##### 



INTERIM CONSOLIDATED FINANCIAL STATEMENTS CALL-NET ENTERPRISES INC. MARCH 31, 2004 (CALLNET LOGO)




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##### 



CALL-NET ENTERPRISES INC.
CONSOLIDATED BALANCE SHEETS
(UNAUDITED) [millions of Canadian dollars] December 31,March 31, 2004
    
    2003Restated [note 1]ASSETSCash and cash equivalents
    
    
    51.4
    
    
    
    56.5Short-term investments
    
    
    27.6
    
    
    
    93.6Cash, cash equivalents and short-term investments
    
    
    79.0
    
    
    
    150.1Accounts receivable [note 2]
    
    
    26.7
    
    
    
    42.7Other current assets [note 3]
    
    
    19.8
    
    
    
    48.9Total current assets
    
    
    125.5
    
    
    
    241.7Capital assets [note 4]
    
    
    497.3
    
    
    
    516.7Other assets [note 5]
    
    
    73.8
    
    
    
    80.7Total assets
    
    
    696.6
    
    
    
    839.1LIABILITIES AND SHAREHOLDERS EQUITYAccounts payable and accrued liabilities[note 6]
    
    
    131.6
    
    
    
    149.4Long-term debt[note 7a]
    
    
    292.3
    
    
    
    387.1Other long-term liabilities[note 7b]
    
    
    48.6
    
    
    
    49.1Commitments [note 7]Shareholders equityCapital stock [note 8]Common shares, unlimited authorized
    
    
    48.7
    
    
    
    49.8Class B non-voting shares, unlimited authorized
    
    
    298.7
    
    
    
    297.6Preferred shares, unlimited authorized
    
    
    
    
    
    
    Contributed surplus [note 1]
    
    
    3.4
    
    
    
    2.9Deficit
    
    
    (126.7
    )
    
    
    (96.8
    )Total shareholders equity
    
    
    224.1
    
    
    
    253.5Total liabilities and shareholders equity
    
    
    696.6
    
    
    
    839.1
 See accompanying notes 2




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##### 



CALL-NET ENTERPRISES INC.
CONSOLIDATED STATEMENTS OF OPERATIONS AND DEFICIT
(UNAUDITED) [millions of Canadian dollars, except per share amounts] Three Months
    
    Three MonthsEnded
    
    EndedMarch 31,
    
    March 31,2004
    
    2003Restated [note 1]Revenue
    
    
    202.5
    
    
    
    202.2Carrier charges
    
    
    95.1
    
    
    
    106.2Gross profit
    
    
    107.4
    
    
    
    96.0Operating costs
    
    
    80.9
    
    
    
    71.5Depreciation and amortization
    
    
    36.8
    
    
    
    40.2Operating loss
    
    
    (10.3
    )
    
    
    (15.7
    )Loss on repurchase of long-term debt [note 7]
    
    
    (4.0
    )
    
    
    Release of change in control provision [note 9]
    
    
    4.7
    
    
    
    Interest on long-term debt
    
    
    (9.7
    )
    
    
    (12.1
    )Interest and other expense
    
    
    (2.2
    )
    
    
    (0.4
    )Foreign exchange gain (loss)
    
    
    (8.1
    )
    
    
    36.2Income (loss) before taxes
    
    
    (29.6
    )
    
    
    8.0Income tax expense
    
    
    (0.3
    )
    
    
    (0.4
    )Net income (loss) for the period
    
    
    (29.9
    )
    
    
    7.6Deficit, beginning of period
    
    
    (93.0
    )
    
    
    (57.7
    )Adjustment for stock-based compensation [note 1]
    
    
    (2.9
    )
    
    
    (1.2
    )Adjustment for asset retirement obligation [note 1]
    
    
    (0.9
    )
    
    
    (0.4
    )Deficit, beginning of period adjusted
    
    
    (96.8
    )
    
    
    (59.3
    )Deficit, end of period
    
    
    (126.7
    )
    
    
    (51.7
    )Basic earnings (loss) per share[note 11]
    
    
    (0.84
    )
    
    
    0.32Diluted earnings (loss) per share[note 11]
    
    
    (0.84
    )
    
    
    0.32
 See accompanying notes 3




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##### 



CALL-NET ENTERPRISES INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS [millions of Canadian dollars] Three Months
    
    Three MonthsEnded
    
    EndedMarch 31,
    
    March 31,2004
    
    2003Restated [note 1]OPERATING ACTIVITIESNet income (loss) for the period
    
    
    (29.9
    )
    
    
    7.6Add (deduct) operating items not requiring cash:Depreciation and amortization
    
    
    36.8
    
    
    
    40.2Interest and other expense
    
    
    1.3
    
    
    
    1.0Foreign exchange (gain) loss on long-term debt
    
    
    6.0
    
    
    
    (33.0
    )Reversal of change in control provision
    
    
    (4.7
    )
    
    
    Loss on repurchase of long-term debt [note 7(a)]
    
    
    4.0
    
    
    
    Cash provided by operations before changes in non-cash
working capital
    
    
    13.5
    
    
    
    15.8Net change in non-cash working capital balances related
to operations
    
    
    (9.9
    )
    
    
    (8.4
    )Cash provided by operating activities
    
    
    3.6
    
    
    
    7.4INVESTING ACTIVITIESDecrease in short-term investments
    
    
    66.0
    
    
    
    45.1Acquisition of capital assets
    
    
    (14.0
    )
    
    
    (8.3
    )Proceeds from sale of accounts receivable [note 2]
    
    
    45.0
    
    
    
    Increase in deferred costs
    
    
    (0.5
    )
    
    
    Net proceeds on disposal of capital assets [note 4]
    
    
    
    
    
    
    2.9Cash provided by investing activities
    
    
    96.5
    
    
    
    39.7FINANCING ACTIVITIESDecrease in right-of-way liability
    
    
    (0.4
    )
    
    
    (0.7
    )Long-term debt repurchase
    
    
    (104.8
    )
    
    
    Cash used in financing activities
    
    
    (105.2
    )
    
    
    (0.7
    )Net increase (decrease) in cash and cash equivalents
during the period
    
    
    (5.1
    )
    
    
    46.4Cash and cash equivalents, beginning of period
    
    
    56.5
    
    
    
    34.1Cash and cash equivalents, end of period
    
    
    51.4
    
    
    
    80.5
 See accompanying notes 4




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##### 



CALL-NET ENTERPRISES INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED) [millions of Canadian dollars, unless otherwise indicated] 1. BASIS OF PRESENTATION The interim consolidated financial statements include the accounts of Call-Net
Enterprises Inc. and its subsidiary companies [collectively the Company]. These
interim consolidated financial statements are prepared using accounting
principles and methods of applications that are in conformity with Canadian
generally accepted accounting principles [Canadian GAAP], and are the same as
those used in preparing the most recent annual statements, except for the
following developments:  Stock-Based Compensation and Other Stock-Based PaymentsDuring 2003, the CICA made changes to Section 3870, Stock-Based
Compensation and Other Stock-Based Payments requiring equity instruments
awarded to employees be measured and expensed using the fair value method.
The main impact for the Company was to record compensation expense relating
to the award of stock options to employees that the Company had previously
chosen to disclose in the notes to the financial statements. The Company
has adopted this change effective January 1, 2004 on a retroactive basis
with restatement of prior periods. The result of this change is reflected
in operating expense in the consolidated statements of operations and
deficit and contributed surplus on the consolidated balance sheets. The
effect of prior-period restatements is a decrease to net income of $0.4 and
a decrease in both basic and diluted earnings per share of $0.01 each for
the three-months ended March 31, 2003 and an increase to deficit of $2.9 as
at December 31, 2003.The fair value of stock options is estimated at the grant date using the
Black-Scholes options pricing model. This model requires the input of a
number of assumptions including dividend yields, expected stock price
volatility, expected time until exercise and risk-free interest rates.
Although the assumptions used reflect managements best estimates, they
involve uncertainties based on market conditions generally outside of the
control of the Company.Asset Retirement ObligationsEffective January 1, 2004, the Company retroactively adopted the new CICA
Handbook Section 3110, Asset Retirement Obligations, which establishes
standards for the recognition, measurement and disclosure of liabilities for
asset retirement obligations and the associated retirement costs. This
section applies to legal obligations associated with the retirement of
tangible long-lived assets that results from their acquisition, lease
construction, development or normal operation. The offset to the initial
asset retirement obligation is an increase in the carrying amount of the
related long-lived asset. Over time, the liability is accreted to its future
value, and the asset is depreciated over the useful life of the related
asset. Upon settlement of the liability, an entity either settles the
obligation for its recorded amount or incurs a gain or loss upon settlement.
This standard is effective on a retroactive basis with restatement of prior
periods. As at January 1, 2003, the Company recorded a liability of $2.2
for the estimated costs of retiring fibre optic cable and leasehold
improvement assets at the maturity of the facility leases.The Company also recorded asset retirement costs of $1.8 as at January 1,
2003 to its fibre optic cable and leasehold improvement assets. The Company
recorded a charge to the January 1, 2003 deficit of $0.4 for the cumulative
effects of the standard and has increased its depreciation expense for the
year ended December 31, 2003 by $0.5 ($0.1 for the three months ended March
31, 2003). The following table details the changes in the asset retirement
liability: 5




