete agreements		33,633		29,095		4,538

	$	46,255	$	31,724	$	14,531

Aggregate amortization expense for intangible assets with definite lives for the year ended December 31, 2002 was $6.7 million. The weighted average amortization period is six years, with estimated amortization expense for the next five years, as follows:

2003	$	2,440
2004		827
2005		827
2006		827
2007		827

The Company did not have any intangible assets with an indefinite life as at December 31, 2002 and 2001.

7. Other assets:

2002	Cost		Accumulated amortization		Net book value
Debt issuance costs (note 7(e))	$	79,303	$	39,840	$	39,463
Long-term investments, at cost, less write-downs (note 7(c))		470		—		470
Restricted cash (note 7(a))		13,500		—		13,500
Other (note 7(c))		3,848		296		3,552

	$	97,121	$	40,136	$	56,985

2001	Cost		Accumulated amortization		Net book value
Debt issuance costs	$	78,926	$	27,602	$	51,324
Retained interest on accounts receivable securitization (note 7(b))		49,829		—		49,829
Long-term investments, at cost		10,745		—		10,745
Other		6,652		843		5,809

	$	146,152	$	28,445	$	117,707

(a): As at December 31, 2002, the Company has restricted cash comprising cash held in trust of $13.5 million, which represents further protection for the directors and officers of the Company with respect to their potential personal liability for certain statutory liabilities. The restrictions will terminate upon the earlier of (i) December 31, 2008 and (ii) three years from the date of the last claim being conclusively resolved.
(b): In 2001, the Company sold accounts receivable under a securitization program with a special purpose trust for initial proceeds of $100 million and recorded a loss of $0.4 million, representing the cost relating to establishing the agreement at the date of the sale. Under the terms of the securitization agreement, the Company had the ability to sell certain of its accounts receivable on a revolving basis through securitization transactions at varying monthly limits. The maximum cash proceeds that could be funded under the program were $150 million. The accounts receivable pool consisted of the Company's trade accounts receivable for telecommunications products and services rendered. On February 20, 2002, the Company repurchased, for approximately $100 million, all of the outstanding accounts receivable sold under their securitization program.

The securitization agreement included the requirement that the Company maintain an investment grade credit rating from both Moody's Investor Services Inc. and Standard & Poor's Rating Services.

(c): In 2002, the Company determined there was an other than temporary decline in the value of its long-term investments and other assets, and recorded a write-down of $8.8 million and $3.1 million, respectively. The determination was based on recent market valuations.
(d): In the second quarter of 2002, the Company sold its remaining interest in STOC for net proceeds of $2.2 million.
(e): The Company recorded a write-off of $2.3 million of unamortized debt issuance costs related to the senior credit facility which was terminated on October 9, 2002 (see note 8(c)).

8. Liabilities subject to compromise and long-term debt:

The liabilities subject to compromise as at December 31, 2002 and long-term debt as of December 31, 2001 are as follows:

		Liabilities subject to compromise				Long-term debt
		2002				2001
	Effective interest rate	2002				2001
	Effective interest rate	Cdn.		U.S.		Cdn.		U.S.
12% unsecured Senior Notes, maturing August 15, 2007		$	356,237	$	225,810	$	395,988	$	248,600
10.75% unsecured Senior Discount Notes, maturing November 1, 2007	11.04%		268,193		170,001		248,227		155,800
9.95% unsecured Senior Discount Notes, maturing June 15, 2008	11.24%		1,440,761		913,262		1,341,482		842,200
10.625% unsecured Senior Notes, maturing November 1, 2008			354,960		225,000		358,380		225,000
7.65% unsecured Senior Notes, maturing September 15, 2006			1,571,255		995,978		1,592,800		1,000,000
7.15% unsecured Senior Notes, maturing September 23, 2004			142,850		—		150,000		—
7.625% unsecured Senior Notes, maturing March 15, 2005			382,568		242,500		398,200		250,000
Senior Credit Facility			—		—		170,000		—

			4,516,824				4,655,077
Accrued interest payable			175,778				—
Accrued liabilities			8,220				—
Other liabilities			18,769				—

		$	4,719,591			$	4,655,077

(a): Liabilities subject to compromise under CCAA proceedings:

Under the CCAA proceedings and the Plan, all of the Company's liabilities to creditors under the Senior Notes, including accrued interest thereon, and certain other affected claims at the Commencement Date, will be compromised subject to the implementation of the Plan. Such liabilities whose treatment and satisfaction are dependent on the outcome of the CCAA proceedings have been segregated and classified as liabilities subject to compromise in the consolidated financial statements.

The Company has followed a court-approved process to prove, administer and adjudicate claims. Notices of claims were mailed to Affected Creditors in November 2002. The last date by which claims against the Company had to be filed with the court-appointed monitor, if the claimants wished to receive any distribution under the CCAA proceedings, was December 23, 2002 ("Claims Bar Date"). If a notice disputing the claim ("Dispute of Claim") had not been received by the Claims Bar Date, the Affected Creditor was deemed to have accepted the claim for both voting and distribution purposes under the Plan. Unknown creditors were also permitted to file a proof of claim by the Claims Bar Date. Separate claims procedures for Affected Creditors other than Noteholders have been established that differentiate claims for voting purposes and distribution purposes under the Plan.

In connection with establishing claims by Noteholders, the Company sent notices to the indenture trustees of each series of Senior Notes, stating the aggregate accrued amount owing under the relevant series up to the Commencement Date. The indenture trustees confirmed the amounts owing under each series. As such, the claims of the Noteholders have been established for voting and distribution purposes pending implementation of the Plan.

Pursuant to the CCAA proceedings, proofs of claim and Disputes of Claims ("Claims") were filed against the Company with the monitor. The Company either accepted the Claims or issued a notice of revision or disallowance for Claims that differ in nature, classification or amount from the Company's records. Where resolution cannot be reached with the Affected Creditor, the claims procedure provides for the adjudication of any disputes by the Court or a Court approved claims officer at the option of the Company. The decision of the Court or claims officer is final and binding pending implementation of the Plan.

The amounts in total may vary from the stated amount of Claims that have been provided to the Company and may be subject to future adjustments depending on the resolution of Claims and/or determinations by the court. Additional claim amounts may also arise.

As of February 25, 2003, 82 claims have been received from Affected Creditors excluding Noteholders. For distribution purposes, as of the same date, 27 Claims have been disallowed in their entirety and 35 Claims, totaling $15.9 million, have been allowed by the Company. The remaining 20 Claims, totaling $106.6 million, are being disputed. In addition, the Company has received five proofs of claim from certain warrant holders which are for unliquidated amounts. These claims have been disallowed by the Company.

Upon implementation of the Plan, claims of Affected Creditors will be compromised and distributed. The determination and ultimate amount of distribution or settlement is subject to an implemented Plan and, therefore, is not currently determinable.

The CCAA proceedings do not allow for principal and interest payments to be made on pre-filing Senior Notes of the Company without Court approval or until the Plan has been implemented. Accordingly, the interest generated subsequent to the Commencement Date no longer accrues to Noteholders and other Affected Creditors if the Plan is implemented. However, the Company has continued to accrue for interest expense on the pre-filing Senior Notes until the Plan is implemented and has classified the amount within liabilities subject to compromise. As at December 31, 2002, interest expense on pre-filing Senior Notes accrued but not paid for the period from October 15, 2002 to December 31, 2002 was $87.1 million.

(b): Long-term debt:

On October 15, 2002, the Company elected not to make interest payments on the Senior Notes totaling approximately U.S. $47.8 million, due on September 15, 2002, and approximately $5.4 million, due on September 23, 2002, related to its 7.65% Senior Notes and 7.15% Senior Notes, respectively, within 30 days from the scheduled interest payment date of the 7.65% Senior Notes. Accordingly, as of October 15, 2002, the Company was in default under the 7.65% Senior Notes and due to cross default provisions in all other series of Senior Notes, the Company has defaulted on all of its outstanding long-term debt. As a result, all of the outstanding long-term debt has either been accelerated or could be accelerated under the terms of the indentures governing these Senior Notes and thus declared due and payable.

On September 24, 2002, the Company unwound all remaining outstanding swaptions and cross-currency swaps as provided for in the agreement, resulting in the Company receiving approximately Cdn. $84.9 million principal amount of certain of its outstanding Senior Notes in satisfaction of the counterparty's settlement obligation to the Company rather than receiving cash (note 17(b)). These Senior Notes are currently being held by the Company and have been recognized as a reduction to the long-term debt outstanding.

(c): Senior Credit Facility (the "Facility"):

On May 24, 2002, the Facility was amended reducing the total facility from $600 million to $400 million. Subsequently, on August 15, 2002, the Facility was amended reducing the total facility from $400 million to approximately $200 million.

On October 9, 2002, the Facility agreement was terminated and the Company repaid the approximately $200 million of outstanding draws, of which $30 million was drawn under the Facility in 2002.

9. Capital lease obligations:

The following is a schedule, by year, of the future minimum lease payments for capital leases, together with the balance of the obligation, as at December 31, 2002:

2003	$	4,819
2004		2,176
2005		1,881
2006		1,850
2007		1,850
2008 and thereafter		18,500

Total minimum lease payments		31,076
Less imputed interest at rates varying from 7.5% to 11.8%		10,523

Balance of the obligations		20,553
Less current portion		3,952

	$	16,601

10. Share capital:

On October 8, 2002, Brascan Financial Corporation and CIBC Capital Partners completed the purchase of all of the outstanding shares of the Company that AT&T Corp. did not previously own for Cdn. $51.21 per share, in cash (the "Back-end"). Upon completion of the Back-end, 1519888 Ontario Limited, a wholly owned subsidiary of Tricap Investments Corp., itself a wholly owned subsidiary of Brascan Financial Corp., had approximately a 63% equity interest and a 50% voting interest in the Company, and 1520034 Ontario Limited, a wholly owned subsidiary of CIBC Capital Partners ("CIBC") had approximately a 6% equity interest and approximately a 27% voting interest in the Company. AT&T Corp. retained the balance of its ownership of the Company, which represents approximately a 31% equity interest and a 23% voting interest, and has a call right on CIBC's voting shares. Subsequent to the closing of the Back-end, one of the Company's warrant holders exercised warrants that resulted in the issuance of approximately 17,000 Class B Non-Voting Shares.

Following the closing of the Back-end on October 8, 2002 the Company's Class B Deposit Receipts were de-listed by the TSX and NASDAQ.

(a): Authorized:

Common:		Unlimited number of convertible Class A Voting Shares without nominal or par value, each Class A Share has one vote, and unlimited number of Class B Non-Voting Shares without nominal or par value. Other than with respect to voting rights and conversion rights, the two classes of common shares have identical rights. Each Class A Voting Share may, under certain circumstances at the option of the holder, be converted into one Class B Non-Voting Share. Each Class B Non-Voting Share may, under certain circumstances at the option of the holder, be converted into one Class A Voting Share. The holders of Common Shares are entitled to receive dividends, as determined by the Board of Directors, subject to the rights of the holders of the Preferred Shares. The holders of Common Shares are also entitled to participate equally in the event of liquidation of the Company, subject to the rights of the holders of the Preferred Shares.
Preferred:		Unlimited number of Non-Voting Preferred Shares without nominal or par value. The Preferred Shares may be issued in one or more series. The Board of Directors of the Company may fix the number of shares in each series and designate rights, privileges, restrictions, conditions and other provisions. The Preferred Shares shall be entitled to preference over any other shares of the Company with respect to the payment of dividends and in the event of liquidation of the Company.

Upon all the restrictions of the foreign ownership of voting shares being removed by an amendment to the Telecommunications Act, the Class B Non-Voting Shares will be converted into Class A Voting Shares on a one-for-one basis.

(b): Outstanding:

Common shares:

	Number of shares (000's)
	Non-Voting Class B	Voting Class A	Total
Balances, December 31, 1999	310	93,561	93,871
Issued — options (note 11)	—	1,959	1,959
Issued for acquisitions (note 3(f))	—	769	769
Issued — warrants (note 10(c))	—	155	155
Issued — ESOP (note 11)	—	40	40

Balances, December 31, 2000	310	96,484	96,794
Issued — options (note 11)	—	2,097	2,097
Issued for acquisitions (note 3(b))	—	967	967
Issued — warrants (note 10(c))	—	121	121
Issued — ESOP (note 11)	—	27	27

Balances, December 31, 2001	310	99,696	100,006
Issued — options (note 11)	—	7,133	7,133
Issued — warrants (note 10(c))	—	53	53
Issued — ESOP (note 11)	—	24	24

Balances, December 31, 2002	310	106,906	107,216

Class	Voting A		Non-Voting B		Total
Balances, December 31,1999	$	416	$	956,281	$	956,697
Issued — options (note 11)		—		33,629		33,629
Issued for acquisitions (note 3(f))		—		45,385		45,385
Issued — warrants (note 10(c))		—		620		620
Issued — ESOP (note 11)		—		2,734		2,734

Balances, December 31, 2000		416		1,038,649		1,039,065
Issued — options (note 11)		—		48,244		48,244
Issued for acquisitions (note 3(b))		—		44,666		44,666
Issued — warrants (note 10(c))		—		483		483
Issued — ESOP (note 11)		—		1,206		1,206

Balances, December 31, 2001		416		1,133,248		1,133,664
Issued — options (note 11)		—		259,022		259,022
Issued — warrants (note 10(c))		—		213		213
Issued — ESOP (note 11)		—		1,095		1,095

Balances, December 31, 2002	$	416	$	1,393,578	$	1,393,994

The Plan contemplates the cancellation of all outstanding classes of shares without compensation as of the Plan Implementation Date (note 1).

(c): Warrants:

	Number (000's)		Amount
Balances, December 31,1999	132		$	1,812
Exercised for shares	(45	)		(620	)

Balances, December 31, 2000	87			1,192
Exercised for shares	(35	)		(483	)

Balances, December 31, 2001	52			709
Exercised for shares	(16	)		(213	)

Balances, December 31, 2002	36		$	496

Warrants entitle the holder thereof to acquire 3.429 Class B Non-Voting Shares at an exercise price of U.S. $0.01, expiring August 15, 2007. The warrants were issued as part of the issue of the 12% Senior Notes described in note 8.

The Plan contemplates the cancellation of all warrants as of the Plan Implementation Date (note 1).

11. Share purchase options:

The Board of Directors established two stock option plans under which options to purchase Class B Non-Voting Shares are granted to directors, officers and employees of the Company. Pursuant to the stock option plans, 17.5 million Class B Non-Voting Shares have been reserved for options. These options were granted at exercise prices estimated to be at least equal to the fair value of Class B Non-Voting Shares, vest over a three-year period and generally expire five years from the date of grant.

In accordance with the Company's stock option plans, all unvested outstanding stock options became vested and exercisable on September 28, 2002 as a result of the Back-end. The Company received $225.4 million in proceeds on October 8, 2002 when 5.8 million of employee options were exercised. Subsequent to the Back-end, no more options were issued under these plans.

	Number of options (000's)		Exercise prices per share					Weighted average exercise price
Outstanding, December 31, 1999	10,019		$	2.25	-	$	58.25	$	28.17
Granted	3,760			42.70	-		90.00		56.28
Cancelled	(1,342	)		2.25	-		90.00		47.97
Exercised	(1,959	)		0.50	-		45.10		17.19

Outstanding, December 31, 2000	10,478			2.25	-		90.00		37.80
Granted	996			44.20	-		47.96		45.67
Cancelled	(587	)		14.00	-		90.00		49.42
Exercised	(2,097	)		2.25	-		45.10		22.79

Outstanding, December 31, 2001	8,790			2.25	-		90.00		41.39
Granted	846			37.99	-		48.05		43.38
Cancelled	(810	)		14.00	-		90.00		53.29
Exercised	(7,133	)		2.25	-		51.00		36.28

Outstanding, December 31, 2002	1,693			17.25	-		90.00		58.10

At December 31, 2002, 1.7 million options (2001 — 4.9 million; 2000 — 4.2 million) were exercisable at a weighted average exercise price of $58.10 per share (2001 — $35.80; 2000 — $22.83).