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##### 



CALL-NET ENTERPRISES INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED) [millions of Canadian dollars, unless otherwise indicated] January 1, 2004
    
    $
    2.4Accretion charges recorded in depreciation expense
    
    
    0.1March 31, 2004
    
    $
    2.5
  The adjustment to the fibre optic cable and leasehold improvement assets in
respect of asset retirement costs is depreciated into income over the
remaining life of the assets, on a straight-line basis. For the three
months ended March 31, 2004, depreciation expense was $0.1. These interim consolidated financial statements should be read in conjunction
with the most recently prepared annual financial statements. 2. ACCOUNTS RECEIVABLE March 31, 2004
    
    December 31, 2003Trade receivables
    
    
    29.3
    
    
    
    46.5Other
    
    
    2.3
    
    
    
    2.4Allowance for doubtful accounts
    
    
    (4.9
    )
    
    
    (6.2
    )26.7
    
    
    
    42.7
 In 2003, the Company entered into a five-year accounts receivable
securitization program whereby it will sell on an on-going basis, an undivided
co-ownership interest in certain of its trade receivables to a securitization
trust (the Trust) to a maximum of $55.0, of which all was utilized as at March
31, 2004. The Company will remain exposed to certain risks of default on the
amount of the receivables under securitization. The Company will retain
servicing responsibilities, and will have a retained interest in the
securitized receivables and rights to future excess cash flows generated by the
Trust. The sales will be on a fully-serviced basis and the Company will not
receive any fees for its on-going servicing responsibilities. The Trust and
its investors have no recourse on the Companys other assets for failure of
debtors to pay when due, other than the retained interest of the Trust. During the quarter ended March 31, 2004, the Company recognized a loss of $1.7
(2003  nil) on the securitization of receivables, and a gain on servicing of
$0.1 (2003  nil). The Company measures the loss on securitization by applying
the same methodology used to estimate the allowance for doubtful accounts. The
result is a provision for anticipated credit losses of approximately 2.7% to
2.9%. The sensitivity of the current fair value of the retained interest to a
10 to 20 per cent adverse change in this assumption is not material. Cash flows from the securitization for the quarter are as follows: March 31,
    
    March 31,2004
    
    2003Proceeds from new securitizations during the quarter
    
    
    45.0
    
    
    
    Proceeds from collections reinvested during the quarter
    
    
    46.0
    
    
    
    Proceeds from collections pertaining to the retained interest during the quarter
    
    
    147.6
    
    
    
    
 3. OTHER CURRENT ASSETS March 31, 2004
    
    December 31, 2003Retained interest in securitized receivables
    
    
    12.1
    
    
    
    41.2Other
    
    
    7.7
    
    
    
    7.719.8
    
    
    
    48.9
 6




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##### 



CALL-NET ENTERPRISES INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED) [millions of Canadian dollars, unless otherwise indicated] 4. CAPITAL ASSETS March 31, 2004
    
    December 31, 2003Accumulated
    
    
    
    
    
    
    
    
    
    AccumulatedDepreciation
    
    Net
    
    
    
    
    
    Depreciationand
    
    Book
    
    
    
    
    
    and
    
    Net BookCost
    
    Amortization
    
    Value
    
    Cost
    
    Amortization
    
    ValueMultiplex and telephone switch
equipment
    
    
    472.3
    
    
    
    146.3
    
    
    
    326.0
    
    
    
    467.4
    
    
    
    128.8
    
    
    
    338.6Fibre optic cable
    
    
    107.2
    
    
    
    14.7
    
    
    
    92.5
    
    
    
    107.2
    
    
    
    12.9
    
    
    
    94.3Computer equipment and software
    
    
    149.9
    
    
    
    95.7
    
    
    
    54.2
    
    
    
    144.8
    
    
    
    87.1
    
    
    
    57.7Buildings
    
    
    14.1
    
    
    
    0.8
    
    
    
    13.3
    
    
    
    14.1
    
    
    
    0.7
    
    
    
    13.4Leasehold improvements
    
    
    12.0
    
    
    
    7.3
    
    
    
    4.7
    
    
    
    12.0
    
    
    
    6.3
    
    
    
    5.7Furniture and fixtures
    
    
    10.4
    
    
    
    4.3
    
    
    
    6.1
    
    
    
    10.4
    
    
    
    3.9
    
    
    
    6.5Land
    
    
    0.5
    
    
    
    
    
    
    
    0.5
    
    
    
    0.5
    
    
    
    
    
    
    
    0.5766.4
    
    
    
    269.1
    
    
    
    497.3
    
    
    
    756.4
    
    
    
    239.7
    
    
    
    516.7
 Details of depreciation expense are as follows: Three Months Ended
    
    Three Months EndedMarch 31, 2004
    
    March 31, 2003Depreciation on capital assets
    
    
    29.4
    
    
    
    34.1Accretion expense on asset retirement obligations
    
    
    0.1
    
    
    
    29.5
    
    
    
    34.1
 Included in capital assets are assets under construction and not yet
depreciating of $17.5 (2003 - $18.0). Included in fibre optic cable assets are right-to-use fibres under indefeasible
right of use agreements with original terms extending to 20 years and net book
value totaling $3.2 (2003 - $3.3). During the three months ended March 31, 2003, the Company disposed of a
customer call centre and capital assets having a book value of $0.6 and related
expenses of $0.3 for proceeds of $0.9 of which $0.6 was received in the period
and $0.3 is included in accounts receivable. Net gain/loss was $nil. During the three months ended March 31, 2003, the Company received proceeds of
$2.3 relating to certain intangible rights sold under a licensing agreement in
2002. This amount was included in accounts receivable at December 31, 2002. 7




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##### 



CALL-NET ENTERPRISES INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED) [millions of Canadian dollars, unless otherwise indicated] 5. OTHER ASSETS March 31, 2004
    
    December 31, 2003NetAccumulated
    
    Book
    
    
    
    
    
    Accumulated
    
    Net BookCost
    
    Amortization
    
    Value
    
    Cost
    
    Amortization
    
    ValueCustomer relationships
    
    
    114.4
    
    
    
    53.0
    
    
    
    61.4
    
    
    
    113.8
    
    
    
    45.7
    
    
    
    68.1Prepaid right-of-way
    
    
    6.7
    
    
    
    
    
    
    
    6.7
    
    
    
    6.9
    
    
    
    
    
    
    
    6.9Deferred costs
    
    
    5.3
    
    
    
    
    
    
    
    5.3
    
    
    
    5.3
    
    
    
    
    
    
    
    5.3Investment in Cybersurf Corp.
    
    
    0.4
    
    
    
    
    
    
    
    0.4
    
    
    
    0.4
    
    
    
    
    
    
    
    0.4126.8
    
    
    
    53.0
    
    
    
    73.8
    
    
    
    126.4
    
    
    
    45.7
    
    
    
    80.7
 Details of amortization expense are as follows: Three Months Ended
    
    Three Months EndedMarch 31, 2004
    
    March 31, 2003Amortization
    
    
    7.3
    
    
    
    6.1
 6. ACCOUNTS PAYABLE AND ACCRUED LIABILITIES March 31, 2004
    
    December 31, 2003Accrued liabilities and trade payables
    
    
    45.5
    
    
    
    62.6Carrier payables
    
    
    47.4
    
    
    
    49.5Commodity, capital and income tax liabilities
    
    
    17.9
    
    
    
    19.6Payroll related liabilities
    
    
    10.8
    
    
    
    14.8Accrued interest on long-term debt
    
    
    7.7
    
    
    
    Other
    
    
    2.3
    
    
    
    2.9131.6
    
    
    
    149.4
 Effective January 1, 2004, the Company reclassed the long-term portion of its
deferred fibre maintenance charge and lease exit costs to long-term liabilities
from accounts payable and accrued liabilities [note 7b].The comparative
figures have been restated to conform to this presentation. 7. LONG-TERM DEBT AND OTHER LONG-TERM LIABILITIES (a) Senior Secured Notes due 2008 Interest Rate
    
    March 31, 2004
    
    December 31, 2003Senior secured notes due 2008
    
    
    10.625
    %
    
    
    292.3
    
    
    
    387.1
 During the three months ended March 31, 2004, the Company purchased for
cancellation a total of U.S. $76.4 ($100.8) of the outstanding senior secured
notes due 2008 at market prices. The total cost of this purchase to the
Company was $104.8 resulting in a loss of $4.0. 8




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##### 



CALL-NET ENTERPRISES INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED) [millions of Canadian dollars, unless otherwise indicated] The Companys remaining outstanding U.S. $223.1 senior secured notes mature on
December 31, 2008. The senior secured notes were issued in 2002 at
approximately par value and are collateralized by substantially all of the
assets of the Company. The senior secured notes bear interest at 10.625% per annum from December 31,
2001, or from the most recent date to which interest has been paid or provided
for, payable semi-annually on June 30 and December 31 in each year, commencing
June 30, 2002. Interest will be computed on the basis of a 360-day year
consisting of twelve 30-day months. The senior secured notes are senior secured obligations of the Company and will
rank pari passuin right of payment to any future senior unsecured debt and
senior to the Companys future subordinated secured debt. The senior secured
notes are governed by a trust indenture which contains certain covenants which,
among other things, restrict the ability of the Company to incur additional
indebtedness, consummate certain sales of assets, make certain investments,
engage in sale-leaseback transactions, pay dividends or repurchase the
Companys capital stock. On or after January 1, 2006, the senior secured notes will be redeemable, at
the Companys option, in whole or in part, at any time or from time to time at
the following redemption prices, plus accrued and unpaid interest to the
redemption date, if redeemed during the 12-month period commencing on January
1, 2006 at 105.313%, January 1, 2007 at 102.657% and January 1, 2008 and
thereafter at 100.000% of the principal amount. In the event of a change of control, the Company is required to offer to
purchase all outstanding notes at a purchase price of 101% of their principal
amount plus accrued and unpaid interest to the date of purchase. (b) Other long-term liabilities Interest Rate
    
    March 31, 2004
    
    December 31, 2003Right-of-way liability
    
    
    10.0
    %
    
    
    36.4
    
    
    
    37.0Deferred fibre maintenance charge
    
    
    N/A
    
    
    
    6.1
    
    
    
    6.0Lease exit costs
    
    
    N/A
    
    
    
    3.6
    
    
    
    3.7Asset retirement obligations
    
    
    10.0
    %
    
    
    2.5
    
    
    
    2.448.6
    
    
    
    49.1
 Effective January 1, 2004, the Company reclassed the long-term portion of its
deferred fibre maintenance charge and lease exit costs to long-term liabilities
from accounts payable and accrued liabilities [note 6].The comparative
figures have been restated to conform to this presentation. The right-of-way liability represents the net present value of payments to be
made under right-of-way agreements with terms ranging from one to 20 years.
The associated assets for the right-of-ways are recorded in capital assets.  9




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##### 



CALL-NET ENTERPRISES INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED) [millions of Canadian dollars, unless otherwise indicated] 8. CAPITAL STOCK SharesNumber of Shares
    
    Common
    
    Class B
    
    PreferredBalance, December 31, 2003
    
    
    4,210,839
    
    
    
    31,369,152
    
    
    
    1Converted during the three months ended March 31,2004 net
    
    
    (120,775
    )
    
    
    120,775
    
    
    
    Sale of plan of arrangement fractional shares during the
three months ended March 31, 2004
    
    
    30
    
    
    
    
    
    
    
    Balance, March 31, 2004
    
    
    4,090,094
    
    
    
    31,489,927
    
    
    
    1
 Dollars
    
    Common
    
    Class B
    
    PreferredBalance, December 31, 2003
    
    
    49.8
    
    
    
    297.6
    
    
    
    Converted during the three months ended March 31, 2004, net
    
    
    (1.1
    )
    
    
    1.1
    
    
    
    Balance, March 31, 2004
    
    
    48.7
    
    
    
    298.7
    
    
    
    
 Stock Options Under the Option Plan, the Company currently has reserved a total maximum of
2,261,000 common and class B non-voting shares. Options granted under the
Option Plan will be non-assignable and will expire no more than 10 years from
their date of grant or as determined by the board of directors. The number of
common shares and class B non-voting shares reserved for issuance in the
aggregate to any one eligible person pursuant to the Option Plan shall not
exceed 5% of the aggregate outstanding common shares and class B non-voting
shares. All shares reserved for issuance under the Option Plan are granted
under the terms and conditions of the Plan of Arrangement. The Option Plan
permits the granting or repricing of options at a price no less than the
closing price of the applicable shares on the Toronto Stock Exchange on the
business day preceding the date on which the option is granted, or re-priced,
as the case may be. Vesting of the options occurs in three yearly installments
of 33.3% each. Vesting of those options carrying an exercise price of $8.50 is
also dependent on the stock price reaching certain performance levels. The following is a continuity of stock options outstanding for which common
shares have been reserved: March 31, 2004WeightedAverageNumber
    
    Exercise PriceCommon Shares
    
    Outstanding
    
    Per ShareBalance, December 31, 2003
    
    
    1,356,067
    
    
    
    6.11Granted during the three months ended March 31, 2004
    
    
    455,000
    
    
    
    4.60Exercised during the three months ended March 31, 2004
    
    
    
    
    
    
    Cancelled during the three months ended March 31, 2004
    
    
    (59,600
    )
    
    
    3.17Balance, March 31, 2004
    
    
    1,751,467
    
    
    
    5.82Exercisable, March 31, 2004
    
    
    130,000
    
    
    
    1.72
 10




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##### 



CALL-NET ENTERPRISES INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED) [millions of Canadian dollars, unless otherwise indicated] The following table summarizes information about the common shares stock
options outstanding at
March 31, 2004:  Common SharesOptions Outstanding
    
    Options ExercisableWeighted 
    
    Weighted 
    
    
    
    
    
    Weighted Number
    
    Average
    
    Average
    
    
    
    
    
    AverageOutstanding at
    
    Remaining
    
    Exercise
    
    Number
    
    ExerciseRange of Exercise
    
    March 31,
    
    Contractual
    
    Price
    
    Exercisable at
    
    Price
    
    ExpiryPrices
    
    2004
    
    Life in Years
    
    Per Share
    
    March 31, 2004
    
    Per Share
    
    Dates$0.65 to $0.80
    
    
    29,067
    
    
    
    5.4
    
    
    $
    0.66
    
    
    
    9,100
    
    
    $
    0.66
    
    
    
    2009$1.80
    
    
    338,800
    
    
    
    5.9
    
    
    $
    1.80
    
    
    
    120,900
    
    
    $
    1.80
    
    
    
    2010$4.35
    
    
    94,000
    
    
    
    6.3
    
    
    $
    4.35
    
    
    
    
    
    
    
    
    
    
    
    2010$4.60
    
    
    455,000
    
    
    
    6.9
    
    
    $
    4.60
    
    
    
    
    
    
    
    
    
    
    
    2011$5.15
    
    
    11,800
    
    
    
    6.6
    
    
    $
    5.15
    
    
    
    
    
    
    
    
    
    
    
    2010$8.50
    
    
    822,800
    
    
    
    5.0
    
    
    $
    8.50
    
    
    
    
    
    
    
    
    
    
    