The Plan contemplates the termination of all unexercised options under these plans as of the Plan Implementation Date, without compensation (note 1).

The following table summarizes information concerning options outstanding and exercisable at December 31, 2002:

	Options outstanding and exercisable
Range of exercise prices	Number outstanding (000's)	Weighted average remaining contractual life (years)	Weighted average exercise price
$17.00 - $45.00	9	1.8	$	37.40
$45.01 - $54.00	717	2.2		53.28
$54.01 - $63.00	495	2.4		56.27
$63.01 - $72.00	408	2.2		65.50
$72.01 - $81.00	21	2.2		74.73
$81.01 - $90.00	43	2.2		85.49

	1,693	2.2		58.10

As permitted by HB 3870, the Company did not adopt the fair value method of accounting for its employee stock option awards. The standard requires the disclosure of pro forma loss for the year and loss per share as if the Company had accounted for employee stock options under the fair value method. Had the Company adopted the fair value method for employee stock options using the fair value method described in note 2(h), loss for the year and loss per share would have increased for the year ended December 31, 2002 as indicated below:

Loss attributable to common shareholders — as reported	$	(1,831,659	)
Stock-based compensation expense		(24,677	)

Loss attributable to common shareholders — pro forma	$	(1,856,336	)

Basic and diluted loss per common share — as reported	$	(17.95	)
Basic and diluted loss per common share — pro forma		(18.19	)

Weighted average number of shares outstanding (in thousands)		102,047

The pro forma stock-based compensation expense recorded during the year related to grants issued subsequent to January 1, 2002 totalled $1.5 million or ($0.02) per share.

For purposes of the above pro forma disclosures, options granted were valued using the Black-Scholes option pricing model with the following weighted average assumptions:

	2002	2001	2000
Risk-free interest rate (%)	4.8%	5.1%	6.2%
Expected volatility (%)	31.3%	35.7%	5.4%
Expected life (in years)	1.23	5	5
Expected dividends	—	—	—

The Black-Scholes option pricing model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. Option pricing models also require estimates, which are highly subjective, including expected volatility of the underlying stock. The Company bases estimates of volatility on historical stock prices. Changes in assumptions can materially affect estimates of fair values.

Options granted during the year had a weighted average fair value of $7.21 (2001 — $18.33; 2000 — $15.16).

Employee Share Ownership Plan ("ESOP"):

The ESOP offered all full-time permanent employees the opportunity to purchase securities of the Company. Employees were able to contribute between 1% and 5% of their salary to buy units in a single stock mutual fund, the Company's Stock Fund, which in turn held only Class B Non-Voting Shares. The Company contributed the equivalent of 25% of participant contributions per quarter. The Company's contributions were made through the issuance of Class B Non-Voting Shares from treasury. 200,000 Class B Non-Voting Shares have been authorized for issuance for this purpose. In 2002, the Company issued 23,396 shares (2001 — 26,592; 2000 — 40,253) under the plan and recorded compensation expense of $1.1 million (2001 — $1.2 million; 2000 — $2.7 million). Effective August 31, 2002, the plan was terminated.

12. Workforce reduction and provision for restructuring:

(a): 2002:

		Net provision		Cash drawdown			Reclassifications			Provision, December 31, 2002
Provision for restructuring:
	2002 Workforce reduction costs	$	52,925	$	(30,400	)	$	—		$	22,525
	2002 Facilities consolidation		34,144		(3,167	)		(18,185	)		12,792

		$	87,069	$	(33,567	)	$	(18,185	)	$	35,317

In 2002, the Company implemented a cost reduction initiative to bring the Company's cost structure in line with its current and projected revenue base, and to allocate resources to further enhance services provided to its established customer base. As a result, the Company recorded a provision of $87.0 million related to these activities.

The charge of $87.0 million is comprised of $52.9 million for employee severance and $34.1 million related to facilities consolidation. Employee severance costs are the result of a reduction in workforce of approximately 1,250 personnel, achieved through terminations, attrition and non-renewal of contract personnel. These personnel were from various areas across the Company, including network services, customer service, marketing, sales and administration. As at December 31, 2002, 1,217 workforce reductions had been completed and $30.4 million of the employee severance costs have been paid. The remaining liability balance of $22.5 million at December 31, 2002 represents salary continuance payments in accordance with employee severance agreements and/or statutory minimum severance requirements.

The provision for facilities consolidation of $34.1 million comprised an initial provision of $34.4 million which was reduced by $0.3 million as certain facilities were subleased earlier than planned. The provision for facilities consolidation represents management's best estimate of the deficiency of expected sublease recoveries over costs associated with certain leased premises being exited as a result of the restructuring plan. These facility leases will expire between 2002 and 2012. The provision will be drawn down over the remaining term of the leases. As at December 31, 2002, the provision was drawn down by $3.2 million. Pursuant to the CCAA proceedings described in note 1, the liabilities related to certain unused leased premises will be compromised and $18.2 million of the provision for facility consolidation costs has been reclassified to liabilities subject to compromise (note 8(a)). Of the remaining provision, $5.0 million has been included in other long-term liabilities.

(b): 2001:

During 2001, management approved and carried out a workforce reduction plan and recorded a provision of $21.9 million for severance and benefits related to the termination of approximately 650 personnel, achieved through terminations, attrition and non-renewal of contract personnel. The personnel terminated were from various areas across the Company, including marketing, network services, customer service, internet and IT services and administration. The Company had substantially completed the terminations as at December 31, 2001. During 2002, the remaining provision of $6.3 million was drawn down.

(c): 2000:

In 2000, the Company adjusted charges recorded in 1999 as a result of negotiation of lower expenditures than originally anticipated and the impact of changes in the real estate market that made it uneconomical to exit certain properties and recorded a reversal of previously recorded charges of $10.2 million. In 2001, the remaining balance of the 1999 charge was drawn down through payments related to lease contract penalties and settlement of lawsuits. The related activities have been completed.

13. Other income (expense):

	2002			2001			2000
Gain (loss) on disposition of STOC (note 7(d))	$	(1,502	)	$	—		$	13,011
Loss on disposition of certain call centres (note 3(a))		—			(8,894	)		—
Other		(723	)		(1,903	)		728

	$	(2,225	)	$	(10,797	)	$	13,739

14. Reorganization expenses:

The Company incurred the following pretax charges for expenses associated with its reorganization under the Plan, as described in note 1:

	2002
Professional fees and other costs	$	7,440
Interest earned on cash accumulated during CCAA proceedings		(375	)

	$	7,065

Professional fees and other costs include legal, financial advisory, accounting and consulting fees incurred subsequent to the filing of the application for creditor protection under the CCAA.

15. Income taxes:

The Company uses the liability method of accounting for income taxes. The tax effects of temporary differences that give rise to significant portions of future income tax assets and liabilities are as follows:

		2002			2001
Future tax assets:
	Future income tax deductions	$	93,172		$	56,244
	Operating loss carryforwards		755,624			794,172
	Deferred foreign exchange		65,569			28,774
	Accounting depreciation booked in excess of amount claimed for tax		409,945			—

	Total future tax assets		1,324,310			879,190
Future tax liabilities:
	Deferred pension asset		(21,997	)		(14,748	)
	Debt and share issue costs		(9,847	)		(6,717	)
	Tax depreciation claimed in excess of depreciation booked		—			(119,926	)

	Total future tax liabilities		(31,844	)		(141,391	)

			1,292,466			737,799
Valuation allowance			(1,292,466	)		(737,799	)

Net future income tax assets		$	—		$	—

The reconciliation of the tax provision for income taxes, which consists only of current taxes, to amounts computed by applying federal and provincial tax rates to loss before minority interest and provision for income taxes is as follows:

		2002				2001				2000
Computed at combined statutory rate		$	(702,593	)	38.5 %	$	(308,238	)	41.8 %	$	(270,481	)	43.5 %
Tax effect of:
	Expenses not deductible for income tax purposes		15,293		(0.8)%		4,210		(0.5)%		1,639		(0.3)%
	Write-off and amortization of non-deductible goodwill		41,697		(2.3)%		46,117		(6.3)%		41,419		(6.6)%
	Income not taxable for income tax purposes		(3,128	)	0.2 %		(891	)	0.1 %		(1,867	)	0.3 %
	Large Corporations Tax		6,741		(0.4)%		7,965		(1.1)%		5,686		(0.9)%
	Reduction in tax assets as a result of loss expiry		5,253		(0.3)%		149,809		(20.3)%		153,670		(24.7)%
	Effect of reduction in tax rates		90,073		(5.0)%		149,317		(20.2)%		149,917		(24.1)%
	Change in valuation allowance		554,667		(30.4)%		(51,180	)	6.9 %		(126,568	)	20.3 %
	Other		(1,262	)	0.1 %		10,856		(1.5)%		52,271		(8.4)%

		$	6,741		(0.4)%	$	7,965		(1.1)%	$	5,686		(0.9)%

At December 31, 2002, the Company has non-capital losses of approximately $2.252 billion, available to reduce future years' taxable income, including any gain on the settlement of liabilities subject to compromise, which expire as follows:

2003	$	190,900
2004		172,100
2005		308,300
2006		169,300
2007		586,700
2008		519,400
2009		255,900
2010		49,900

	$	2,252,500

Certain amendments to tax filings may be made to avoid the expiry of losses that would otherwise expire in 2003.

16. Employee benefits:

The Company provides a number of retirement benefits, including defined benefit plans, providing pension, other retirement and post-employment benefits to most of its employees.

(a): The total expense (income) for the Company's defined benefit plans is as follows:

		2002			2001			2000
Plans providing pension benefits		$	8,661		$	(26,860	)	$	5,627
Plans providing other benefits			952			505			474

The average remaining service periods of the active employees covered by the pension plans range from 11 to 13 years (2001 — 10 to 14 years; 2000 — 10 to 12 years).

The average remaining service period of the active employees covered by the post-retirement life insurance program is 13 years (2001 — 13 years; 2000 — 13 years).

The average remaining life expectancy of the former employees covered by the post-retirement medical and dental insurance programs is 15 years (2001 — n/a; 2000 — n/a).

Information about the Company's defined benefit and other retirement benefit plans as at December 31, 2002, 2001 and 2000, in aggregate, is as follows:

		2002						2001						2000
		Pension benefit plans			Other benefit plans			Pension benefit plans			Other benefit plans			Pension benefit plans			Other benefit plans
Accrued benefit obligation:
	Balance, beginning of year	$	535,475		$	6,152		$	477,665		$	5,390		$	443,824		$	5,965
	Interest cost		34,260			728			34,158			379			33,218			353
	Actuarial loss (gain)		134			(335	)		46,514			374			32,146			(1,012	)
	Current service cost		7,069			173			7,543			227			6,769			213
	Employees' contributions		2,826			—			2,867			—			2,397			—
	Plan amendments		—			5,638			4,711			—			1,031			—
	Benefits paid		(48,521	)		(416	)		(38,349	)		(192	)		(37,320	)		(129	)
	Settlements		—			—			—			—			(4,400	)		—
	Curtailment loss (gain)		120			(263	)		366			(26	)		—			—

Balance, end of year		$	531,363		$	11,677		$	535,475		$	6,152		$	477,665		$	5,390

Plan assets:
	Fair value, beginning of year	$	488,727		$	—		$	541,237		$	—		$	528,069		$	—
	Actual return on plan assets		(43,975	)		—			(24,716	)		—			44,953			—
	Employer contributions		18,824			416			7,688			192			7,538			129
	Accrued employer contributions		5,093			—			—			—			—			—
	Employees' contributions		2,826			—			2,867			—			2,397			—
	Benefits paid		(48,521	)		(416	)		(38,349	)		(192	)		(37,320	)		(129	)
	Settlements		—			—			—			—			(4,400	)		—

Fair value, end of year		$	422,974		$	—		$	488,727		$	—		$	541,237		$	—

	2002						2001						2000
	Pension benefit plans			Other benefit plans			Pension benefit plans			Other benefit plans			Pension benefit plans			Other benefit plans
Funded status — plan surplus (deficit)	$	(108,389	)	$	(11,677	)	$	(46,748	)	$	(6,152	)	$	63,572		$	(5,390	)
Unrecognized actuarial loss (gain)		165,491			(1,334	)		87,110			(1,061	)		(21,940	)		(1,510	)
Unrecognized prior service costs		3,328			5,262			4,812			—			928			—

Accrued benefit asset (liability)		60,430			(7,749	)		45,174			(7,213	)		42,560			(6,900	)
Valuation allowance (note 16(b))		—			—			—			—			(31,934	)		—

Accrued benefit asset (liability), net of valuation allowance	$	60,430		$	(7,749	)	$	45,174		$	(7,213	)	$	10,626		$	(6,900	)

The accrued benefit liability for other benefit plans is included in other long-term liabilities.

The significant actuarial assumptions adopted in measuring the Company's accrued benefit obligations are as follows (weighted average assumptions as of December 31, 2002, 2001 and 2000):

	2002		2001		2000
	Pension benefit plans	Other benefit plans	Pension benefit plans	Other benefit plans	Pension benefit plans	Other benefit plans
Discount rate	6.5%	6.5%	6.5%	6.5%	7.0%	7.0%
Expected long-term rate of return on plan assets	7.75%	—	8.0%	—	8.0%	—
Rate of compensation increase	3.5%	—	3.5%	—	3.5%	—

The Company's net benefit plan expense for the year ended December 31, 2002, 2001 and 2000 is as follows:

	2002						2001						2000
	Pension benefit plans			Other benefit plans			Pension benefit plans			Other benefit plans			Pension benefit plans			Other benefit plans
Current service cost	$	7,069		$	173		$	7,543		$	227		$	6,769		$	213
Interest cost		34,260			728			34,158			379			33,218			353
Expected return on plan assets		(38,335	)		—			(38,711	)		—			(37,397	)		—
Prior service costs amortization		475			376			574			—			103			—
Valuation allowance (reversed) provided against accrued benefit asset (note 16(b))		—			—			(31,934	)		—			2,937			—
Actuarial loss (gain) recognized		2,363			(62	)		(24	)		(75	)		(3	)		(92	)
Curtailment loss		2,829			(263	)		1,534			(26	)		—			—

Net benefit plan expense (income)	$	8,661		$	952		$	(26,860	)	$	505		$	5,627		$	474

(b): Change in valuation allowance:

An accrued benefit asset arises when the accumulated cash contributions to a pension plan exceed the accumulated pension expense. The accrued benefit asset on an employer's books is comprised of two components:

(i): plan surplus (i.e., the excess of the fair value of the plan assets over the accrued benefit obligation of the plan); and
(ii): net unrecognized (gains) losses (i.e., the sum of the unamortized past service costs, actuarial (gains) and losses and any transitional (asset) or transitional obligation).

The expected future benefit from a surplus is generally the present value of employer contribution holidays expected in future years. However, if there is a net unrecognized loss, the accrued benefit asset will be expected to decrease over time due to the amortization of the net unrecognized loss. As a result, the accrued benefit asset on an employer's books cannot exceed the sum of the expected employer future benefit and any net unrecognized losses. When the accrued benefit asset first exceeds the limit, a valuation allowance is established in order to keep the accrued benefit asset on an employer's books at the limit. In future accounting periods, any change in the valuation allowance is recorded through the consolidated statements of operations.

At December 31, 2000, the accrued benefit asset relating to the Company's defined benefit pension plans was affected by the limit and contained a cumulative valuation allowance of $31.9 million. The impact of negative returns on plan assets in the Company's defined benefit pension plans was an elimination of the pension surplus and generation of unamortized losses at December 31, 2001. Under generally accepted accounting principles, the limit on the accrued benefit asset is required to be increased by the amount of the losses that will be charged as an expense in future years, resulting in a reduction in the valuation allowance and a credit to the pension expense amount of the Company. The impact of the above is that the valuation allowance of $31.9 million was no longer required and was recognized in income in 2001.

At December 31, 2002, the Company had unfunded solvency deficits under its defined benefit pension plans of approximately $135 million. The Company is required to fund this deficit over a five-year period.