    2009
 During the three months ended March 31, 2004, there were no stock options
granted for which class B non-voting shares have been reserved. As at March
31, 2004, there were no class B non-voting shares stock options outstanding.
For stock options granted to employees, the Company determined compensation
costs based on their fair values at grant dates of the stock options consistent
with the method prescribed by CICA Handbook Section 3870 and has recorded these
compensation costs as operating expenses [note 1]. The weighted average fair value for options granted during the three month
period ended March 31, 2004 is $2.85 [2003 - $1.20]. The fair value of each
option granted was estimated on the date of grant using the Black-Scholes
option pricing model with the following assumptions: Three
    
    ThreeMonths Ended
    
    Months EndedMarch 31, 2004
    
    March 31, 2003Risk free interest rate
    
    
    2.14
    %
    
    
    3.50
    %Expected dividend yield
    
    
    0
    %
    
    
    0
    %Expected volatility, common shares
    
    
    103.1
    %
    
    
    107.9
    %Expected time until exercise
    
    3 years
    
    3 years
 Shareholders Rights Plan The Rights Plan was adopted to ensure that if a person or group is seeking to
acquire beneficial ownership of 15% or more of the common shares, or 20% of the
aggregate shares of the Company, the shareholders and the board of directors
are given sufficient time to evaluate the transaction, negotiate with the
proposed acquirer, encourage competing bids to emerge, and ensure that all
alternatives to the transaction designed to maximize shareholder value have
been considered. The term of the Rights Plan is until the termination of the
Companys 2004 annual shareholders meeting. Under the Rights Plan, one right
was issued in respect of each share outstanding immediately following the
implementation of the Plan of Arrangement. In addition, one right will be
issued in respect of each new share issued thereafter. When exercisable, each
right will permit the holder to purchase shares with a market value of 200
dollars on payment of 100 dollars. 11




---



##### 



CALL-NET ENTERPRISES INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED) [millions of Canadian dollars, unless otherwise indicated] Restricted Stock Unit Plan Restricted stock units [RSUs] are subject to vesting provisions, which may
include, at the discretion of the board of directors, the achievement of
performance criteria. RSU grants 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 based on the five trading day average of
the closing price of the common shares on the Toronto Stock Exchange. If
shares are to be delivered, the Company will have the option to deliver shares
issued from treasury or shares purchased on the Toronto Stock Exchange by an
independent administrator. The RSUP provides that the maximum number of shares
deliverable to participants under the RSUP shall be 678,000 Shares. The
maximum term for any RSU is three years. The outstanding RSUs vest in three
annual installments of 33.3% each. The resulting compensation expense recorded
for the three month period ended March 31, 2004 is $0.2 [2003  $0.5]. The following is a continuity of RSUs outstanding for which common shares have
been reserved: Restricted Stock Units March 31,
2004Number OutstandingBalance, December 31, 2003
    
    
    346,001Settled during the three months ended March 31, 2004
    
    
    Balance, March 31, 2004
    
    
    346,001
 Deferred Share Unit Plan On July 29, 2003 the Company adopted a Deferred Share Unit Plan [DSUP].
Participants of the DSUP can elect to receive a portion of their annual
compensation in the form of Deferred Share Units [DSUs]. The number of DSUs
received is calculated using the amount of compensation directed to the plan,
divided by the share price, based on the five trading day average of the
closing price of the common shares or class B non-voting shares as applicable
on the Toronto Stock Exchange. DSUs are redeemable upon the departure of the
participant from the Company by the delivery of common shares or class B
non-voting shares as applicable, equal to the number of DSUs credited to the
participant, or at the participants option, the delivery of cash equal to the
number of DSUs credited to the participants account multiplied by the closing
price of the applicable shares on the Toronto Stock Exchange on the date of
termination. If shares are to be delivered, the shares will be purchased on
the Toronto Stock Exchange by an independent administrator. The following is a continuity of DSUs outstanding: Deferred Share Units March 31, 2004Number OutstandingBalance, December 31, 2003
    
    
    7,198Granted during the three months ended March 31, 2004
    
    
    31,394Balance, March 31, 2004
    
    
    38,592
 12




---



##### 



CALL-NET ENTERPRISES INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED) [millions of Canadian dollars, unless otherwise indicated] 9. CHANGE IN CONTROL PROVISION On February 20, 2004, the Court of Appeal of Ontario agreed with the trial
judge and dismissed the appeal of an earlier decision regarding a change in
control agreement. As at April 20, 2004, the 60-day period in which the
appellants had to seek leave to appeal to the Supreme Court of Canada expired.
The Company reversed a $4.7 provision related to this action for the three
months ending March 31, 2004. 10. ACQUISITION On September 27, 2002, the Company acquired 75% of the non-voting shares and
24% of the voting shares in Time iCR Inc., a provider of customized, managed
and hosted call processing solutions, for $1.0. The assets and liabilities
acquired were less than $2.6 and $2.6 respectively. The Company also had a
call right under a contractual arrangement with a member of Time iCRs
management who owns 51% of the outstanding voting rights of Time iCR Inc. As a
result, while the Company did not have voting control of Time iCR Inc., the
Company determined under generally accepted accounting principles it would
consolidate its interest in Time iCR Inc. On February 13, 2004 the Company
acquired the remaining 25% non-voting shares and 76% voting shares of Time iCR. 11. EARNINGS (LOSS) PER SHARE Earnings (loss) per share have been calculated on the basis of income (loss)
divided by the weighted average number of common shares and class B non-voting
shares outstanding during the period after recapitalization [March 31, 2004 
35,580,021; March 31, 2003 - 23,906,138]. Due to a loss for the three months
ended March 31, 2004, no incremental shares from the potential exercise of
stock options are included because the effect would be anti-dilutive. 12. SEGMENTED INFORMATION The Company is a facilities-based carrier of long distance, data, local and
wireless telecommunications services. It offers different products or services
to three market segments: (i) Consumer Services including residential and small
office and home office customers (ii) Business Solutions, including small,
medium and large business and government customers and (iii) Carrier Services
including other providers and carriers of telecommunications services. During
the fourth quarter 2003, the Company changed the presentation by customer
segment to better align with the management structure. Accordingly, segmented
information of previous periods has been restated to reflect this change.
Substantially all of the Companys assets are located in Canada, and revenues
are derived from long distance, data and local telecommunications services
provided in Canada. Assets, including the fibre optic cable network, are not
segmented by business unit as assets are shared by all segments. 13




---



##### 



CALL-NET ENTERPRISES INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED) [millions of Canadian dollars, unless otherwise indicated] Customer Segments Consumer
    
    Business
    
    Carrier
    
    CorporateServices
    
    Solutions
    
    Services
    
    and other
    
    TotalThree months ended
March 31, 2004Long distance
    
    
    43.0
    
    
    
    39.5
    
    
    
    34.8
    
    
    
    
    
    
    
    117.3Data
    
    
    3.3
    
    
    
    33.5
    
    
    
    11.8
    
    
    
    
    
    
    
    48.6Local/home phone services
    
    
    24.3
    
    
    
    9.3
    
    
    
    1.3
    
    
    
    
    
    
    
    34.9Wireless
    
    
    1.7
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1.7Total revenues
    
    
    72.3
    
    
    
    82.3
    
    
    
    47.9
    
    
    
    
    
    
    
    202.5Operating costs
    
    
    (31.3
    )
    
    
    (18.3
    )
    
    
    (2.2
    )
    
    
    (29.1
    )
    
    
    (80.9
    )41.0
    
    
    
    64.0
    
    
    
    45.7
    
    
    
    (29.1
    )
    
    
    121.6Carrier costs
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (95.1
    )Depreciation and amortization
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (36.8
    )Operating loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (10.3
    )
 Consumer
    
    Business
    
    Carrier
    
    CorporateServices
    
    Solutions
    
    Services
    
    and other
    
    TotalThree months ended
March 31, 2003Long distance
    
    
    44.1
    
    
    
    39.0
    
    
    
    43.1
    
    
    
    
    
    
    
    126.2Data
    
    
    4.3
    
    
    
    33.2
    
    
    
    13.7
    
    
    
    
    
    
    
    51.2Local/home phone services
    
    
    17.1
    
    
    
    6.5
    
    
    
    1.2
    
    
    
    
    
    
    
    24.8Wireless
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total revenues
    
    
    65.5
    
    
    
    78.7
    
    
    
    58.0
    
    
    