17. Financial instruments:

(a): Fair values of financial assets and liabilities:

The fair values of cash and cash equivalents, accounts receivable, accounts payable, accrued liabilities and accrued interest payable approximate their carrying values due to the short-term nature of these instruments. The settlement amount of liabilities subject to compromise is not determinable and will be subject to the Plan approved by the Court (note 8).

The fair value of the Senior Notes, including the attached warrants, at December 31, 2002, was approximately $743.0 million (2001 — $3,022.1 million), based on current trading values.

Certain foreign currency financial instruments were unwound in the second quarter of 2002 and the remaining foreign currency financial instruments were unwound on September 24, 2002.

(b): Foreign currency risk:

The Company is exposed to foreign currency fluctuations on its U.S. dollar-denominated debt, cash and cash equivalents.

As described below, in May and September 2002, the Company monetized all remaining outstanding swaptions, cross-currency swaps and forward contracts. The deferred gains are being recognized in income over the remaining original contractual term to maturity of the underlying debt for which these derivatives were designated as cash flow hedges.

On September 24, 2002, the Company received approximately Cdn. $84.9 million in face value of its outstanding Senior Notes in satisfaction of the counterparty's settlement obligation to the Company. The Senior Notes are currently being held by the Company and have been recognized as a reduction to the long-term debt outstanding (note 8(b)).

In 2001, the Company monetized certain foreign currency options, cross-currency swaps and a forward contract. The net deferred gain is being recognized in earnings over the remaining original contractual term to maturity of the underlying debt for which the derivatives were designated as cash flow hedges.

The above transactions are summarized as follows:

		Notional value (U.S. dollars)		Proceeds on monetization		Loss (gain) on unwind			Deferred gain (loss) December 31, 2001			Amount recognized during 2002			Deferred gain (loss) December 31, 2002
2001:
	May	$	1,208,401	$	123,964	$	(33,708	)	$	29,529		$	(6,687	)	$	22,842
	November		207,040		26,700		84			(84	)		8			(76	)

		$	1,415,441	$	150,664	$	(33,624	)	$	29,445			(6,679	)		22,766

2002:
	May	$	1,784,500	$	85,504	$	(46,899	)		—			(5,751	)		41,148
	September		994,581		84,866		(76,340	)		—			(3,802	)		72,538

		$	2,779,081	$	170,370	$	(123,239	)		29,445		$	(16,232	)		136,452

Less current portion of deferred foreign exchange gains										—						29,835

Deferred foreign exchange gain									$	29,445					$	106,617

As at December 31, 2001, the Company held the following financial instruments to hedge the following financings:

Debt instrument	Financial instruments type	Foreign currency obligation notional value	Maturity date	Foreign exchange rates weighted average	Canadian equivalent interest rate weighted average	Fair market value
		(In millions)				(In millions)
10.75% Notes	Cross-currency swaps	U.S. $170.0	November 1, 2007	Cdn. $1.5702 to U.S. $1.00	11.24%	$	(2.8	)
9.95% Notes	Cross-currency swaps	U.S. $970.0	June 15, 2008	Cdn. $1.5276 to U.S. $1.00	9.73%	$	71.5
7.65% Notes	Cross-currency swaps	U.S. $500.0	September 15, 2006	Cdn. $1.4977 to U.S. $1.00	7.72%	$	47.4
7.625% Notes	Cross-currency swaps	U.S. $250.0	March 15, 2005	Cdn. $1.5489 to U.S. $1.00	7.87%	$	5.7
12% Notes	Forward exchange contract	U.S. $250.0	February 28, 2002	Cdn. $1.5532 to U.S. $1.00	n/a	$	10.1
10.625% Notes	Forward exchange contract	U.S. $225.0	February 28, 2002	Cdn. $1.5532 to U.S. $1.00	n/a	$	9.0
						$	140.9

In addition to the financial instruments above, the Company held foreign currency options with a fair value of ($2.1) million, comprising assets of $28.1 million offset by liabilities of $30.2 million.

(c): Interest rate risk:

The following table summarizes the Company's exposure to interest rate risk.

	Fixed interest rate maturing within
2002	Floating rate		1 year		1 - 5 years		After 5 years		Non-interest bearing
Financial assets:
Cash and cash equivalents	$	420,542	$	—	$	—	$	—	$	—
Accounts receivable		—		—		—		—		166,434
Financial liabilities:
Current liabilities		—		3,952		—		—		287,407
Capital leases		—		—		16,601		—
Liabilities subject to compromise		—		—		2,721,103		1,795,721		202,767

	Fixed interest rate maturing within
2001	Floating rate		1 year		1 - 5 years		After 5 years		Non-interest bearing
Financial assets:
Cash and cash equivalents	$	537,294	$	—	$	—	$	—	$	—
Accounts receivable		—		—		—		—		70,640
Financial liabilities:
Current liabilities		—		—		—		—		406,108
Capital leases		—		1,930		17,661		—		—
Long-term debt		170,000		—		2,127,672		2,357,404		—

(d): Credit risk:

The Company's financial instruments that are exposed to credit risk are cash and cash equivalents, accounts receivable and financial instruments used for hedging purposes. Cash and cash equivalents, which consist of investments in highly liquid, highly secure money market instruments, are on deposit at major financial institutions. Credit risk with respect to accounts receivable is limited due to the large number of customers to which the Company provides services.

18. Segmented information:

The Company currently operates in one operating segment, the telecommunications industry in Canada. The Company offers a number of products, delivered through its integrated fibre optics networks, sold by a national sales force, agents and telemarketers and provisioned by one operations group. The Company makes decisions and evaluates financial performance primarily based on product revenue.

Revenue by product is as follows:

	2002		2001		2000
Data	$	457,962	$	485,031	$	465,407
Local		235,095		209,207		177,424
Internet and IT Services		195,600		171,852		129,865
Other		26,693		20,843		32,643

		915,350		886,933		805,339
Long distance		572,795		657,788		700,039

	$	1,488,145	$	1,544,721	$	1,505,378

During the years ended December 31, 2002, 2001 and 2000, no customers of the Company individually represented more than 10% of the Company's revenue.

19. Related party transactions:

Services are exchanged between the Company and its shareholders and certain of their subsidiaries. These transactions are in the normal course of operations and are measured at the exchange amounts being the amounts agreed to by the parties.

Transactions with the above related parties were as follows:

		2002			2001			2000
Revenue		$	162,153		$	146,759		$	114,278
Expenses			95,999			100,900			117,173

Amounts due from and to the above related parties are as follows:

		2002			2001
Accounts receivable		$	23,672		$	14,958
Accounts payable			17,399			22,297

20. Change in non-cash working capital:

	2002			2001			2000
Accounts receivable	$	(45,965	)	$	184,114		$	10,469
Other current assets		(8,891	)		(986	)		1,734
Other assets		(13,500	)		—			—
Accounts payable		(16,249	)		(20,663	)		(110,155	)
Accrued liabilities		(48,070	)		(1,576	)		18,977
Accrued interest payable		104,778			21,544			3,349
Income taxes payable		1,472			438			(4,785	)
Other long-term liabilities		2,117			765			—

	$	(24,308	)	$	183,636		$	(80,411	)

21. Supplemental cash flow information:

		2002			2001			2000
Supplemental cash flow information:
	Interest paid	$	157,931		$	213,890		$	165,362
	Income taxes paid		9,258			6,241			7,148
Supplemental disclosures of changes in non-cash investing and financing activities:
	Accrued liabilities and accounts payable incurred for the acquisition of property, plant and equipment		(10,461	)		(15,476	)		(60,291	)
	Extinguishment of bonds on termination of swaps (note 17(b))		84,866			—			—
	Capital lease obligations incurred for the purchase of networks and equipment		—			—			560
	Class B Non-Voting Shares issued for acquisitions		—			44,666			45,385
	Class B Non-Voting Shares issued for conversion of warrants		213			483			620
	Class B Non-Voting Shares issued for the Company's contributions to the Employee Share Ownership Plan		1,096			1,206			2,734

22. Reclassification of prior periods amounts:

Certain amounts presented in 2001 and 2000 have been reclassified to conform with the presentation adopted for 2002.

23. Reconciliation to accounting principles generally accepted in the United States:

(a): Consolidated statements of operations, consolidated statements of comprehensive loss and consolidated balance sheets:

The application of U.S. GAAP would have the following effect on loss for the year, deficit, basic and diluted loss per common share as reported:

		2002			2001			2000
					(as restated — note 2(g))
Loss for the year, Canadian GAAP		$	(1,831,659	)	$	(745,375	)	$	(523,207	)
Stock-based compensation expense (note 23(a)(ii))			(330	)		(15,023	)		(4,364	)
Depreciation and amortization (note 23(a)(vi))			10,899			—			—
Impairment of property, plant and equipment (note 23(a)(vi))			(161,000	)		—			—
Gain (loss) on derivative instruments (note 23(a)(iii))			22,519			(12,034	)		—
Change in valuation allowance (note 23(a)(iv))			—			(31,934	)		—

Loss for the year, U.S. GAAP before accounting changes			(1,959,571	)		(804,366	)		(527,571	)
Cumulative effect of accounting change, adoption of SFAS 133 (note 23(a)(iii))			—			4,028			—
Cumulative effect of accounting change, adoption of SFAS 142 (note 23(a)(v))			(1,530,767	)		—			—

Loss for the year, U.S. GAAP			(3,490,338	)		(800,338	)		(527,571	)
Opening deficit, U.S. GAAP			(1,594,518	)		(794,180	)		(266,609	)

Ending deficit, U.S. GAAP		$	(5,084,856	)	$	(1,594,518	)	$	(794,180	)

Basic and diluted loss per common share under U.S. GAAP:
	Before accounting change	$	(19.20	)	$	(8.17	)	$	(5.52	)
	Cumulative effect of accounting change		(15.00	)		0.04			—

		$	(34.20	)	$	(8.13	)	$	(5.52	)

Weighted average number of common shares outstanding (in thousands)			102,047			98,406			95,561

U.S. GAAP also requires disclosure of a statement of comprehensive income (loss). Comprehensive income (loss) generally encompasses all changes in shareholders' equity, except those arising from transactions with shareholders:

		2002			2001			2000
Loss for the year, U.S. GAAP		$	(3,490,338	)	$	(800,338	)	$	(527,571	)
Other comprehensive income, net of tax of nil:
	Cumulative effect of accounting change on adoption of SFAS 133 (note 23(a)(iii))		—			21,990			—
	Unrealized gain on derivative instruments (note 23(a)(iii))		90,055			10,397			—
	Minimum pension liability (note 23(a)(iv))		(112,354	)		—			—

Comprehensive loss, U.S. GAAP		$	(3,512,637	)	$	(767,951	)	$	(527,571	)

The following table indicates the differences between the amounts of consolidated balance sheet items determined in accordance with Canadian and U.S. GAAP:

	2002									2001
	U.S. GAAP			Canadian GAAP			Difference			U.S. GAAP			Canadian GAAP			Difference
Assets
Financial derivatives	$	—		$	—		$	—		$	138,773		$	—		$	138,773
Property, plant and equipment		802,598			952,699			(150,101	)		2,180,773			2,180,773			—
Deferred pension asset (liability)		(83,858	)		60,430			(144,288	)		13,240			45,174			(31,934	)
Deferred foreign exchange		—			—			—			—			144,287			(144,287	)
Liabilities and Shareholders' Deficiency
Accrued liabilities		204,210			234,549			30,339			266,778			267,229			451
Deferred foreign exchange		—			106,617			106,617			—			29,445			29,445
Common shares and additional capital		1,422,824			1,393,994			(28,830	)		1,162,164			1,133,664			(28,500	)
Accumulated other comprehensive income		10,088			—			(10,088	)		32,387			—			(32,387	)
Deficit		(5,084,856	)		(4,888,505	)		196,351			(1,594,518	)		(1,526,079	)		68,439

(i): Consolidated statements of cash flows:

Canadian GAAP permits the disclosure of a subtotal of the amount of funds provided by (used in) operations before changes in non-cash working capital items in the consolidated statements of cash flows. U.S. GAAP does not permit this subtotal to be included.

(ii): Stock-based compensation expense:

For U.S. GAAP purposes, the Company has chosen to account for stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board Opinion ("APB") No. 25, "Accounting for Stock Issued to Employees," and related interpretive guidance. Accordingly, compensation expense for U.S. GAAP purposes has been recognized at the date of share purchases or option grants at the amount by which the quoted market price of the stock exceeds the amount an employee must pay to acquire the stock.

During the year, the Company recorded stock compensation expense of $0.3 million (2001 — $1.4 million; 2000 — $4.4 million) as a result of accelerating the vesting period of certain employee stock option awards that would have otherwise expired unexercisable pursuant to their original terms. In addition, the Company recorded nil (2001 — $13.6 million; 2000 — nil) in stock compensation expense as a result of extending the expiry date of certain employee stock option awards.

U.S. GAAP also requires that pro forma net loss and loss per share information be reported annually as if the Company had adopted the fair value approach under the Statement of Financial Accounting Standard ("SFAS") No. 123.

Had the Company determined compensation expense costs based on the fair value at the date of grant for stock options under SFAS No. 123, loss attributable to common shareholders and basic loss per share would have increased as indicated below.

	2002			2001			2000
Loss attributable to common shareholders, U.S. GAAP — as reported	$	(3,490,338	)	$	(800,338	)	$	(527,571	)
Add stock-based employee compensation expense included in reported net loss		330			15,023			4,364
Deduct total stock-based employee compensation expense determined under fair value-based method for all rewards		(24,677	)		(56,158	)		(54,993	)

Loss attributable to common shareholders, U.S. GAAP — pro forma	$	(3,514,685	)	$	(841,473	)	$	(578,200	)

Loss per common share — as reported	$	(34.20	)	$	(8.13	)	$	(5.52	)
Loss per common share — pro forma		(34.44	)		(8.55	)		(6.05	)

Weighted average number of common shares outstanding (in thousands)		102,047			98,406			95,561

In 2002, 846,000 (2001 — 996,939; 2000 — 3,760,500) options with a weighted average fair value of $7.21 (2001 — $18.33; 2000 — $15.16) were granted, and valued for pro forma disclosure purposes using the following weighted average assumptions:

	2002	2001	2000
Risk-free interest rate (%)	4.8%	5.1%	6.2%
Expected volatility (%)	31.3%	35.7%	5.4%
Expected life (in years)	1.23	5	5
Expected dividends	—	—	—

(iii): Gain (loss) on derivative instruments:

For U.S. GAAP reporting purposes, the Company adopted SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," as amended by SFAS No. 137 and SFAS No. 138 ("SFAS No. 133") on January 1, 2001. SFAS 133 establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities. All derivatives, whether designated in hedging relationships or not, are required to be recorded on the balance sheet at fair value. If the derivative is designated as a fair value hedge, the changes in the fair value of the derivative and of the hedged item attributable to the hedged risk are recognized in earnings. If the derivative is designated as a cash flow hedge, the effective portions of changes in the fair value of the derivative are recorded in accumulated other comprehensive income ("AOCI") and are recognized in the income statement when the hedged item affects earnings. Changes in fair values of derivative instruments not designated as hedging instruments and ineffective portion of hedges, if any, are recognized in earnings in the current year.

On adoption, the Company recognized a one-time transition gain of $26.0 million, which represented the net effect of recognizing the market value of the Company's derivative portfolio of $84.5 million (consisting of assets of $98.2 million and liabilities of $13.7 million), the derecognition of the unamortized balance of swaption premiums of $17.6 million and the derecognition of deferred foreign exchange losses of $40.9 million as at December 31, 2000. The portion of the one-time transition gain that relates to derivatives designated and qualifying as cash flow hedges, totaling $22.0 million, was recognized in the AOCI account and will be reclassified into earnings over the life of the underlying hedged items, of which the last expires in June 2008. The portion of the one-time transition gain related to derivatives not designated as hedges, totaling $4.0 million, was recognized in earnings as the cumulative effect of the accounting change on adoption of SFAS No. 133.

For the year ended December 31, 2002, as a result of SFAS No. 133 relative to Canadian GAAP, the Company realized a net gain of $22.5 million (2001 — loss of $12.0 million) due to the net effect of foreign exchange gains on debt not hedged under U.S. GAAP of $20.1 million, the favourable net change in time value of the swaptions of $4.7 million, offset by the unfavourable net change in the fair market value of derivatives not designated as hedging instruments of $(0.4) million, and the net difference between the amortization of deferred gains on unwound swaps under U.S. and Canadian GAAP of $(1.9) million.

For the year ended December 31, 2001, as a result of SFAS No. 133 relative to Canadian GAAP, the Company realized a net loss of $12.0 million due to the unfavourable change in time value of the swaptions of $12.1 million, the net gain in the fair market value of foreign exchange forward contracts not designated as hedging instruments of $(39.4) million, the effect of foreign exchange losses on the related debt of $44.3 million, the reversal of amortization of option premiums recorded under Canadian GAAP of $(5.4) million and recognition of $(3.9) million of a deferred gain relating to unwound swaps, offset by the reversal of the amortization of the deferred gain under Canadian GAAP of $4.3 million.

Foreign currency risk:

As at December 31, 2002, as a result of the transactions described below, the Company held no derivative financial instruments.

As at December 31, 2001, the Company had designated derivatives with a net notional value of U.S. $1,890 million (composed of derivatives to purchase U.S. $2,097 million and derivatives to sell U.S. $207 million) as cash flow hedges which hedged the foreign currency risk of cash flows relating to U.S. dollar-denominated debt with a face value of the same amount. These cash flow hedges were highly effective in hedging foreign currency rate risk. The fair value of the derivatives designated as cash flow hedges was $119.7 million, consisting of assets of $159.9 million and liabilities of $40.2 million.

Other derivatives:

In addition, at December 31, 2001, the Company held foreign exchange forward contracts with a notional value totaling U.S. $475 million that were not eligible to be designated as effective hedges, since the term of the contracts did not match the underlying debt being hedged and, therefore, the changes in their market value were recorded in earnings. As at December 31, 2001, the fair value of the foreign exchange contracts was $19.1 million.

Termination of derivative contracts:

In May 2002, the Company unwound certain swaptions, cross-currency swaps and forward contracts with notional value totaling U.S. $1,784.5 million for proceeds of $85.5 million (note 17(b)). The related AOCI balances of the derivatives unwound represented a gain of $37.5 million. This gain is being recognized in earnings over the remaining original contractual term to maturity of the underlying debt for which these derivatives were designated as cash flow hedges.

On September 24, 2002, the Company unwound all remaining outstanding swaptions and cross-currency swaps with a notional value of U.S. $994.6 million, and in accordance with their terms, the Company received approximately Cdn. $84.9 million in face value of its outstanding Senior Notes in satisfaction of the counterparties' obligations to the Company. The Senior Notes are currently being held by the Company. The related AOCI balances of the derivatives unwound represented a gain of $76.4 million. The gain of $76.4 million is being recognized in earnings over the remaining original contractual term to maturity of the underlying debt for which these derivatives were designated as cash flow hedges. The termination of these hedges resulted in an increase in the Company's overall foreign currency exposure.

In May 2001, the Company unwound certain swaptions, cross-currency swaps and a forward contract. The related AOCI balances of the derivatives unwound represented a deferred gain of $29.6. This gain is being recognized in earnings over the remaining original contractual term to maturity of the underlying debt for which these derivatives were designated as cash flow hedges.

The gains to be recognized related to the above monetizations in future periods are as follows:

2003	$	27,418
2004		27,418
2005		23,872
2006		21,092
2007		16,232
2008 and thereafter		6,410

	$	122,442

(iv): Benefit plan:

In 2001, the Company recognized a gain under Canadian GAAP of $31.9 million from the reversal of the valuation allowance on the accrued benefit asset relating to its defined benefit pension plan. The reversal of the valuation allowance is not permitted under U.S. GAAP and, accordingly, the gain has been reversed in the consolidated statements of operations for U.S. GAAP reporting purposes.

Under U.S. GAAP, SFAS No. 87, "Employers Accounting for Pensions," the Company is required to record an additional minimum pension liability when the benefit plans' accumulated benefit obligation exceeds the plans' assets by more than the amounts previously accrued for as pension costs. Under U.S. GAAP, these charges are recorded as a reduction to shareholders' equity, as a component of accumulated other comprehensive loss. In 2002, the Company recorded a minimum liability of $112.4 million (2001 and 2000 — nil).

(v): Business combinations, goodwill and other intangible assets:

Effective January 1, 2002, the Company adopted SFAS No. 141, "Business Combinations," and SFAS No. 142, "Goodwill and Other Intangible Assets," issued by the Financial Accounting Standards Board ("FASB") in July 2001, which are substantially consistent with equivalent Canadian HB 1581, "Business Combinations," and HB 3062, "Goodwill and Other Intangible Assets," except that under U.S. GAAP, any transitional impairment charge is recognized in earnings as a cumulative effect of a change in accounting principles. The accounting policy is described in note 2(e).

(vi): Accounting for the impairment or disposal of long-lived assets:

Effective January 1, 2002, the Company adopted SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." The statement supersedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," and the accounting and reporting provisions of APB Opinion No. 30, "Reporting the Results of Operations — Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions" ("Opinion 30"), for the disposal of a segment of a business (as previously defined in that Opinion). SFAS No. 144 retains the fundamental provisions in SFAS No. 121 for recognizing and measuring impairment losses on long-lived assets held for use and long-lived assets to be disposed of by sale. It also provides guidance on how a long-lived asset that is used as part of a group should be evaluated for impairment, establishes criteria for when a long-lived asset is held for sale, and prescribes the accounting for a long-lived asset that will be disposed of other than by sale. SFAS No. 144 retains the basic provisions of Opinion 30 on how to present discontinued operations in the income statement but broadens that presentation to include a component of an entity (rather than a segment of a business). There was no effect on adoption of SFAS No. 144, effective January 1, 2002, on the Company's results of operations and financial position. In June 30, 2002, a write-down of property, plant and equipment was recorded (note 5) and resulted in a U.S. GAAP difference as described below.

SFAS No. 144 requires the measurement of an impairment charge to be based on the excess of the carrying value over the fair value of the assets, while Canadian GAAP measures the impairment as the excess of the carrying value over the net recoverable amount of the assets. The Company assessed the fair value of the affected asset group based on the market price for similar functionality and changes in the intended use of the asset group and asset group's remaining life given changes to the Company's strategy. The difference in the basis of measurement resulted in an additional impairment charge of $161 million under U.S. GAAP recorded in the second quarter of 2002. For the year ended December 31, 2002, depreciation expense is $10.9 million less under U.S. GAAP as a result of the difference in measuring the impairment charge.

(b)

Other disclosures:

(i): Accounts receivable are net of an allowance for doubtful accounts of $20.2 million (2001 — $24.3 million) at December 31, 2002.
(ii): In addition to the commitments and contingencies described in note 24, the Company has also provided routine indemnifications, whose terms range in duration and often are not explicitly defined. These indemnifications relate to adverse effects due to changes in tax laws, infringements by third parties related to intellectual property, and under certain supplier agreements, losses arising from claims by third parties against suppliers, including customers, in connection with the use of services and related equipment by the third party. The maximum amounts from these indemnifications cannot be reasonably estimated. Historically, the Company has not made significant payments related to these indemnifications. The Company has also indemnified a third party in connection with a marketing agreement, and has determined that the potential maximum loss is not significant. The Company has also indemnified certain financial advisors regarding liability they may incur as a result of their activity as advisors to the Company or the Company's Noteholders.

(iii): Recently issued accounting standards:

In June 2001, FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations." SFAS No. 143 requires the Company to record the fair value of an asset retirement obligation as a liability in the period in which it incurs a legal obligation associated with the retirement of tangible long-lived assets that result from the acquisition, construction, development and/or normal use of the assets. The Company also records a corresponding asset that is depreciated over the life of the asset. Subsequent to the initial measurement of the asset retirement obligation, the obligation will be adjusted at the end of each period to reflect the passage of time and changes in the estimated future cash flows underlying the obligation. The Company is required to adopt SFAS No. 143 on January 1, 2003. The Company is currently evaluating the impact of adoption on the consolidated financial statements.

In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements Nos. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections." SFAS No. 145 amends existing guidance on reporting gains and losses on the extinguishment of debt to prohibit the classification of the gain or loss as extraordinary, as the use of such extinguishments have become part of the risk management strategy of many companies. SFAS No. 145 also amends SFAS No. 13 to require sale-leaseback accounting for certain lease modifications that have economic effects similar to sale-leaseback transactions. The provisions of the Statement related to the rescission of Statement No. 4 is applied in fiscal years beginning after May 15, 2002. Earlier application of these provisions is encouraged. The provisions of the Statement related to Statement No. 13 were effective for transactions occurring after May 15, 2002, with early application encouraged. The Company is currently evaluating the impact of adoption on the consolidated financial statements.

In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities," which requires companies to recognize costs associated with exit or disposal activities when they are incurred rather than at the date of a commitment to an exit or disposal plan. SFAS No. 146 is to be applied prospectively to exit or disposal activities initiated after December 31, 2002. There was no effect on adoption of SFAS No. 146 on the Company's results of operations and financial position for 2002 and prior years.

In November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others" ("FIN 45"), which requires certain disclosures of obligations under guarantees. The disclosure requirements of FIN 45 are effective for the Company's year ended December 31, 2002 and are included in note 23(b)(ii) to these consolidated financial statements. Effective for 2003, FIN 45 also requires the recognition of a liability by a guarantor at the inception of certain guarantees entered into or modified after December 31, 2002, based on the fair value of the guarantee. The Company has not determined the impact of the measurement requirements of FIN 45.

In November 2002, the Emerging Issues Task Force reached a consensus on Issue 00-21, addressing how to account for arrangements that involve the delivery or performance of multiple products, services, and/or rights to use assets. Revenue arrangements with multiple deliverables are divided into separate units of accounting if the deliverables in the arrangement meet the following criteria: (a) the delivered item has value to the customer on a standalone basis; (b) there is objective and reliable evidence of the fair value of undelivered items; and (c) delivery of any undelivered item is probable. Arrangement consideration should be allocated among the separate units of accounting based on their relative fair values, with the amount allocated to the delivered item being limited to the amount that is not contingent on the delivery of additional items or meeting other specified performance conditions. The final consensus will be applicable to agreements entered into in fiscal periods beginning after June 15, 2003 with early adoption permitted. The Company is currently evaluating the impact of adoption on the consolidated financial statements.

In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation — Transition and Disclosure, an amendment of FASB Statement No. 123." This Statement amends FASB Statement No. 123, "Accounting for Stock-Based Compensation," to provide alternative methods of transition for a voluntary change to the fair value method of accounting for stock-based employee compensation. In addition, this Statement amends the disclosure requirements of Statement No. 123 to require prominent disclosures in both annual and interim financial statements. Certain of the disclosure modifications are required for fiscal years ending after December 15, 2002 and are included in the notes to these consolidated financial statements.

In January 2003, the FASB issued Interpretation No. 46, "Consolidation of Variable Interest Entities, an interpretation of ARB No. 51." This Interpretation addresses the consolidation by business enterprises of variable interest entities as defined in the Interpretation. The Interpretation applies immediately to variable interests in variable interest entities created after January 31, 2003, and to variable interests in variable interest entities obtained after January 31, 2003. The Interpretation requires certain disclosures in financial statements issued after January 31, 2003 if it is reasonably possible that the Company will consolidate or disclose information about variable interest entities when the Interpretation becomes effective. The application of this Interpretation will not have a material effect on the Company's financial statements.

24. Commitments and contingencies:

(a): Contractual commitments:

Under the terms of its operating lease agreements for fibre optics maintenance, operating facilities, equipment rentals and minimum purchase commitments under supply contracts and customer contracts, the Company is committed to make the following payments for the years ending December 31, as follows:

2003	$	159,883
2004		106,891
2005		90,570
2006		47,881
2007		37,944
Thereafter		252,316

	$	695,485

(b)

Contingent liabilities:

(i): Professional fees:

Upon successful completion of the Plan, the Company is required to pay success fees to certain financial advisors. These fees will consist of: (a) a fixed restructuring transaction fee of U.S. $10.0 million, and (b) a transaction fee, equal to 0.75% of the fair market value of all cash and/or other securities received by the Noteholders pursuant to the Plan. The total amount of these fees due upon successful implementation of the Plan will be reduced by the monthly payments made to these financial advisors during 2002 to emergence from CCAA. These success fees have not been accrued as at December 31, 2002 because payment is contingent on successful implementation of the Plan.

(ii): Litigation:

As a result of the Company's CCAA filing, virtually all pending pre-petition litigation against the Company is currently stayed. A significant portion of the Company's pending pre-petition litigation will be dealt with during the CCAA proceedings as described in note 8.

In the normal course of operations, the Company may be subject to litigation and claims from customers, suppliers and former employees. Management believes that adequate provisions have been recorded in the accounts where required. Although it is not possible to estimate the extent of potential costs, if any, management believes that the ultimate resolution of such contingencies would not have a material adverse effect on the financial position of the Company.

(c): Letters of credit:

In the normal course of business, the Company issues letters of credit in compliance with its right-of-way agreements with various municipalities and utility companies. In general, the terms of the letter of credit permit the municipality or the utility company to draw on the letter of credit to recover any losses incurred under the right-of-way agreement, as defined. As at December 31, 2002, the Company had letters of credit outstanding of $1.3 million with nil drawn.

(d): Collective bargaining agreement:

As at December 31, 2002, approximately 21% or 847 employees of the Company were union members covered by collective bargaining agreements. The union employees of the Company are currently represented by two unions, the Canadian Auto Workers ("CAW") Local 2000 and the United Steelworkers of America ("UWSA") TC Local 1976. The collective bargaining agreements are effective from January 1, 2001 to December 31, 2003. In 2003, the Company will need to negotiate new collective agreements with its union partners.

25. Subsequent events:

In order to facilitate the reorganization pursuant to the Plan, on January 16, 2003, AT&T Canada entered into the Sale and Call Agreement with New OpCo, Canada Corp., AT&T Corp., AT&T Canada Holdings Limited Partnership ("AT&T LP"), Brascan Financial Corporation, Tricap Investments Corporation and 1519888 Ontario Limited ("BCo"), whereby AT&T LP agreed to sell all of its direct and indirect ownership interests in both AT&T Canada and Canada Corp. to BCo. BCo has granted a call option (the "Option") to New OpCo to buy the shares it acquires from AT&T LP representing a direct and indirect ownership interest in Canada Corp. (other than the shares of AT&T Canada) for a purchase price of $0.15 million. The Option is exercisable on or at any time after March 15, 2003. In the event that New OpCo does not exercise the Option before the implementation of the Plan, New OpCo has agreed to pay $0.15 million to BCo upon implementation of the Plan. On February 17, 2003 AT&T Corp. sold all of its direct and indirect ownership interest in Canada Corp. to BCo.

On January 17, 2003, the Company announced it had established a new commercial agreement with AT&T Corp. The new commercial agreements among other things, require AT&T Canada to launch a new brand name by September 9, 2003, and to cease use of the AT&T brand by no later than December 31, 2003. In addition, these agreements provide a timeframe for continuity of the Company's global connectivity, technology platform and product suite, and maintain network ties between the two companies for the benefit of customers. These agreements enable AT&T Canada and AT&T Corp. to continue working together on a non-exclusive basis, and provide the Company the ability to forge additional supplier relationships that will enhance its connectivity and product offerings. Also, these arrangements recognize AT&T Corp.'s ability to serve Canadian customers directly, including competing with AT&T Canada.

On February 20, 2003, the Plan was approved by the Company's Noteholders and its other Affected Creditors.

On February 25, 2003, the Court issued an order sanctioning the Plan and the U.S. Court issued an order recognizing and enforcing the Court's sanction order.