    
    
    
    
    202.2Operating costs
    
    
    (20.5
    )
    
    
    (15.3
    )
    
    
    (2.8
    )
    
    
    (32.9
    )
    
    
    (71.5
    )45.0
    
    
    
    63.4
    
    
    
    55.2
    
    
    
    (32.9
    )
    
    
    130.7Carrier costs
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (106.2
    )Depreciation and amortization
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (40.2
    )Operating loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (15.7
    )
 14




---



##### 



(CALLNET LOGO) Managements Discussion & Analysis For the period ending March 31, 2004 Managements Discussion and Analysis (MD&A) is intended to help readers
understand the dynamics of Call-Nets business and the key factors underlying
its financial results. It explains trends in Call-Nets financial condition
and results of operations for the quarter ended March 31, 2004 compared with
the operating results for the quarter ended March 31, 2003 and the quarter
ended December 31, 2003. It also compares the balance sheet as at March 31,
2004 to the balance sheet as at December 31, 2003. The MD&A is prepared in
accordance with National Instrument 51-102  Continuous Disclosure Obligations
and Form 51-102F1  Managements Discussion and Analysis. This MD&A should be
read in conjunction with the Interim Consolidated Financial Statements for
March 31, 2004 and Audited Consolidated Financial Statements and MD&A for
December 31, 2003. Forward-Looking Statements The consolidated financial statements and MD&A necessarily include amounts and
conclusions based on informed judgments and estimates of the expected effects
of current events and transactions with appropriate consideration to
materiality. Certain statements in the MD&A also constitute forward-looking statements.
They involve known and unknown risks, uncertainties, and other factors that may
cause the results, performance or achievements of Call-Net to differ materially
from those expressed or implied by such statements. Such factors include,
among others, general economic and business conditions, demographic changes,
regulation, major technology changes, timing of product introductions,
competition and the ability of Call-Net to attract and retain key employees. Non GAAP Measures Certain financial measures used in this MD&A do not have any standardized
meaning under Canadian generally accepted accounting principles (GAAP). Below
is a definition of each of the non-GAAP financial measures used in this MD&A.
At the point in the MD&A at which each non-GAAP financial measure is first
discussed, a table has been provided to reconcile that financial information to
the most directly comparable GAAP measure. EBITDA Earnings before interest, taxes, depreciation and amortization (EBITDA) is a
financial metric used by investors to analyze the operating results of
companies and their ability to incur and service debt. Call-Net uses EBITDA as
an operating performance benchmark and defines it as revenue less carrier
charges and operating costs. Readers are cautioned that EBITDA as calculated
by Call-Net may not be comparable to similarly titled amounts reported by other
companies. Free Cash Flow Free cash flow is defined as EBITDA less financing costs (including interest
expense on long-term debt, servicing fees, bank charges and late payment
charges), cash income taxes paid, net capital expenditures and the cash
component of changes in deferred costs. Call-Net Enterprises Inc.
    
    1
    
    Interim MD&A Q1 2004




---



##### 



Call-Nets Business Call-Net is a national, full-service telecommunications alternative to the
long-established telephone companies, known as incumbent local exchange
carriers, or ILECs. Primarily through its wholly owned subsidiary Sprint
Canada Inc. (Sprint Canada), the Company offers home phone, long distance,
dial-up Internet, and wireless services to residential customers in Canadas
largest metropolitan areas, as well as local, long distance, data and Internet
protocol solutions (including high-speed access) to Canadian businesses of all
sizes and governments. Call-Net is a facilities-based company operating 14,000 route kilometres (8,600
route miles) of fibre in North America. This network connects Canadas largest
markets and key United States markets. It also connects with Europe, through
company-owned international gateway switches in New York City and London and a
trans-Atlantic fibre indefeasible right of usage. Call-Net is seamlessly
connected to the network of Sprint Communications Company L.P. (Sprint) at
multiple points across the Canada/U.S. border. In Canada, Call-Net also owns
and operates a national Cisco Internet protocol (IP) network. Local and home
phone service is provided through equipment co-located in the switch centres of
the ILECs. At March 31, 2004, Call-Net had 148 active co-locations in five
major urban centres incorporating 30 of Canadas most populous municipalities.
In Toronto, Montreal and Vancouver, certain co-locations are connected to
Call-Nets local switches by metro area networks (MANs). Call-Net provides services through three businesses units  Consumer Services,
Business Solutions and Carrier Services. The first two operate largely under
the Sprint Canada brand, while carrier services are delivered under the
Call-Net brand. Call-Net is headquartered in Toronto and has operations in 13 offices across
Canada and four in the United States, employing over 1,700 people. Quarterly Summary Information Over the past eight quarters, Call-Nets revenue has been quite stable, ranging
from a low of $194.1 million to a high of $204.9 million. Gains from the
introduction of new products and services, and the marketing success of new
pricing plans offset declines in the per-minute and per-unit price of services.
The volume of traffic on Call-Nets network continues to grow each year. Call-Net Enterprises Inc.
    
    2
    
    Interim MD&A Q1 2004




---



##### 



Quarterly Summary Information 2002
    
    2003
    
    2004(millions of Canadian dollars,except per share data)
    
    Q1
    
    Q2
    
    Q3
    
    Q4
    
    Q1
    
    Q2
    
    Q3
    
    Q4
    
    Q1[Restated]
    
    [Restated]Statement of OperationsRevenue
    
    $
    201.8
    
    
    $
    197.9
    
    
    $
    198.6
    
    
    $
    202.4
    
    
    $
    202.2
    
    
    $
    194.1
    
    
    $
    204.9
    
    
    $
    204.1
    
    
    $
    202.5Carrier charges
    
    
    116.8
    
    
    
    118.4
    
    
    
    113.9
    
    
    
    103.4
    
    
    
    106.2
    
    
    
    98.4
    
    
    
    108.5
    
    
    
    96.8
    
    
    
    95.1Gross profit
    
    
    85.0
    
    
    
    79.5
    
    
    
    84.7
    
    
    
    99.0
    
    
    
    96.0
    
    
    
    95.7
    
    
    
    96.4
    
    
    
    107.3
    
    
    
    107.4EBITDA
    
    
    11.9
    
    
    
    (10.1
    )
    
    
    14.6
    
    
    
    30.2
    
    
    
    24.5
    
    
    
    23.7
    
    
    
    23.0
    
    
    
    24.9
    
    
    
    26.5Operating income (loss)
    
    
    (29.9
    )
    
    
    (74.5
    )
    
    
    (26.0
    )
    
    
    (15.9
    )
    
    
    (15.7
    )
    
    
    (23.0
    )
    
    
    (15.8
    )
    
    
    (13.6
    )
    
    
    (10.3
    )Net Income (loss)
    
    
    (91.8
    )
    
    
    (62.9
    )
    
    
    28.6
    
    
    
    (24.9
    )
    
    
    7.6
    
    
    
    2.0
    
    
    
    (30.2
    )
    
    
    (16.8
    )
    
    
    (29.9
    )EPS, basic
    
    
    (20.26
    )
    
    
    (2.64
    )
    
    
    1.20
    
    
    
    (1.04
    )
    
    
    0.32
    
    
    
    0.08
    
    
    
    (1.15
    )
    
    
    (0.47
    )
    