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Consolidated Financial Statements (Expressed in Canadian dollars) AT&T CANADA INC. Years ended December 31, 2002, 2001 and 2000
auditors' report to the shareholders
comments by the auditors for u.s. readers on canada-u.s. reporting differences
consolidated balance sheets
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EX-99.3 5 a2132723zex-99_3.htm AT&T MD&A 2002
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AT&T CANADA INC.

Management's Discussion and Analysis of Financial Condition and Results of Operations (p. 1)

Consolidated Financial Statements (p. 20)

management's discussion and analysis
of financial condition and results of operations

(dollar amounts are stated in thousands of Canadian dollars except where otherwise noted)

Forward-looking statements

This discussion and analysis explains AT&T Canada Inc.'s (the "Company" or "AT&T Canada") financial condition and results of operations for the year ended December 31, 2002 compared with the year ended December 31, 2001, and is intended to help shareholders and other readers understand the Company's business and the key factors underlying its financial results. Certain statements in this Management's Discussion and Analysis ("MD&A") and Consolidated Financial Statements constitute forward-looking statements. Such forward-looking statements involve known and unknown risks, uncertainties, and other factors which may cause the actual results, performance or achievements of the Company, to be materially different from any future results, performance, or achievements expressed or implied by such forward-looking statements. Such factors include, among others, the following: the risks associated with the proceedings under the Companies' Creditors Arrangement Act ("CCAA") including the Company's ability to operate as a going concern, the risks associated with implementing a reorganization plan, and new commercial arrangements with AT&T Corp., transitioning to a new brand, liquidity, the regulatory environment, competition, technological changes, restrictions on foreign ownership and control, absence of an established public trading market for the new shares issued pursuant to the reorganization plan, and negative trends in global market and economic conditions.

Overview

The Company is the country's largest competitor to the incumbent local exchange carriers ("ILECs"). With over 18,700 route kilometers of local and long haul broadband fiber optic network, world class managed service offerings in data, Internet, voice and IT Services, the Company provides a full range of integrated communications products and services to help Canadian businesses communicate locally, nationally and globally.

During 2002, the Canadian telecommunications market was characterized by a number of challenges that included softening of demand for telecommunications services, intense competition to gain market share often through price reductions in all product groups, and excess capacity of network facilities. In addition to these challenges, the Company was faced with a regulatory decision that did not meet its expectations and consequently, the Company is appealing the decision. Also, the combination of the significant long-term debt incurred by the Company to build its telecommunications network and infrastructure, the slower growth in demand for its services and the decline in prices for many of its core services, created a capital structure that was unsustainable.

In response to these pressures, the Company initiated a three-point strategic plan. The first strategic component was initiated in May 2002 with a series of operational cost saving and productivity enhancing measures. These measures focused on building operating efficiencies in those areas of the business where the Company could earn the highest returns. Operating initiatives resulted in a reduction of the Company's workforce by 1,217 personnel as at December 31, 2002 and the lowering of capital spending to $144 million in 2002. The second strategic component was to improve the Company's capital structure to achieve long term growth which the Company expects to achieve through the reorganization proceedings described below. The third strategic component is to pursue a competitively neutral regulatory framework that permits Canadian telecom customers to reap the benefits of competition.

Significant events

Reorganization proceedings

On January 22, 2003, the Company announced it had filed a Consolidated Plan of Arrangement and Reorganization (the "Plan") and related Management Information Circular with the Ontario Court of Justice, Toronto, Ontario, Canada (the "Court"). The purpose of the Plan is to restructure the balance sheet and equity of the Company, provide for the compromise, settlement and payment of liabilities of certain creditors of the Company. The Plan provides for, amongst other things:

•: the exchange and compromise of the senior notes of the Company ("Senior Notes") and certain other affected claims ("Affected Creditors") for a combination of cash, which will not be less than $200 million, and 100% of the equity of New AT&T Canada upon emergence from Companies' Creditors Arrangement Act ("CCAA");

•: the cancellation of all existing outstanding equity, including warrants and share purchase options of AT&T Canada Inc. and AT&T Canada Corp. for no consideration; and
•: transactions that will result in a corporate structure with a new parent company ("New AT&T Canada"), which will own the existing holding company, AT&T Canada Inc. and a wholly owned operating subsidiary ("New Opco"), which will be created as a consequence of the amalgamation of certain of the existing subsidiaries of AT&T Canada Inc.

The Plan and related Management Information Circular were mailed to registered noteholders and other affected creditors on or before January 24, 2003. On February 20, 2003, the Plan was approved by the holders of the Senior Notes ("Noteholders") and other affected creditors. On February 25, 2003, the Court issued an order sanctioning the Plan and the U.S. court issued an order recognizing and enforcing the Court's sanction order.

On October 15, 2002, the Company elected not to make the interest payments on one of its Senior Notes, due on September 15, 2002. As a result, the Company defaulted under the indentures governing certain of its Senior Notes as the Company failed to make its required interest payments. With cross default provisions applicable to its other series of Senior Notes, all of the Company's outstanding indebtedness under its Senior Notes of approximately $4.5 billion was in default and as a result, on October 15, 2002, the Company and certain of its subsidiaries voluntarily filed for protection from creditors under CCAA in the Court and obtained an order from the Bankruptcy Court in the Southern District of New York (the "U.S. Court") under Section 304 of the U.S. Bankruptcy Code to recognize the CCAA proceedings in the United States.

The completion of the Plan and emergence from the CCAA proceedings are subject to a number of conditions, including that an appeal period of the Court's approval has expired with either no appeal commenced or a final determination made by the Court, and the receipt of certain exemptions orders from securities regulatory authorities in Canada to provide that the shares of New AT&T Canada (the "New Shares") issued under the Plan will be freely tradable and the listing of the New Shares on the Toronto Stock Exchange ("TSX"). While the Company is confident that it can satisfy all of these conditions, there can be no assurance, however, that it will emerge from the CCAA proceedings.

Regulatory environment

On May 30, 2002, the Canadian Radio-television and Telecommunications Commission ("CRTC") released the price cap decision (the "Price Cap Decision") which dealt with, among other things, the costs incurred by competitive providers to utilize the ILECs network facilities and services in order to service customers. The Company estimates that its network costs will be reduced by approximately 13% to 15% as a result of this Decision. The Company has appealed the Price Cap Decision to the Federal Cabinet and the CRTC has initiated its own proceeding to review and vary certain aspects of the Price Cap Decision. Both of these initiatives could lead to further savings for the Company.

Purchase of outstanding shares of the company not previously owned by AT&T Corp and repayment of senior credit facility

On October 8, 2002, Brascan Financial Corporation and CIBC Capital Partners, acquired all of the issued and outstanding shares of the Company not already owned by AT&T Corp. or its affiliates for an aggregate purchase price of approximately $5.5 billion (the "Back-end"). Upon completion of the Back-end, the Company received $225.4 million upon the exercise of employee stock options, $200 million of which the Company used to repay in full all amounts drawn under its senior credit facility.

Negotiation of new commercial agreements with AT&T Corp.

On January 17, 2003, the Company announced it had established a new commercial agreement with AT&T Corp. The new commercial agreements, among other things, require the Company to launch a new brand name by September 9, 2003, and to cease use of the AT&T brand by no later than December 31, 2003. In addition, these agreements provide a timeframe for continuity of the Company's global connectivity, technology platform and product suite, and maintain network ties between the two companies for the benefit of customers. These agreements enable the Company and AT&T Corp. to continue working together on a non-exclusive basis, and provide the Company the ability to forge additional supplier relationships that will enhance its connectivity and product offerings. Also, these arrangements recognize AT&T Corp. to serve Canadian customers directly, including competing with the Company. The Company is also negotiating a master services agreement with AT&T Corp. to allow for the continued use of AT&T technology and capabilities. There can be no assurance that such an agreement will be negotiated and in the event a master services agreement is not executed by June 30, 2003, the Company may be required by AT&T Corp. to cease use of all AT&T technology and capabilities by June 30, 2004 or earlier.

Comprehensive revaluation

The consolidated financial statements have been prepared on a going concern basis in accordance with Canadian generally accepted accounting principles ("GAAP"). The going concern basis of presentation assumes that the Company will continue in operation for the foreseeable future and will be able to realize its assets and discharge its liabilities and commitments in the normal course of business. There is doubt surrounding the appropriateness of the use of the going concern assumption in the preparation of the consolidated financial statements because of circumstances of the CCAA reorganization proceedings and circumstances giving rise to this event, including the Company's long-term debt, which is in default. The consolidated financial statements do not reflect adjustments that would be necessary in the carrying value of assets and liabilities, the reported revenue and expenses and the balance sheet classifications used if the going concern basis was not appropriate.

If the Plan is implemented, New AT&T Canada will be required to perform a comprehensive revaluation of its balance sheet under the provisions of The Canadian Institute of Chartered Accountants ("CICA") Handbook Sections ("HB") 1625, "Comprehensive Revaluation of Assets and Liabilities" ("fresh start accounting"). Under fresh start accounting, the Company's assets and liabilities will be recorded at management's best estimate of their fair values. The reported amounts in the consolidated financial statements could materially change, because they do not give effect to the adjustments to the carrying value of assets and liabilities that may ultimately result from the adoption of fresh start accounting. In particular, it is expected that there will be significant differences (either positive or negative) between the fair value and the carrying value in the following areas: capital assets, deferred pension asset and long-term liabilities, which are further described in the Management Information Circular dated January 20, 2003.

Results of operations

Year ended December 31, 2002 compared to year ended December 31, 2001

Key financial data:

Years ended December 31		2002			2001			2000
Revenue
	Data	$	457,962		$	485,031		$	465,407
	Local		235,095			209,207			177,424
	Internet and IT Services		195,600			171,852			129,865
	Other		26,693			20,843			32,643

		$	915,350		$	886,933		$	805,339
	Long Distance		572,795			657,788			700,039

Total Revenue		$	1,488,145		$	1,544,721		$	1,505,378

Service Costs		$	931,949		$	1,005,790		$	1,034,860
Gross Margin		$	556,196		$	538,931		$	470,518
*Gross Margin %*			37.4%			34.9%			31.3%
Selling, General and Administrative Costs ("SG&A")		$	333,044		$	385,966		$	411,947
Loss from operations		$	(1,340,215	)	$	(334,536	)	$	(333,731	)
Net Loss		$	(1,831,659	)	$	(745,375	)	$	(523,207	)
Basic and diluted loss per common share		$	(17.95	)	$	(7.57	)	$	(5.48	)

Supplementary Financial Information

Years ended December 31		2002			2001			2000
Loss from operations		$	(1,340,215	)	$	(334,536	)	$	(333,731	)
Add:
	Depreciation and amortization		273,142			465,600			402,551
	Write-down of property, plant and equipment and goodwill		1,203,196			—			—
	Workforce reduction and provision for restructuring		87,069			21,901			(10,249	)
	Pension valuation allowance		—			(31,934	)		—

*EBITDA ()**		$	223,192		$	121,031		$	58,571

(*): EBITDA is a measure commonly used in the telecommunications industry to evaluate operating results and is generally defined as earnings before interest, income taxes, depreciation and amortization. The Company has also excluded the write-down of property, plant and equipment and goodwill, provisions from restructuring and workforce reduction, and a pension valuation allowance adjustment as these items are not expected to be re-occurring in nature as the Company is restructuring its balance sheet through the CCAA proceeding. The Company is restructuring its balance sheet through a CCAA proceeding and is expecting to emerge from the proceeding on or about April 1, 2003. EBITDA does not have a standardized meaning under GAAP and is not necessarily comparable to similar measures disclosed by other issuers. Accordingly, EBITDA is not intended to replace income/(loss) from operations, net income/(loss) for the period, cash flow, or other measures of financial performance and liquidity reported in accordance with Canadian GAAP.

Revenue

The Company's proportion of revenue from data, local, Internet and IT Services, and other services grew to 62% of the Company's total revenue in 2002 from 57% in 2001. The proportion of revenues from long distance services declined to 38% in 2002 from 43% in the prior year.

The year-over-year decrease in data revenue was mainly due to declines in legacy products, principally high speed data (Private Line and VPN Frame Relay) and data equipment sales, partially offset by growth in Transparent LAN services and Managed Data Network services. Data revenue decreased by $27,069 or 5.6% to $457,962 in 2002, from $485,031 in 2001.

The year-over-year increase in local revenue was due to higher average line count for retail customers over 2002 that was partially offset by the negative impact of general economic conditions which included lower demand from the wholesale and Internet service provider markets as customers in these sectors experienced financial difficulty. Local revenue increased by $25,888 or 12.4% to $235,095 in 2002, from $209,207 in 2001. During 2001, the Company acquired the rights to a customer base from the receiver of an insolvent Canadian competitive local exchange carrier ("CLEC"), resulting in the addition of 42,430 new local lines. Local access lines in service totaled 537,940 at December 31, 2002.

The year-over-year increase in Internet and IT Services revenue was mainly due to the full year impact in 2002 of revenues from the Company's strategic acquisition of MONTAGE in 2001, and growth in high speed dedicated Internet access, managed hosting and security solutions. Internet and IT Services revenue increased by $23,748 or 13.8% to $195,600 in 2002, from $171,852 in 2001. Consistent with the Company's strategy to focus on higher growth and higher value added products, the Internet and IT Services portfolio increased to 13.1% in 2002 as a proportion of total revenue from 11.1% in 2001.

Other revenue increased by $5,850 or 28.1% to $26,693 in 2002, from $20,843 in 2001, primarily due to higher telecommunications equipment sales, partially offset by the sale of certain of the Company's call centers.

The year-over-year decrease in long distance ("LD") revenue was due to lower prices per minute and a decline in minutes. LD revenue decreased by $84,993 or 12.9% to $572,795 in 2002, from $657,788 in 2001. Year-over-year, minutes decreased by 3.5% and prices dropped by 9.8%, primarily the result of intense price competition.

Service costs and selling, general and administrative expenses

The Company's principal operating expenses consist of service costs; selling, general and administrative costs ("SG&A"); and depreciation and amortization. Service costs consist of expenses directly related to delivering service to customers and servicing the operations of the Company's networks, expenses associated with fibre and other leases where the Company does not presently have its own facilities, local and long distance transport costs paid to other carriers, maintenance costs, right-of-way fees, municipal access fees, hub site lease expenses, costs of service personnel and leases of utility space in buildings connected to the Company's networks. SG&A expenses include the costs of sales and marketing personnel, promotional and advertising expenses and corporate administrative expenses.

Service costs decreased by $73,841 or 7.3% to $931,949 in 2002, from $1,005,790 in 2001. This decrease was due to cost reductions from regulatory decisions, including the contribution rate reduction from 4.5% to 1.3% effective January 1, 2002 and the Price Cap Decision, lower personnel and related costs from workforce reductions, and lower international volumes; offset by higher telecommunications equipment sales, strategic acquisitions during 2001 and higher local volumes.

Gross Margin increased by $17,265 or 3.2% to $556,196 in 2002, from $538,931 in 2001, the result of lower service costs from regulatory decisions and operating efficiency gains, offset in part by the impact of lower revenues.

SG&A expenses decreased by $52,922 or 13.7% to $333,044 in 2002 from $385,966 in 2001. This decrease was due to lower personnel and related costs from workforce reductions; a lower level of uncollectible accounts from a year-over-year improvement of customer profiles; and lower sales and distributor commissions; offset by the change in the valuation allowance of $31.9 million related to the Company's defined benefit pension plans in 2001, and higher professional fees related to the Plan, namely $17.1 million incurred prior to the CCAA filing.

EBITDA

EBITDA increased to $223,192 in 2002 from $121,031 in 2001. On a percentage of revenue basis, EBITDA grew to 15.0% in 2002 from 7.8% in 2001. The EBITDA increase was due to the aforementioned gross margin improvements and lower SG&A expenses.

Workforce reduction and provision for restructuring

In 2002, the Company implemented a cost reduction initiative to bring the Company's cost structure in line with its current and projected revenue base and to allocate resources to further enhance services provided to its established customer base. As a result, the Company recorded a provision of $87.0 million related to these activities.