    
    (0.84
    )Carrier charges as % of revenue
    
    
    57.9
    %
    
    
    59.8
    %
    
    
    57.4
    %
    
    
    51.1
    %
    
    
    52.5
    %
    
    
    50.7
    %
    
    
    53.0
    %
    
    
    47.4
    %
    
    
    47.0
    %Gross profit %
    
    
    42.1
    %
    
    
    40.2
    %
    
    
    42.6
    %
    
    
    48.9
    %
    
    
    47.5
    %
    
    
    49.3
    %
    
    
    47.0
    %
    
    
    52.6
    %
    
    
    53.0
    %Operating costs as a % revenue
    
    
    36.2
    %
    
    
    45.3
    %
    
    
    35.3
    %
    
    
    34.0
    %
    
    
    35.4
    %
    
    
    37.1
    %
    
    
    35.8
    %
    
    
    40.4
    %
    
    
    40.0
    %EBITDA as a % of revenue
    
    
    5.9
    %
    
    
    -5.1
    %
    
    
    7.4
    %
    
    
    14.9
    %
    
    
    12.1
    %
    
    
    12.2
    %
    
    
    11.2
    %
    
    
    12.2
    %
    
    
    13.1
    %
 The most significant trend over the past eight quarters has been the consistent
decline in carrier charges and the consequent increase in gross profit. Over
the past two years, carrier charges, as a per cent of revenue, have declined
from 57.9% to 47.0%, while gross profit, as a percentage of revenue, has risen
from 42.1% to 53.0%. First Quarter 2004 Operating Results Highlights In the first quarter of 2004, total revenue grew by $0.3 million, or 0.1%, from
the first quarter of 2003 to $202.5 million, but declined by $1.6 million, or
0.8% from the fourth quarter of 2003. Continued growth in the Companys
business solutions and consumer services operations was offset by wholesale
carrier revenue declines. Call-Net continued to make inroads in the market for local services, adding
25,200 net consumer lines and 8,800 net equivalent business lines for a total
of 34,000 lines in the quarter and bringing its total number of local lines to
over 301,000. Lines and Customers 2003
    
    2004Q1
    
    Q2
    
    Q3
    
    Q4
    
    Q1[Restated]Consumer Home Phone Service Lines
    
    
    144,600
    
    
    
    157,100
    
    
    
    175,400
    
    
    
    206,000
    
    
    
    231,200Business Local Line Equivalents*
    
    
    43,900
    
    
    
    51,500
    
    
    
    59,500
    
    
    
    61,600
    
    
    
    70,400Total Local Lines
    
    
    188,500
    
    
    
    208,600
    
    
    
    234,900
    
    
    
    267,600
    
    
    
    301,600Average Monthly Churn **
    
    
    3.2
    %
    
    
    3.6
    %
    
    
    3.3
    %
    
    
    2.7
    %
    
    
    2.2
    %Consumer LD Customers
    
    
    530,600
    
    
    
    522,800
    
    
    
    632,600
    
    
    
    609,100
    
    
    
    583,200Consumer Dial-Up Customers
    
    
    72,000
    
    
    
    69,700
    
    
    
    68,400
    
    
    
    65,400
    
    
    
    63,600Consumer Wireless Customers
    
    
    
    
    
    
    
    
    
    
    2,600
    
    
    
    12,800
    
    
    
    18,300
 * Business local line equivalents include Primary Rate Interfaces (PRIs) quantified as 23 individual business lines
(IBLs) ** Average Monthly Churn equals monthly disconnections divided by the average number of lines per month. Customer churn in local services declined significantly to 2.2% in the quarter,
down from an average of 3.2% in the first quarter of 2003 and an average of
2.7% in the fourth quarter of 2003. The Company attributes this churn
reduction to several factors: Call-Net Enterprises Inc.
    
    
    3
    
    
    Interim MD&A Q1 2004




---



##### 



i)
    
    on-going success in the Companys customer retention program;ii)
    
    a lower level of Sprint-initiated churn as the credit profile of
the consumer base improves;iii)
    
    the recent CRTC decision to extend the no-winback period  the
period of time after Call-Net signs up a customer where the ILEC is
prohibited from attempting to win them back  from three months to
twelve months; andiv)
    
    the effect of the implementation of the CRTCs DSL unbundling
decision of July 2003. In the quarter, the Company identified an inconsistency in its internal
reporting of business local line additions relating to PRIs. As a result, net
local line additions in the business solutions group were previously overstated
by approximately 2,000, 3,000, and 5,000 in each of the second, third and
fourth quarters of 2003. The above table has been restated to correct for the
error. The inconsistency related only to internal reporting and has no impact
on the operating or financial condition of the Company. Consumer Services Revenue Call-Net provides local, long distance, dial-up Internet access and wireless
services to consumers in five geographic areas comprising 30 different
municipalities. Overall, consumer revenue increased in the first quarter of 2004 by $6.8
million or 10% over the first quarter of 2003 to $72.3 million, and by $0.4
million, or 1% from the fourth quarter of 2003. Call-Net has focused on
selling bundled products to its customers as a means of reducing churn and
increasing its share of its customers monthly communications spending. In the
first quarter of 2004, over 55% of consumer services revenue came from
customers who purchase more than one product from Call-Net. Consumer Service Revenue Change from
    
    Change fromThree Months Ended
    
    Prior Year
    
    Prior QuarterMar 31,
    
    Mar 31,
    
    Dec 31,(millions of Canadian dollars)
    
    2004
    
    2003
    
    2003
    
    $
    
    %
    
    $
    
    %Long distance
    
    
    43.0
    
    
    
    44.1
    
    
    
    45.4
    
    
    
    (1.1
    )
    
    
    (2.5
    )%
    
    
    (2.4
    )
    
    
    (5.3
    )%Data
    
    
    3.3
    
    
    
    4.3
    
    
    
    3.4
    
    
    
    (1.0
    )
    
    
    (23.3
    )%
    
    
    (0.1
    )
    
    
    (2.9
    )%Local
    
    
    24.3
    
    
    
    17.1
    
    
    
    21.8
    
    
    
    7.2
    
    
    
    42.1
    %
    
    
    2.5
    
    
    
    11.5
    %Wireless
    
    
    1.7
    
    
    
    
    
    
    
    1.3
    
    
    
    1.7
    
    
    
    
    
    
    
    0.4
    
    
    
    30.8
    %Consumer Services Revenue
    
    
    72.3
    
    
    
    65.5
    
    
    
    71.9
    
    
    
    6.8
    
    
    
    10.4
    %
    
    
    0.4
    
    
    
    0.6
    %
 Consumer Long Distance Revenue Long distance revenue decreased in the quarter compared to both the first and
fourth quarters of 2003. The decrease in revenue was brought about by a lower
level of net stand-alone long distance activations in the quarter. Long
distance churn was consistent with the levels seen in previous quarters.
Average revenue per minute (ARPM) in long distance was down in the quarter due
primarily to price decreases in Canadian, US and international plans. A
portion of the ARPM decline in Canada and the U.S. has been a result of the
success of the Companys Unlimited Call-Net Enterprises Inc.
    
    
    4
    
    
    Interim MD&A Q1 2004




---



##### 



North American Dialing Plan as customers on
the plan use more long distance minutes per month than average. Consumer Home Phone Service Revenue Local, or home phone, service revenue was $24.3 million in the quarter, an
increase of 42% or $7.2 million from the first quarter of 2003 and 11%, or $2.5
million from the previous quarter. These results continue a trend initially
established in the third quarter of 2003 of quarter over quarter growth in home
phone service revenue in excess of 10%. Consumer Data Revenue Revenue from dial-up Internet customers was $3.3 million for the quarter, a
decline of $1.0 million, or 23% from the first quarter of 2003, and $0.1
million, or 3% from the fourth quarter of 2003. The number of subscribers
stood at 63,600 at quarter-end, down 3% from the year-end number of 65,400.
Churn in dial-up Internet continues to be high, in excess of 5% per month, as
Canadian households continue to migrate to high-speed Internet services.
However, the Company activated over 8,000 new dial-up Internet customers in the
quarter. Consumer Wireless Revenue Call-Net bundled wireless service under the Fido® brand had a good quarter of
growth. Quarterly activations are running at over 6,000, with approximately
15% of new home phone service customers opting to add a wireless second line.
Revenue from wireless services was $1.7 million for the quarter, up 31% from
$1.3 million in the fourth quarter of 2003. Business Solutions Revenue Call-Net continues to focus on four initiatives in the business market in
Canada:  
    
    Maintain and develop its working relationship with Sprint to offer
multi-national corporations (MNCs) single-service, single-invoice
seamless North American network coverage;
    
    Deliver the Companys IP Enabled Solutionsat substantial cost
savings and time efficiencies to Canadian customers allowing them to
integrate legacy systems with next-generation services in an efficient
and cost-effective manner;
    
    Continue its EVS initiative by penetrating the call centre sector
with complex interactive voice response (IVR) and advanced voice
recognition (AVR) applications; and
    
    Bundle long distance, local, and high-speed Internet access for
small and medium-sized enterprises (SME). Business Solutions Revenue In the first quarter of 2004, Call-Net grew business solutions revenue in every
category - long distance, data and local services. Total business solutions
revenue grew by 5% or $3.6 million from the first quarter of 2003, and by 3%,
or $2.7 million, from the fourth quarter of 2003. This growth reflected
stronger product offerings - including IP Enabled Solutions, growth in long
distance minutes, and the continued success of its cross border initiative and
its third-party agency sales channel for small and medium-sized business. Call-Net Enterprises Inc.
    