The charge of $87.0 million is comprised of $52.9 million for employee severance and $34.1 million related to facilities consolidation. Employee severance costs are the result of a reduction in workforce of approximately 1,250 personnel, achieved through terminations, attrition and non-renewal of contract personnel. These personnel were from various areas across the Company, including network services, customer service, marketing, sales and administration. As at December 31, 2002, workforce reductions of 1,217 had been completed and $30.4 million of the employee severance costs had been paid. The remaining liability balance of $22.5 million at December 31, 2002 represents salary continuance payments in accordance with employee severance agreements and/or statutory minimum severance requirements.

The provision for facilities consolidation of $34.1 million comprised an initial provision of $34.4 million, which was reduced by $0.3 million as certain facilities were subleased earlier than planned. The provision for facilities consolidation represents management's best estimate of the deficiency of expected sublease recoveries over costs associated with certain leased premises being exited as a result of the restructuring plan. These facility leases will expire between 2002 and 2012. The provision is to be paid over the remaining term of the leases. As at December 31, 2002, the provision was drawn down by $3.2 million. In conjunction with the Company submitting a capital restructuring plan under the protection of CCAA, certain unused leased premises will be compromised through these proceedings and $18.2 million of the provision for facility consolidation costs has been reclassified to liabilities subject to compromise. Of the remaining provision, $5.0 million has been included in other long-term liabilities.

During the second quarter of 2002, the Company completed its transitional goodwill impairment test and determined that unamortized goodwill of $1,530.8 million as at January 1, 2002, was impaired under the fair value approach. This amount was charged to opening deficit with a corresponding reduction in goodwill. In addition, the Company performed an assessment of the carrying values of its long-lived assets, including goodwill. The assessment was performed due to regulatory decisions in the first half of 2002 affecting the Company's business plan and the substantial decline of market value of companies in the telecommunications services sector. Based on this assessment, the Company recorded a charge of $1,095 million and $108.2 million for write-downs of its property, plant and equipment and goodwill, respectively. The $108.2 million of goodwill related to the Company's IT Services group.

Depreciation and amortization

Depreciation and amortization expense decreased by $192,458 to $273,142 in 2002 compared to $465,600 in 2001. The decrease was primarily the impact of the write-down of property, plant and equipment in the second quarter and of the write-down of goodwill, offset by increased depreciation from capital asset additions.

Loss from operations

The Company's loss from operations increased by $1,005,679 for 2002 primarily due to the write-down of property, plant and equipment and the provision for restructuring; offset by no goodwill amortization in 2002, lower depreciation due to the write-down of property, plant and equipment in the second quarter of 2002, and improvements in EBITDA.

Interest income and expense

Interest income decreased to $9,193 in 2002, from $19,134 in 2001. The decrease of $9,941 was due to lower average cash and short-term deposits during the year compared with 2001. A portion of the interest income has been reclassified against reorganization costs consistent with related accounting guidance.

Interest expense increased to $431,625 in 2002, from $401,114 in 2001. The interest expense amount in 2002 is comprised of $157,931 of cash interest, $156,855 for accretion on the senior discount notes, $10,807 in amortization of debt issue costs and the remaining $108,108 was accrued interest in 2002, offset by $2,138 representing other interest costs. The increase was due to higher average long-term debt in 2002. The CCAA proceedings do not allow for principal and interest payments to be made on pre-filing Senior Notes of the Company without Court approval or until the Plan has been implemented. Accordingly, interest generated subsequent to October 15, 2002, the date of the Company's CCAA filing, no longer accrues to Noteholders and other Affected Creditors if the Plan is implemented. However, the Company has continued to accrue for interest expense on pre-filing Senior Notes until the Plan is implemented. As at December 31, 2002, interest expense on pre-filing Senior Notes accrued but not paid for the period from October 15, 2002 to December 31, 2002 was $87.1 million.

Foreign exchange gain (loss)

Effective January 1, 2002, AT&T Canada adopted the new accounting standard HB 1650 "Foreign Currency Translation" which eliminates the deferral and amortization of foreign currency translation gains and losses. In 2002, the Company recorded foreign currency translation losses of $41,126 compared to gains of $10,097 in 2001. These losses were mainly the result of devaluation in the Canadian dollar relative to the U.S. dollar during the period, and an increase in the amount of unhedged U.S. dollar denominated debt due to the termination, in the period, of all remaining foreign currency financial instruments.

Write-down of long-term investments and other assets

In 2002, the Company determined there was an other than temporary decline in the value of its long-term investments and other assets and recorded a write-down of $11.9 million.

Other income (expenses)

Other expenses were $2,225 for 2002 compared to $10,797 for 2001. Other expenses for 2002 related to a $1,502 disposition of the balance of the Company's ownership in Shared Technologies of Canada Inc. Other expenses for 2001 related to an $8,894 loss on the sale of certain call centers in May 2001.

Net loss

The Company's net loss increased by $1,086,284 for 2002 primarily due to the write-down of long-term investments and other assets, higher interest expense, increased foreign exchange losses, and professional fees related to the Plan of $7.4 million incurred subsequent to the CCAA filing.

Liquidity and capital resources

Cash Flow from Operating Activities

During 2002, net cash used in operating activities was $147,759, including cash used to fund changes in non-cash working capital of $24,308, mainly due to the repurchase of the accounts receivable sold in a securitization program in the amount of $100 million, the payment of employee severance costs of $30,400 and the payment of advisory fees related to the Company's balance sheet restructuring of $19,842. During 2001, net cash generated by operating activities was $58,292, including cash generated from changes in non-cash working capital of $183,636, mainly due to proceeds from the sale of accounts receivable in a securitization program.

Capital expenditures

Cash expenditures on property, plant and equipment during 2002 totaled $143,865 compared to $419,173 in 2001. The lower spending level in 2002 was the result of the substantial completion of the Company's local and long haul network during 2001, and strategic operating initiatives in the second quarter of 2002 lowering capital spending.

Liquidity

On October 8, 2002, Brascan Financial Corporation and CIBC Capital Partners, acquired of all the outstanding shares of AT&T Canada that AT&T did not already own for cash of $51.21 per share, pursuant to the terms of the Deposit Receipt Agreement. Upon completion of the Back-end, AT&T Canada's Class B deposit receipts were de-listed from the TSX and the National Market System ("NASDAQ"). Contemporaneous with the closing of this transaction, AT&T Canada employees exercised stock options which together with other stock option exercises that occurred during the third quarter, generated cash proceeds to the Company of $240 million. On October 9, AT&T Canada used approximately $200 million of these monies to repay in full all amounts drawn under its bank credit facility.

On October 15, 2002 the Company defaulted under the indentures governing its Senior Notes as the Company failed to pay interest payments. With cross default provisions applicable to its other series of Senior Notes, all of the Company's outstanding note indebtedness of approximately $4.5 billion was in default. On October 15, 2002, the Company applied for and received protection under the CCAA. While under CCAA protection, the Company has conducted business as usual as it serves customers and pays its employees and ongoing suppliers without interruption.

On February 20, 2003, the Plan was approved by the Noteholders and other affected creditors. Under the Plan, in exchange and compromise for the Company's approximately $4.5 billion of outstanding Senior Notes and certain other affected claims, the Company's Noteholders and other affected creditors will receive a pro-rata combination of cash, which will not be less than $200 million, and 100% of the equity in the New AT&T Canada upon emergence from CCAA. The Plan also requires the Company to obtain a TSX listing of its shares before emergence from CCAA and to apply for a NASDAQ listing.

At December 31, 2002, the Company had unfunded deficits under its defined benefit pension plans of approximately $135 million. The Company is required to fund this deficit over a five year period commencing with an estimated payment of $40 million in 2003.

2003 outlook

In 2003, the Company will focus on markets and services that optimize margin performance and cash flows and on leveraging its existing network infrastructure and customer base. This includes using existing assets more effectively by targeting customers where it has existing network capacity; leveraging its existing customer base more effectively by investing in customer retention programs; cross-selling additional services and bundled offerings; and working with customers to meet their growth requirements. In addition, the Company will focus on customers with national, North American and global requirements and continue to drive its sources of differentiation by offering a full suite of telecommunications services, including global connectivity and managed infrastructure solutions.

The Company expects that, in 2003, it will generate positive income from operations and will report net income for the year. With the implementation of the Plan, the Company will go forward with no long-term debt, and will incur substantially no interest expense and will not be subject to foreign currency gains and losses on the translation of long-term debt. Also, with the comprehensive revaluation of its balance sheet, which is required on emergence from CCAA, it is expected that the value of the Company's capital assets will be lower and thus there will be a corresponding reduction of depreciation expense.

Risks & uncertainties

Risk factors relating to non-implementation of the plan

The Company has obtained both creditor and court approval for the Plan described above, however if the Plan is not implemented and another plan is not proposed and implemented, an insolvency proceeding involving the liquidation of the assets of the Company with a view to recovering the amounts owing to creditors will likely result. Under a forced liquidation, realizations on the assets of the Company will likely be significantly less than the values currently ascribed to such assets.

Risk factors relating to the implementation of the plan

(a): Conditions precedent to implementation

The following are the conditions to the Plan being effective:

•: The appeal period with respect to the CCAA sanction order and the CBCA sanction order shall have expired without an appeal having been commenced, or in the event of an appeal or application for leave to appeal, a final determination shall have been made by the applicable appellate tribunal unless otherwise waived by the Company.
•: The appeal period with respect to the US proceedings order shall have expired without an appeal having been commenced, or in the event of an appeal or application for leave to appeal, a final determination shall have been made by the applicable appellate tribunal unless otherwise waived by the Company and the Court-appointed monitor.
•: No determination shall have been made by the Company not to proceed with the Plan prior to the implementation date of the Plan.
•: All of the applicable approvals and orders of, and all applicable submissions, and filings with, governmental, regulatory and judicial authorities having jurisdiction in respect of the completion of transactions contemplated by the Plan (other than the filings to be made with and the certificates to be obtained from the relevant Director of Corporations and Registrar of Companies), and including the issuance, listing and posting for trading of the New Shares to be issued under the Plan have been obtained or made by the Company, in each case to the extent deemed necessary or advisable by the Company and the restricted committee of noteholders in form and substance satisfactory to the Company and the restricted committee of noteholders, to permit holders of the New Shares to freely trade and dispose of the New Shares in the ordinary course, as the case may be, including any orders, rulings, approvals of listings and exemption orders from the relevant securities regulatory authorities in Canada and the United States and the TSX. The TSX shall have listed the New Shares to be issued under the Plan and such shares will be freely tradable under Canadian securities law in the ordinary course (other than by holders who are "Control Persons" under applicable Canadian securities laws) immediately following the distribution of New Shares on the implementation date of the Plan.
•: The Company has received a legal opinion from their United States counsel substantially to the effect that (i) the issuance of the New Shares is exempt from registration pursuant to Section 3(a)(10) of the U.S. Securities Act of 1933 ("1933 Act") and (ii) the New Shares to be issued under the Plan will be freely tradable under the 1933 Act except for such New Shares held by Persons who are deemed to be affiliates of the Company on or prior to the plan implementation date or who are deemed to be affiliates of the Company after the implementation date of the Plan.

(b): Brand transition and change in AT&T Corp. relationship

The Company currently makes use of, and following the implementation of the Plan during the term of the new commercial agreements with AT&T and its wholly owned subsidiary AT&T Canada Enterprises Company, the Company will, on a transitional basis, make use of certain AT&T technology as well as the AT&T brand and certain trade names in Canada in respect of its services.

The Company is currently negotiating a master services agreement with AT&T to allow for the continued use of AT&T technology and capabilities. The Company expects to execute such an agreement by June 30, 2003. However, there can be no assurance that such an agreement will be negotiated and in the event a master services agreement is not executed by June 30, 2003, the Company may be required by AT&T to cease use of all AT&T technology and capabilities by June 30, 2004 or earlier.

The new commercial agreements require AT&T Canada to launch a new brand name by September 9, 2003 and cease use of the AT&T brand by no later than December 31, 2003, with the exception of the use of the AT&T brand for its calling card and Internet domain names which must end no later than June 30, 2004. The new brand license agreement contains many provisions, which would allow for AT&T to terminate the agreement prior to December 31, 2003 and there can be no assurance that events and circumstances will not give AT&T Corp the right to terminate such agreement. The new brand license agreement is terminable in the event of, among other things, failure to comply in a material respect with marketing specifications, bankruptcy (with the exception of the CCAA Proceedings), and failure to develop or have approved the brand conversion plan or implement the brand conversion plan. The licensee shall have 30 days to cure any breach (other than with respect to bankruptcy and strategic competitor acquisition and failure to develop and have an approved brand conversion plan or specific identified breaches where shorter periods have been identified), failing which the new brand license agreement shall terminate on the specified conversion date without further notice. The licensee may in its sole discretion and without cause terminate the new brand license agreement. The new brand license agreement contains the customary obligations on the part of the licensee to cease all use of the licensed subject matter after termination or expiration. Disputes arising under the new brand license agreement may be resolved pursuant to certain arbitration provisions prescribed in the new brand license agreement. AT&T Canada and AT&T have agreed on a framework to deal with ongoing co-operation and a process to transition network support provided by AT&T for the Company's toll-free platform by December 31, 2005 with the details of the transition plan to be completed by no later than December 31, 2003. The transitional network support arrangement may be extended by mutual agreement; may be accelerated under certain conditions to June 30, 2004; or accelerated in the event of an acquisition of 20% or more of AT&T Canada's equity by a strategic competitor or in other circumstances.

AT&T has the ability to serve Canadian customers directly, including competing with AT&T Canada. There can be no assurance that the Company will not incur a significant loss of revenue from business ongoing with or influenced by AT&T as a result of those new commercial arrangements.

(c): Cash flow and operating losses

The Company incurred net losses of $5.3 million, $523.2 million, $745.4 million and $1,831.6 million for the fiscal years ended December 31, 1999, 2000, 2001 and 2002 respectively. If losses were to continue it could impact the New Company's ability to obtain required additional funds to sustain its operations following the implementation of the Plan.

(d): Additional capital

If cash flow from operations and cash on hand are insufficient, there can be no assurance that, following the implementation of the Plan, the New Company will be able to obtain sufficient funds on terms acceptable to it to provide adequate liquidity and to finance the operating and capital expenditures necessary to execute its operating strategy. Failure to generate additional funds, whether from operations, additional debt or equity financing, may require the New AT&T Canada to delay or abandon some or all of its anticipated expenditures, which could have a material adverse effect upon the growth of the affected businesses and on the New AT&T Canada. Furthermore, the ability of competitors to raise money on more acceptable terms could create a competitive disadvantage for the New AT&T Canada.

(e): Competition

The Company faces intense competition in all of its markets for its existing and planned services from, among others, the ILECs, cable companies, competitive long distance providers, wireless providers, CLECs, internet service providers, Centrex resellers and other current and planned telecommunications providers. The Company's ability to compete effectively in the Canadian telecommunications industry may be adversely effected by continuing consolidation and expansion amongst its competitors.

In each of the business areas currently served by the Company, the principal competitor is the ILEC serving that geographic area. The ILECs have long-standing relationships with their customers and have historically benefited from a monopoly over the provision of local switched services. In addition, the ILECs have financial, marketing, technical, personnel, regulatory and other resources that exceed those of the Company, as applicable. There can be no assurance that the Company will be successful in its attempt to offer services in competition with the services offered by the ILECs.

Although the ILECs are generally subject to greater pricing and regulatory constraints than the CLECs, the ILECs have, as a result of the regulatory framework and especially the Price Cap Decision, achieved increased pricing flexibility for their local services and maintained control of the existing Public Switched Telephone Network that CLECs must utilize in order to compete. Since CLECs do not have competitively neutral access to this existing ILEC controlled network and are therefore subject to a significant cost disadvantage, the ILECs continue to be able to compete against the CLECs solely on the basis of price. If the ILECs lower rates or engage in substantial volume and term discount pricing practices for their customers, there would be downward pressure on certain rates charged by the Company, which pressure could adversely affect the Company.