    
    5
    
    
    Interim MD&A Q1 2004




---



##### 



Business Solutions Revenue Change from
    
    Change fromThree Months Ended
    
    Prior Year
    
    Prior QuarterMar 31,
    
    Mar 31,
    
    Dec 31,(millions of Canadian dollars)
    
    2004
    
    2003
    
    2003
    
    $
    
    %
    
    $
    
    %Long distance
    
    
    39.5
    
    
    
    39.0
    
    
    
    37.8
    
    
    
    0.5
    
    
    
    1.3
    %
    
    
    1.7
    
    
    
    4.5
    %Data
    
    
    33.5
    
    
    
    33.2
    
    
    
    33.0
    
    
    
    0.3
    
    
    
    0.9
    %
    
    
    0.5
    
    
    
    1.5
    %Local
    
    
    9.3
    
    
    
    6.5
    
    
    
    8.8
    
    
    
    2.8
    
    
    
    43.1
    %
    
    
    0.5
    
    
    
    5.7
    %Business Solutions Revenue
    
    
    82.3
    
    
    
    78.7
    
    
    
    79.6
    
    
    
    3.6
    
    
    
    4.6
    %
    
    
    2.7
    
    
    
    3.4
    %
 Average revenue per minute in business long distance declined by approximately
5% from the fourth quarter of 2003, but this was more than offset by a 10%
quarter- over-quarter growth in total minutes. As a result, business long
distance revenue increased moderately to $39.5 million as compared with $39.0
million in the first quarter of 2003 and $37.8 million in the fourth quarter of
2003. In spite of the growth in long distance revenue and minutes, long
distance, as a percentage of business solutions revenue, continues to decline 
from a level of 50% of business solutions revenue in the first quarter of 2003,
to a level of 48% of revenue in each of the last two quarters. New business local line equivalents grew by 8,800 lines, or 14% from the fourth
quarter of 2003. The Company had 60% more local service customers at the end
of the first quarter of 2004, as compared to the first quarter of 2003.
Revenue from business local services expanded by 6% from the previous quarter
and 43% from the first quarter of 2003. Data revenue also grew in the quarter compared to both the fourth quarter of
2003 and the first quarter of 2003. This revenue increase is reflective, in
part, of the success of the Companys IP Enabled Solutionsoffering. Carrier Services Call-Nets strategy is to optimize the contribution from wholesale services, by
focusing on profitability, rather than revenue growth. With approximately 125
wholesale customers, the Company works closely with the 20 largest that
represent about 75% of carrier services revenue. Call-Nets largest customers
are actually other large carriers such as MCI, Sprint, AT&T and the Canadian
ILECs. Carrier Services Revenue In the first quarter of 2004, wholesale revenue continued to decline, as
expected. Carrier service revenue in the quarter totaled $47.9 million,
reflecting a 9% decline from the fourth quarter of 2003 and a 17% decline from
the first quarter of 2003. Carrier services revenues now comprise less than
24% of consolidated revenue. Average revenue per-minute in wholesale declined
by approximately 13% from the previous quarter reflecting both a change in the
mix of international minutes away from higher cost international destinations
in favour of lower cost countries, and the continuing decline in the price
per-minute of North American traffic. In wholesale, the Company is somewhat
insulated from the ARPM decline in international long distance, as costs are
highly variable and the per-minute cost of terminating traffic in these
jurisdictions has decreased in step with revenue. Call-Net Enterprises Inc.
    
    
    6
    
    
    Interim MD&A Q1 2004




---



##### 



Carrier Services Revenue Change from
    
    Change fromThree Months Ended
    
    Prior Year
    
    Prior QuarterMar 31,
    
    Mar 31,
    
    Dec 31,(millions of Canadian dollars)
    
    2004
    
    2003
    
    2003
    
    $
    
    %
    
    $
    
    %Long distance
    
    
    34.8
    
    
    
    43.1
    
    
    
    39.6
    
    
    
    (8.3
    )
    
    
    (19.3
    )%
    
    
    (4.8
    )
    
    
    (12.1
    )%Data
    
    
    11.8
    
    
    
    13.7
    
    
    
    11.8
    
    
    
    (1.9
    )
    
    
    (13.9
    )%
    
    
    
    
    
    
    0.0
    %Local
    
    
    1.3
    
    
    
    1.2
    
    
    
    1.2
    
    
    
    0.1
    
    
    
    8.3
    %
    
    
    0.1
    
    
    
    8.3
    %Carrier Services Revenue
    
    
    47.9
    
    
    
    58.0
    
    
    
    52.6
    
    
    
    (10.1
    )
    
    
    (17.4
    )%
    
    
    (4.7
    )
    
    
    (8.9
    )%
 Carrier Charges, Operating Costs & Operating Profit/Loss Carrier Charges Carrier charges declined to $95.1 million in the first quarter of 2004, from
$96.8 million in the fourth quarter of 2003 and $106.2 million in the first
quarter of 2003. Call-Net continues to have success in network optimizations
and international carrier negotiations. As a result of these carrier charge reductions, gross margin of $107.4 million
for the quarter was essentially unchanged as compared with the previous
quarter, in spite of a $1.6 million revenue decline over the period. When
compared to the same period last year, gross margin is up 12% from the $96.0
million recorded in the first quarter of 2003. Carrier Charges, Operating Costs & Operating Profit Change from
    
    Change fromThree Months Ended
    
    Prior Year
    
    Prior QuarterMar 31,
    
    Mar 31,
    
    Dec 31,(millions of Canadian dollars)
    
    2004
    
    2003
    
    2003
    
    $
    
    %
    
    $
    
    %[Restated]Revenue
    
    
    202.5
    
    
    
    202.2
    
    
    
    204.1
    
    
    
    0.3
    
    
    
    0.1
    %
    
    
    (1.6
    )
    
    
    (0.8
    )%Carrier charges
    
    
    95.1
    
    
    
    106.2
    
    
    
    96.8
    
    
    
    (11.1
    )
    
    
    (10.5
    )%
    
    
    (1.7
    )
    
    
    (1.8
    )%Gross profit
    
    
    107.4
    
    
    
    96.0
    
    
    
    107.3
    
    
    
    11.4
    
    
    
    11.9
    %
    
    
    0.1
    
    
    
    0.1
    %Operating costs
    
    
    80.9
    
    
    
    71.5
    
    
    
    82.4
    
    
    
    9.4
    
    
    
    13.1
    %
    
    
    (1.5
    )
    
    
    (1.8
    )%EBITDA
    
    
    26.5
    
    
    
    24.5
    
    
    
    24.9
    
    
    
    2.0
    
    
    
    8.2
    %
    
    
    1.6
    
    
    
    6.4
    %Depreciation and amortization
    
    
    (36.8
    )
    
    
    (40.2
    )
    
    
    (38.5
    )
    
    
    3.4
    
    
    
    (8.5
    )%
    
    
    1.7
    
    
    
    (4.4
    )%Operating loss
    
    
    (10.3
    )
    
    
    (15.7
    )
    
    
    (13.6
    )
    
    
    5.4
    
    
    
    (34.4
    )%
    
    
    3.3
    
    
    
    (24.3
    )%Carrier charges as a % of revenue
    
    
    47.0
    %
    
    
    52.5
    %
    
    
    47.4
    %
    
    
    
    
    
    
    (5.5
    )%
    
    
    
    
    
    
    (0.4
    )%Gross profit as a % of revenue
    
    
    53.0
    %
    
    
    47.5
    %
    
    
    52.6
    %
    
    
    
    
    
    
    5.5
    %
    
    
    
    
    
    
    0.4
    %Operating costs as a % of revenue
    
    
    40.0
    %
    
    
    35.4
    %
    
    
    40.4
    %
    
    
    
    
    
    
    4.6
    %
    
    
    
    
    
    
    (0.4
    )%EBITDA as a % of revenue
    
    
    13.1
    %
    
    
    12.1
    %
    
    
    12.2
    %
    
    
    
    
    
    
    1.0
    %
    
    
    
    
    
    
    0.9
    %
 Operating Costs First quarter operating costs, while down 2%, or $1.5 million from the fourth
quarter of 2003, are up 13%, or $9.4 million from the first quarter of 2003.
Operating costs as a percentage of revenue have risen to 40% in the first
quarter of 2004, as compared to 35% of revenue in the first quarter of 2003.
This change was expected Call-Net Enterprises Inc.
    