The Company also faces competition from entities utilizing other communications technologies and may face competition from other technologies being developed or to be developed in the future. For example, there is a trend toward the convergence of the telecommunications and cable industries. The convergence of the telecommunications and the cable industries may add substantial new competition that could adversely affect the operations and financial condition of the Company. There can be no assurance that one or more of the technologies currently utilized by the Company will not become obsolete at some time in the future.

The Company believes that providers of wireless services will increasingly offer products that will compete with, and ultimately may replace, certain wireline telecommunications services, using new wireless technologies. Competition with providers of wireless telecommunications services may be intense and may further limit the prices with the level of service and price that customers demand at which the Company can profitably compete.

The telecommunications industry is subject to rapid and significant changes in technology with related changes in customer demands, including the need for new production and services at competitive prices. The Company's ability to compete effectively will depend, to a great extent, on its ability to anticipate, invest in and implement, or otherwise obtain new technologies. Furthermore, there may not be a demand for any of the Company's new products or services, the Company may be unable to deliver its new products and services to the public on a timely and competitive basis, and the Company may have to make additional capital investments to upgrade or replace its existing technology.

(f): Rapid technological changes

The telecommunications services industry is subject to rapid and significant changes in technology that may reduce the relative effectiveness of existing technology and equipment. Although the Company has invested in what it currently views as the best technology available, all aspects of voice, data, and video telecommunications are undergoing rapid technological change. There can be no assurance that the Company's technologies will satisfy future customer needs, that the Company's technologies will not become obsolete in light of future technological developments, or that the Company will not have to make additional capital investments to upgrade or replace its technology. The effect on the Company of technological changes, including changes relating to emerging wireline and wireless transmission and switching technologies, cannot be predicted and could have a material adverse effect on the Company's business, financial condition, results of operations and prospects.

In addition, the Company may be required to select one technology over another because it is not possible to predict with any certainty which technology will prove to be the most economic, efficient or capable of attracting customer usage. Furthermore, the Company may be unable to develop or acquire new technologies and products to compete effectively in the North American and global telecommunications markets. It is also impossible to predict whether existing, proposed or as yet undeveloped technologies will become dominant or otherwise render the Company's telecommunications services less profitable or less viable. If the Company fails to maintain competitive services or obtain new technologies, its business, financial condition and results of operations could be materially adversely affected.

The Company may be adversely affected by the insolvency or bankruptcy of its key suppliers or customers. The Company relies on the financial stability of its key suppliers and customers. The insolvency or bankruptcy of such parties could result in the Company not being able to realize on its capital investments, having to make alternate supplier arrangements, potentially at significant cost to the Company, or being unable to receive revenue or collect receivables from an insolvent or bankrupt customer.

(g): Governmental regulation and potential for change in regulatory environment

The Company is subject to regulation by Canada's telecommunications regulatory authority, the CRTC, pursuant to the provisions of the Telecommunications Act (Canada) (the "Telecommunications Act") and, to a lesser extent, the Radiocommunication Act (Canada) (the "Radiocommunication Act"), administered by Industry Canada. Since the passage of the Telecommunications Act, the policy of the government of Canada and subsequently the CRTC has been to recognize the importance of competition in the provision of telecommunications services in Canada.

There can be no assurance, however, that regulatory rulings of the CRTC within that policy framework will not have materially adverse effects on competition whether in relation to terms of access to the existing ILEC-controlled network, control of ILEC behaviour in view of their dominant market position or otherwise.

(h): Restrictions on foreign ownership and control

Under the ownership and control provisions of the Telecommunications Act and the Radiocommunication Act, a "Canadian carrier" is not eligible to operate as a Canadian telecommunications common carrier and is not eligible to hold a licence as a radiocommunication carrier unless it is Canadian owned and controlled and is incorporated or continued under the laws of Canada or a province. No more than 20% of the members of the board of directors of an eligible Canadian carrier may be non-Canadians, and no more than 20% of the voting shares of a Canadian carrier may be beneficially owned by non-Canadians. In addition, no more than 33¹/3% of the voting shares of a non-operating parent corporation of a Canadian carrier may be beneficially owned or controlled by non-Canadians and neither the Canadian carrier nor its parent may be otherwise controlled in fact by non-Canadians. The eligibility of AT&T Canada Corp. and AT&T Canada Telecom Services Company, and after the implementation date of the Plan, New OpCo, to continue to operate as Canadian carriers could be jeopardized if the Company and the New AT&T Canada, respectively, or any of their respective subsidiaries fail to comply with the requirements relating to ownership and control. In addition to ensuring that the New AT&T Canada does not violate the prohibition on control in fact by non-Canadians, any issuances of equity securities of the New AT&T Canada to non-Canadians must be of limited or non-voting securities or, if common shares or other voting securities, are issued such common shares or other non-voting securities are also issued to Canadian residents in such amounts as are necessary to allow the company to continue to meet the ownership restrictions. These ownership restrictions may limit the New AT&T Canada's ability to raise equity capital from non-Canadians.

The term "control in fact" is not defined in the relevant legislation and raises various complex questions of interpretation. A number of factors have been considered relevant to the determination of whether a regulated entity is not controlled in fact by non-Canadians, including the election and composition of the board of directors, the industry specific experience of the non-Canadian shareholders, the ability to appoint senior management, the power to determine policies, operations and strategic decision-making and the percentage of equity interest.

Although management believes that it has at all times been in compliance with the relevant legislation, and in particular believes that the current ownership structure of the Company and that the proposed ownership structure for the New AT&T Canada as it emerges from CCAA protection comply with Canadian ownership rules, there can be no assurance that any CRTC or Industry Canada determination or events beyond the control of the Company will not result in it or the New AT&T Canada ceasing to comply with the relevant legislation. Should this occur or should the CRTC or Industry Canada otherwise find the Company or the New AT&T Canada ineligible to operate telecommunications or radio communication facilities, the ability of the Company and its principal operating subsidiaries to act as a Canadian carrier under the Telecommunications Act or to maintain, renew or secure licences under the Radiocommunication Act could be jeopardized and the business of the Company or the New AT&T Canada could be materially adversely affected. If the Company or the New AT&T Canada becomes subject to proceedings before or against the CRTC or Industry Canada with respect to the Company's compliance with the relevant legislation, the Company or the New AT&T Canada, as applicable, could be materially adversely affected, even if the Company was ultimately successful in such a proceeding.

On November 19, 2002, Canada's Minister of Industry issued a discussion paper entitled, Foreign Investment Restrictions Applicable to Telecommunications Common Carriers, and announced a parliamentary committee (the "Parliamentary Committee") review of the federal government's current policies and legislation governing foreign ownership and control of telecommunications common carriers operating in Canada. The Industry Minister has asked for a report back from the Parliamentary Committee in early 2003 addressing thirteen questions in three specific areas, namely (i) overall investment in the telecommunications sector, (ii) the experience of other countries in restricting foreign investment, and (iii) the timing of implementation of any changes the government might make to the current foreign investment restrictions. Among the specific questions contained in the federal government's discussion paper was whether altering Canada's foreign investment restrictions could materially affect the ability of new competitive providers to establish and maintain financial stability, and to what extent any relaxation of foreign investment restrictions could be linked to the creation of a more competitive Canadian telecommunications industry. In announcing its telecommunications foreign investment review, the federal government stated that "it is time to re-evaluate whether the current approaches represent the most effective means of achieving balanced policy objectives in the telecommunications sector", and questioned how Canadians might gain "access to a larger capital pool for investment in new and improved telecommunications infrastructure without compromising their national sovereignty policy objectives". The Company is participating fully in the review and is arguing in favour of liberalization of the investment regime and removal of the current investment restrictions applicable to competitive providers. Should the federal government decide to liberalize the existing restrictions, legislative amendments would be required. Accordingly, a liberalized regime would not come into effect until the government had introduced the legislation into Parliament and passed amended legislation.

(i): Listings; absence of public trading markets

Listing is being sought on the TSX and on NASDAQ for the New Shares upon the Company's emergence from CCAA protection and the Company believes, based on legal and financial advice, including advice from the legal and financial advisors to the noteholders as to the estimated number of beneficial holders of the Notes, that the New AT&T Canada will be able to meet the listing criteria for these exchanges. The implementation of the Plan is conditional, among other things, upon the listing of the New Shares on the TSX. The Company will use reasonable best efforts to cause the New Shares to be listed on NASDAQ as soon as practicable on or after the implementation of the Plan. Subject to any change of control transaction, the New AT&T Canada will use reasonable efforts to maintain it's listing on the TSX and NASDAQ National Market System for at least three years. If a listing is obtained, there can be no assurance that any such listing will continue or that an active trading market will develop or be sustained. If a market does develop there can be no assurance that the price will reflect the estimated net value of the New AT&T Canada. The market price of the New Shares may be highly volatile and could be subject to wide fluctuations in response to variations in results of operations, changes in financial estimates by securities analysts, changes in the regulatory regime governing the telecommunications industry or other events and factors. Historically, securities markets have periodically experienced significant price and volume fluctuations that are unrelated to the financial performance of particular companies. These broad market fluctuations may also adversely affect the market price of the New Shares. Further, non-Canadians may not acquire voting securities on the secondary market if such acquisition would contravene the restrictions of foreign ownership and control discussions in (h) above.

(j): Market and economic conditions

The Company's future operating results may be affected by trends and factors beyond its control. Such trends and factors include the policies of Canada and the United States in regard to foreign trade, investments and taxes, foreign exchange rate controls and fluctuations, political instability and increased payment periods, adverse change in the conditions in the specific markets for the Company's and after the implementation of the Plan, the Company's products and services, the conditions in the broader market for communications and the conditions in the domestic or global economy generally. More specifically, the Company's financial performance will be affected by the general economic conditions as demand for services tends to decline when economic growth and retail and commercial activity decline. Recently, the slowdown in global economic activity in Canada and the United States, has made the overall global and Canadian economic environment more uncertain and could, depending on the duration and extent of such slowdown and on the pace of an eventual economic recovery, have an important adverse impact on the demand for products and services and on the financial performance of the Company. Such negative trends in global market and economic conditions could have an adverse effect on purchasing patterns of subscribers and customers especially in the case of products and services provided by the Company and, after the implementation of the Plan, the New AT&T Canada that are more subject to being affected by economic slowdown. These negative trends could also adversely affect the financial condition and credit risk of subscribers and customers, which would, in turn, increase uncertainties regarding the Company's and, after the implementation of the Plan, the New AT&T Canada's ability to collect receivables. During the economic slowdown, business telecommunications customers may delay new service purchases, reduce volumes of use and/or discontinue use of services. One or more of these factors could have a significantly negative effect on the financial situation and results of the Company and after the implementation of the Plan, the New AT&T Canada.

(k): Foreign exchange

The Company has significant U.S. dollar debt service requirements to 2008, which, as at December 31, 2002, the Company no longer hedges. All such obligations will be compromised upon implementation of the Plan and therefore this risk will have minimal impact upon implementation of the Plan.

Critical accounting policies

The Company believes that the following selected accounting policies and issues are critical to understanding the estimates, assumptions and uncertainties that affect the amounts reported and disclosed in the Company's consolidated financial statements and notes to the financial statements. See Note 2 to the 2002 annual consolidated financial statements for a more comprehensive discussion of the Company's significant accounting policies.

Use of estimates

The preparation of the consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses. Actual results could differ from those estimates.

Recoverability of Capital Assets

Due to the capital intensive nature of the telecommunications industry, the Company has made significant investments in capital assets. These assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. Assessments of the recoverability of capital assets require estimates of useful lives, future cash flows, discount rates and terminal values. Management develops cash flow projections using assumptions that reflect the Company's planned courses of action and management's best estimate of the most probable set of economic conditions. If the total of the expected future undiscounted cash flows is less than the carrying amount of the asset, a write-down is recognized for the difference between the expected future undiscounted cash flows and carrying value of the asset.

Valuation of accounts receivable

The Company's allowance for doubtful accounts is based on a specific percentage using historical experience applied to aging categories and an additional amount for specific delinquent balances.

Provision for restructuring activities

Accrued restructuring charges require significant estimates including estimated sublease recoveries from properties vacated and expected time required to enter into sublease agreements.

Provisions for contingent liabilities

In the normal course of business, the Company is subject to proceedings, lawsuits and other claims. Such matters are subject to many uncertainties, and outcomes are not predictable with assurance. The Company maintains and regularly updates on a case-by-case basis, provisions for such items when the expected loss is both probable and can be reasonably estimated. The Company is unable to ascertain the ultimate aggregate amount of monetary liability or financial impact with respect to these matters as at December 31, 2002. These matters could affect the operating results of any one quarter when resolved in future periods.

Liabilities subject to compromise

Liabilities subject to compromise under the CCAA proceedings have been estimated by management based upon the Court-approved process to prove, administer and adjudicate claims. The claims of Noteholders have been determined in accordance with such process. Claims of other affected creditors and the amount recorded as liabilities have been estimated using the information provided by the Affected Creditors and management's assessment of the merits of the claims.

New accounting standards

Business combinations, and goodwill and other intangible assets

Effective January 1, 2002, the Company adopted the Canadian Institute of Chartered Accountants Handbook Section ("HB") 1581 "Business Combinations", and HB 3062 "Goodwill and Other Intangible Assets". The new sections are substantially consistent with equivalent U.S. pronouncements, SFAS No. 141 "Business Combinations" and SFAS No. 142 "Goodwill and Other Intangible Assets", issued by the Financial Accounting Standards Board ("FASB") in July 2001.

HB 1581 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001. Use of the pooling-of-interests method is no longer permitted. Adoption of HB 1581 did not affect the result of operations as the Company currently accounts for all business combinations under the purchase method.

HB 3062 no longer permits the amortization of goodwill and indefinite-lived intangible assets. Instead, these assets must be reviewed annually (or more frequently under certain conditions) for impairment using a fair value approach rather than the undiscounted cash flow approach previously used. During the second quarter, the Company completed its transitional goodwill impairment test and determined that unamortized goodwill of $1,530.8 million as at January 1, 2002, was impaired under the fair value approach. This amount was charged to opening retained earnings with a corresponding reduction in goodwill.

See additional discussion in Note 2 to the 2002 consolidated financial statements.

Foreign currency translation and hedging relationships

Effective January 1, 2002, the Company adopted amended HB 1650 "Foreign Currency Translation", which eliminates the deferral and amortization of foreign currency translation gains and losses on long-term monetary items with a fixed or ascertainable life. At December 31, 2001, the Company had approximately $12.3 million of unamortized foreign exchange losses that were affected by this change. Upon adoption, deferred foreign exchange has been reduced by this amount, with a corresponding increase in opening deficit as of January 1, 2002. HB 1650 also requires restatement of prior periods, the effect of which was to increase the reported net loss for the year ended December 31, 2001 by $12.3 million (2000 — nil).

Effective January 1, 2004, the Company will adopt the new Accounting Guideline, AcG-13, "Hedging Relationships," which requires that in order to apply hedge accounting, all hedging relationships must be identified, designated, documented and effective, where hedging relationships do not meet these requirements hedge accounting must be discontinued. The Company is currently evaluating the impact of adoption of AcG-13 and has not yet determined the effect of adoption on its results of operations or financial condition.

See additional discussion in Note 2 to the 2002 consolidated financial statements.

Stock-based compensation

Effective January 1, 2002, the Company adopted the new HB 3870 "Stock-based Compensation and Other Stock-based Payments", which establishes standards for the recognition, measurement and disclosure of stock-based compensation and other stock-based payments made in exchange for goods and services. HB 3870 permits the Company to continue its existing policy of treating all other employee stock options as capital transactions (or settlement method), but requires pro forma disclosure of net earnings and per share information as if the Company had accounted for employee stock options under the fair value method which has been included in note 2 to the consolidated financial statements.

Recent pronouncements

Effective January 1, 2003, the Company will adopt AcG-14, "Disclosure of Guarantees", which requires a guarantor to disclose significant information about guarantees it has provided, without regard to whether it will have to make any payments under the guarantees and in addition to the accounting required by HB 3290 "Contingencies". The Guideline is generally consistent with disclosure requirements for guarantees in the FASB No.45 but, unlike the FASB's guidance, does not apply to product warranties and does not encompass recognition and measurement requirements. The Company is currently evaluating the impact of adoption of AcG-14 and has not yet determined the effect of adoption on its results of operations and financial condition.

The Company will adopt new HB 3063, "Impairment of Long-Lived Assets", which will be effective for fiscal years beginning on or after April 1, 2003, with earlier adoption encouraged. Application of HB 3063 is prospective. The new standard replaces requirements on the write-down of assets previously contained in HB 3061, "Property, Plant and Equipment", and harmonizes Canadian accounting for the impairment of long-lived assets with US GAAP (FASB No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets"). The Company is currently evaluating the impact of adoption of HB 3063 and has not yet determined the effect of adoption on its results of operations and financial condition.

The Company will adopt new HB 3475, "Disposal of Long-Lived Assets and Discontinued Operations". The new HB 3475 applies to disposal activities initiated by an enterprise's commitment to a plan on or after May 1, 2003, with earlier adoption encouraged. Application of the new HB 3475 is prospective. The new HB replaces requirements on the disposal of assets and discontinued operations that were contained in HB 3061, "Property, Plant and Equipment", and in the previous HB 3475, "Discontinued Operations", and harmonizes Canadian accounting with US GAAP (FASB No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets") for these topics. The Company is currently evaluating the impact of adoption of HB 3475 and has not yet determined the effect of adoption on its results of operations and financial condition.

Results of operations

Year ended December 31, 2001 compared to year ended December 31, 2000

(All dollar amounts are stated in thousands of Canadian dollars except where otherwise noted)

Revenue

The Company holds an 11% share of the Canadian business telecommunications market from its data, local, Internet and E-Business solutions services, and from its long distance services. The Company's proportion of revenue from data, local, Internet and E-Business solutions, and other services grew to 57% of the Company's total revenue in 2001 from 53% in 2000. The proportion of revenues from long distance services declined to 43% in 2001 from 47% in the prior year. During 2002, the Company will continue its focus on growth in data, local, and Internet and E-Business solutions.

The year-over-year increase in data revenue was mainly due to the growth in Data VPN Frame Relay (the Company's virtual private network product), Asynchronous Transfer Mode ("ATM"), high speed data (MACH), and local and wide area network ("LAN/WAN"), partially offset by decreases in legacy private line data services. Data revenue increased by $19,624 or 4.2% to $485,031 in 2001 from $465,407 in 2000. In 2002, the Company will seek to improve its data product mix by continuing to market more advanced and higher margin data products and strengthen its product portfolio through its licensing arrangements with AT&T Corp. to provide customers with North American and global frame relay and LAN/WAN.

The year-over-year increase in local voice revenue was due to the addition of 137,997 new local access lines. Local voice revenue increased by $31,783 or 17.9% to $209,207 in 2001 from $177,424 in 2000. The growth in 2001 was the result of focus on customers in the small and medium sized business markets, offset by the negative impact of general economic conditions which included lower demand from the wholesale and internet service provider ("ISP") markets as customers in this sector experienced financial difficulty. During the year, the Company acquired the rights to a customer base from the receiver of an insolvent Canadian CLEC, resulting in the addition of 42,430 new local lines. The Company reduced the number of access lines reported by 33,661 due to a one-time adjustment, the result of historical system conversion and other adjustments. This adjustment was statistical in nature and had no effect on revenue. Local access lines in service totaled 548,969 at December 31, 2001. During 2001, the Company completed an additional two local city networks to achieve a footprint of 29 cities. In 2002, the Company will focus its efforts on increasing its market share in the business local market.

The year-over-year increase in Internet and E-Business solutions revenue was mainly due to the Company's strategic acquisition of MONTAGE and significant growth in high speed dedicated Internet access, managed hosting and security solutions. Internet and E-Business solutions revenue increased by $41,987 or 32.3% to $171,852 in 2001 from $129,865 in 2000. Consistent with the Company's strategy to focus on higher growth and higher value added products, the Internet and E-Business solutions portfolio increased to 11.1% in 2001 as a proportion of total revenue from 8.6% in 2000. In 2002, the Company plans to further strengthen its product portfolio and continues to expect growth in this area as economic conditions improve.

Other revenue decreased by $11,800 or 36.1% to $20,843 in 2001, from $32,643 in 2000 primarily due to the sale of certain of the Company's call centers and lower telecommunications equipment sales.

The year-over-year decrease in long distance ("LD") revenue was mainly due to lower prices per minute, partially offset by growth in minutes. LD revenue decreased by $42,251 or 6.0% to $657,788 in 2001 from $700,039 in 2000. Year-over-year, minutes increased by 9.6% while prices dropped by 14.0% primarily as a result of intense price competition. During 2002, the Company will continue to optimize long distance products and to leverage established customer relationships to cross sell the Company's data, local, Internet, and E-Business solutions.

Service costs and selling, general and administrative expenses

The Company's principal operating expenses consist of service costs; selling, general and administrative costs ("SG&A"); and depreciation and amortization. Service costs consist of expenses directly related to delivering service to customers and servicing the operations of the Company's networks, expenses associated with fibre and other leases where the Company does not presently have its own facilities, local and long distance transport costs paid to other carriers, maintenance agreements, right-of-way fees, municipal access fees, hub site lease expenses, costs of service personnel and leases of utility space in buildings connected to the Company's networks. SG&A expenses include the costs of sales and marketing personnel, promotional and advertising expenses and corporate administrative expenses.

Service Costs decreased by $29,070 or 2.8%, to $1,005,790 in 2001, from $1,034,860 in 2000. This decrease was due to the positive impact of the change in the contribution regime, lower toll free rates and optimization of access methods, offset, in part, by additional costs related to higher volume and costs associated with strategic acquisitions in 2000 and 2001. The Company will experience further cost reductions as the contribution rate will be reduced from 4.5% to 1.4% on an interim basis effective January 1, 2002. A number of appeals relating to the decision to change the contribution regime were filed and have been dismissed. However, Telus Communications Inc., which filed an earlier appeal to the Federal Court that was dismissed, has filed a further appeal with the CRTC relating to issues around the amount of the subsidy going forward.

Gross margin increased by $68,413 to $538,931 in 2001 from $470,518 in 2000 as the Company benefited from its emphasis on higher growth and higher margin products and services, the acquisition of MONTAGE and improvements in its service costs structure.

SG&A expenses decreased by $25,981 or 6.3% to $385,966 in 2001 from $411,947 in 2000. This decrease was due to the change in the valuation allowance related to the Company's defined benefit pension plans and lower sales costs, offset primarily by an increase in personnel costs from strategic acquisitions and from the Company's focus on improving customer service including provisioning, customer care processes support and information systems.

At the beginning of the year, the Company's defined benefit pension plans were in a surplus position, net of unamortized actuarial gains, giving rise to an accrued benefit asset. The amount of the accrued benefit asset that can be recorded by the Company is subject to a limit, being the sum of the expected employer future benefit and any net unrecognized losses. The balance of the valuation allowance recorded against the accrued benefit asset due to this limit at December 31, 2000, was $31,934. During 2001, the impact of negative returns on plan assets in the Company's defined benefit pension plans has been an elimination of the pension surplus and generation of unamortized losses at December 31, 2001. Under generally accepted accounting principles, the limit on the accrued benefit asset is required to be increased by the amount of the losses that will be charged as an expense in future years, resulting in a reduction in the valuation allowance and a credit to the pension expense amount of the Company. The impact of the above is that the valuation allowance of $31,934 is no longer required and has been recognized into income in 2001.

EBITDA

EBITDA before integration costs, provision for restructuring and workforce reduction costs, pension valuation allowance and minority interest increased to $121,031 in 2001 from $58,571 in 2000. On a percentage of revenue basis, EBITDA grew to 7.8% in 2001 from 3.9% in 2000. This increase was due to the gross margin improvements and lower SG&A expenses.

2001 workforce reduction costs

In July 2001, in consideration of the difficult industry conditions, the Company initiated a cost reduction initiative in its drive towards profitable growth. During the third quarter of 2001, a provision of $21,901 was recorded principally for severance and benefits related to the termination of approximately 650 personnel. The personnel terminated were from various areas across the Company including marketing, network services, customer service, Internet and E-Business solutions services and administration. Substantially all of the workforce reductions were completed as at December 31, 2001. The remaining liability associated with the workforce reduction costs of $6,215 represent salary continuance payments in accordance with the termination agreements.

1999 integration costs and provision for restructuring

Substantially all of the activities that were provided for in the 1999 integration costs and provision for restructuring were completed as at December 31, 2001.

Depreciation and amortization

Depreciation and amortization expense increased to $465,600 in 2001 compared to $402,551 in 2000. The increase was primarily due to the Company's strategic acquisitions in 2000 and 2001 and an increase in the level of depreciation from the Company's capital spending program.

Interest income and expense

Interest income increased to $19,134 in 2001 from $17,243 in 2000. The increase of $1,891 was due to higher average cash and short-term deposits during the year compared with 2000.

Interest expense increased to $401,114 in 2001 from $319,046 in 2000. Of the interest expensed, $213,890 represented cash interest payments, $145,148 was accreted on the senior discount notes, $15,661 was amortization of debt issue costs, and the remaining $26,415 was accrued interest. The increase was due to higher average debt balances from the issuance of U.S. $500,000 Senior Notes on March 30, 2001 and higher average foreign exchange rates impacting unhedged U.S. dollar denominated interest expense.

Other income (expenses)

Other expenses were $10,797 for 2001 compared to other income of $13,739 for 2000. Other expenses for 2001 related to a $8,894 loss on the sale of certain call centers in May 2001 and foreign exchange gains and losses. Other income for 2000 related mainly to the disposition of a significant portion of the Company's ownership in Shared Technologies of Canada Inc.

Net loss

Net loss increased to $745,375 in 2001 from $523,207 in 2000 mainly due to the impact of minority interest loss absorption in 2000, an increase in interest expense as a result of higher long term debt, an increase in amortization expense and workforce reduction costs incurred in 2001, partially offset by an improvement in EBITDA as described above. In 2000, the Company recognized into income the gain from the disposition of a significant portion of the Company's ownership in Shared Technologies of Canada Inc. and reversed a portion of its provision for restructuring recorded in 1999.

QUARTERLY FINANCIAL INFORMATION
(Unaudited)

		2002
Quarters ended		March 31			June 30			September 30			December 31
Revenue
	Data	$	115,568		$	119,459		$	110,229		$	112,706
	Local		59,669			59,708			58,242			57,477
	Internet and E-Business solutions		48,980			50,210			47,509			48,900
	Other		5,313			8,508			7,620			5,252

		$	229,530		$	237,885		$	223,600		$	224,335
	Long Distance		154,300			146,972			136,261			135,262

Total Revenue		$	383,830		$	384,857		$	359,861		$	359,597

Service Costs		$	255,169		$	251,056		$	223,003		$	202,721
Gross Margin		$	128,661		$	133,801		$	136,858		$	156,876
*Gross Margin %*			33.5%			34.8%			38.0%			43.6%
Selling, General and Administrative Costs ("SG&A")		$	90,636		$	83,318		$	82,578		$	76,471
Net Income (loss) from operations		$	(53,001	)	$	(1,314,346	)	$	7,605		$	19,527
Net Loss		$	(157,619	)	$	(1,353,431	)	$	(256,839	)	$	(63,769	)
Basic and diluted loss per common share		$	(1.57	)	$	(13.45	)	$	(2.54	)	$	(0.60	)

Supplementary Financial Information

		2002
Quarters ended		March 31			June 30			September 30		December 31
Income (loss) from operations		$	(53,001	)	$	(1,314,346	)	$	7,605	$	19,527
Add:
	Depreciation and amortization		91,026			91,074			46,675		44,367
	Write-down of property, plant and equipment and goodwill		—			1,203,196			—		—
	Workforce reduction and provision for restructuring		—			70,558			—		16,511

*EBITDA ()**		$	38,025		$	50,482		$	54,280	$	80,405

(*): EBITDA is a measure commonly used in the telecommunications industry to evaluate operating results and is generally defined as earnings before interest, income taxes, depreciation and amortization. The Company has also excluded the write-down of property, plant and equipment and goodwill, provisions from restructuring and workforce reduction, and a pension valuation allowance adjustment as these items are not expected to be re-occurring in nature as the Company is restructuring its balance sheet through a CCAA proceeding. The Company is restructuring its balance sheet through a CCAA proceeding and is expecting to emerge from the proceeding on or about April 1, 2003. EBITDA does not have a standardized meaning under GAAP and is not necessarily comparable to similar measures disclosed by other issuers. Accordingly, EBITDA is not intended to replace income/(loss) from operations, net income/(loss) for the period, cash flow, or other measures of financial performance and liquidity reported in accordance with Canadian GAAP.

QUARTERLY FINANCIAL INFORMATION
(Unaudited)

		2001
Quarters ended		March 31			June 30			September 30			December 31
Revenue
	Data	$	122,714		$	115,553		$	125,024		$	121,740
	Local		46,266			52,168			52,207			58,566
	Internet and E-Business solutions		37,646			40,094			46,421			47,691
	Other		5,758			6,911			3,846			4,328

		$	212,384		$	214,726		$	227,498		$	232,325
	Long Distance		175,480			160,441			159,723			162,144

Total Revenue		$	387,864		$	375,167		$	387,221		$	394,469

Service Costs		$	247,191		$	245,462		$	253,157		$	259,980
Gross Margin		$	140,673		$	129,705		$	134,064		$	134,489
*Gross Margin %*			36.3%			34.6%			34.6%			34.1%
Selling, General and Administrative Costs ("SG&A")		$	109,114		$	104,157		$	103,764		$	68,931
Net Income (loss) from operations		$	(76,789	)	$	(87,153	)	$	(110,780	)	$	(59,814	)
Net loss		$	(167,475	)	$	(174,729	)	$	(232,475	)	$	(170,697	)
Basic and diluted loss per common share		$	(1.73	)	$	(1.78	)	$	(2.35	)	$	(1.74	)

Supplementary Financial Information

		2001
Quarters ended		March 31			June 30			September 30			December 31
Loss from operations		$	(76,789	)	$	(87,153	)	$	(110,780	)	$	(59,814	)
Add:
	Depreciation and amortization		108,348			112,701			119,179			125,372
	Workforce reduction and provision for restructuring		—			—			21,901			—
	Pension valuation allowance		—			—			—			(31,934	)

*EBITDA ()**		$	31,559		$	25,548		$	30,300		$	33,624

(*): EBITDA is a measure commonly used in the telecommunications industry to evaluate operating results and is generally defined as earnings before interest, income taxes, depreciation and amortization. The Company has also excluded the write-down of property, plant and equipment and goodwill, provisions from restructuring and workforce reduction, and a pension valuation allowance adjustment as these items are not expected to be re-occurring in nature as the Company is restructuring its balance sheet through a CCAA proceeding. The Company is restructuring its balance sheet through a CCAA proceeding and is expecting to emerge from the proceeding on or about April 1, 2003. EBITDA does not have a standardized meaning under GAAP and is not necessarily comparable to similar measures disclosed by other issuers. Accordingly, EBITDA is not intended to replace income/(loss) from operations, net income/(loss) for the period, cash flow, or other measures of financial performance and liquidity reported in accordance with Canadian GAAP.

QuickLinks

AT&T CANADA INC. Management's Discussion and Analysis of Financial Condition and Results of Operations (p. 1) Consolidated Financial Statements (p. 20)
management's discussion and analysis of financial condition and results of operations
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April 1
Successful completion of restructuring process

TSX:
ALR.A
ALR.B

NASDAQ:
ALLSA
ALLSB

April 1
Introduction of new Board of Directors with depth of experience across multiple industries and disciplines

April 1
Moves forward with no long-term public debt and generating positive cash flow and net income

April 1
Begins trading on TSX and NASDAQ