    
    7
    
    
    Interim MD&A Q1 2004




---



##### 



as the Company has resolved to use cost savings
generated in carrier charges to invest in revenue growth in consumer services
and business solutions. Operating costs, as a percentage of revenue are
expected to remain high relative to historical levels as the Company invests in
sales, marketing, provisioning and customer care in pursuit of its growth
objectives. EBITDA EBITDA for the first quarter of 2004 was $26.5 million, an increase of $1.6
million or 6% over the fourth quarter of 2003 and $2 million, or 8% over the
first quarter of 2003. Operating Profit (Loss) Depreciation and amortization totaled $36.8 million, a 4% decline from the
fourth quarter of 2003 and a 9% decline from the first quarter of 2003.
Depreciation and amortization has generally been falling as the Companys
capital spending program has declined. Operating loss was narrowed to $10.3 million for the quarter, down from $13.6
million in the previous quarter, and $15.7 million in the first quarter of
2003. Operating Profit/Loss and Other Expenses Change from
    
    Change fromThree Months Ended
    
    Prior Year
    
    Prior Quarter(millions of Canadian dollars,
    
    Mar 31,
    
    Mar 31,
    
    Dec 31,except per share data)
    
    2004
    
    2003
    
    2003
    
    $
    
    %
    
    $
    
    %[Restated]EBITDA
    
    
    26.5
    
    
    
    24.5
    
    
    
    24.9
    
    
    
    2.0
    
    
    
    8.2
    %
    
    
    1.6
    
    
    
    6.4
    %Depreciation and amortization
    
    
    (36.8
    )
    
    
    (40.2
    )
    
    
    (38.5
    )
    
    
    3.4
    
    
    
    (8.5
    )%
    
    
    1.7
    
    
    
    (4.4
    )%Operating loss
    
    
    (10.3
    )
    
    
    (15.7
    )
    
    
    (13.6
    )
    
    
    5.4
    
    
    
    (34.4
    )%
    
    
    3.3
    
    
    
    (24.3
    )%Loss on repurchase of long-term debt
    
    
    (4.0
    )
    
    
    
    
    
    
    
    
    
    
    (4.0
    )
    
    
    
    
    
    
    (4.0
    )
    
    
    Release of change in control provision
    
    
    4.7
    
    
    
    
    
    
    
    
    
    
    
    4.7
    
    
    
    
    
    
    
    4.7
    
    
    
    Interest on long-term debt
    
    
    (9.7
    )
    
    
    (12.1
    )
    
    
    (8.9
    )
    
    
    2.4
    
    
    
    (19.8
    )%
    
    
    (0.8
    )
    
    
    9.0
    %Interest and other income (expense)
    
    
    (2.2
    )
    
    
    (0.4
    )
    
    
    (2.7
    )
    
    
    (1.8
    )
    
    
    450.0
    %
    
    
    0.5
    
    
    
    (270.0
    )%Foreign exchange gain (loss)
    
    
    (8.1
    )
    
    
    36.2
    
    
    
    12.8
    
    
    
    (44.3
    )
    
    
    (122.4
    )%
    
    
    (20.9
    )
    
    
    (163.3
    )%Income tax benefit (expense)
    
    
    (0.3
    )
    
    
    (0.4
    )
    
    
    (4.4
    )
    
    
    0.1
    
    
    
    (25.0
    )%
    
    
    4.1
    
    
    
    (93.2
    )%Net Income (Loss)
    
    
    (29.9
    )
    
    
    7.6
    
    
    
    (16.8
    )
    
    
    (37.5
    )
    
    
    (493.4
    )%
    
    
    (13.1
    )
    
    
    78.0
    %EPS, basic
    
    
    (0.84
    )
    
    
    0.32
    
    
    
    (0.47
    )
    
    
    (1.16
    )
    
    
    (362.5
    )%
    
    
    (0.37
    )
    
    
    78.7
    %
 Other Expenses In the first quarter of 2004, Call-Net recorded a loss of $4.0 million in
connection with the repurchase for cancellation of approximately US$76.4
million (approximately $100.8 million) of long-term debt. The Company also
recorded a one-time gain of $4.7 million in connection with the elimination of
a reserve established in connection with the application brought by Montreal
Trust Company of Canada (now Computershare Investor Services) discussed in Note
12 of the Audited Consolidated Financial Statements for December 31, 2003 and
Note 9 of the Consolidated Financial statements for March 31, 2004. Both the
initial decision and the subsequent appeal were in favour of the Company and
the plaintiffs in the case did not seek leave to appeal further. Call-Net Enterprises Inc.
    
    
    8
    
    
    Interim MD&A Q1 2004




---



##### 



Interest expense in the quarter was $9.7 million, down from $12.1 million in
the first quarter of 2003, but up from $8.9 million in the fourth quarter of
2003. Variations in interest expense were a function of: 1) fluctuations in
the Canadian dollar exchange rate, which results in fluctuations in Canadian
dollar interest payments on the Companys senior secured notes as these notes
are denominated in U.S. dollars; and 2) the market purchase of US$76.4 million
(approximately $100.8 million) of senior secured notes in March 2004 and the
consequent elimination of interest costs associated with the repurchased notes. In the first quarter, the Company recorded a foreign exchange loss of $6.0
million on the principal portion of its long-term debt as the result of the
decline of the Canadian dollar against the U.S. dollar. After giving effect to
the note repurchase, a one cent change in the value of the Canadian dollar
against the U.S. currency now increases or decreases the Companys long-term
debt by approximately $4.0 million. Net Income (Loss) In the quarter, Call-Net recorded a net loss of $29.9 million, or $0.84 per
share, compared with a net loss of $16.8 million in the fourth quarter of 2003
and net income of $7.6 million in the first quarter of 2003. Quarterly changes
in net income/(loss) have been most heavily influenced by changes in the
Canadian dollar exchange rate. Cash Flow Cash Flow Summary Change from
    
    Change fromThree Months Ended
    
    Prior Year
    
    Prior QuarterMar 31,
    
    Mar 31,
    
    Dec 31(millions of Canadian dollars)
    
    2004
    
    2003
    
    2003
    
    $
    
    %
    
    $
    
    %[Restated]Net income (loss)
    
    
    (29.9
    )
    
    
    7.6
    
    
    
    (16.8
    )
    
    
    (37.5
    )
    
    
    (493.4
    )%
    
    
    (13.1
    )
    
    
    78.0
    %Depreciation and amortization
    
    
    36.8
    
    
    
    40.2
    
    
    
    38.5
    
    
    
    (3.4
    )
    
    
    (8.5
    )%
    
    
    (1.7
    )
    
    
    (4.4
    )%Interest and other (income)/expense
    
    
    1.3
    
    
    
    1.0
    
    
    
    0.6
    
    
    
    0.3
    
    
    
    30.0
    %
    
    
    0.7
    
    
    
    116.7
    %Foreign exchange (gain)/loss
    
    
    6.0
    
    
    
    (33.0
    )
    
    
    (17.4
    )
    
    
    39.0
    
    
    
    (118.2
    )%
    
    
    23.4
    
    
    
    (134.5
    )%Income taxes
    
    
    
    
    
    
    
    
    
    
    4.3
    
    
    
    
    
    
    
    
    
    
    
    (4.3
    )
    
    
    Reversal of change in control provision
    
    
    (4.7
    )
    
    
    
    
    
    
    
    
    
    
    (4.7
    )
    
    
    
    
    
    
    (4.7
    )
    
    
    Loss on repurchase of long-term debt
    
    
    4.0
    
    
    
    
    
    
    
    
    
    
    
    4.0
    
    
    
    
    
    
    
    4.0
    
    
    
    Cash flow from operating activities
before change in non-cash working capital
    
    
    13.5
    
    
    
    15.8
    
    
    
    9.2
    
    
    
    (2.3
    )
    
    
    (14.6
    )%
    
    
    4.3
    
    
    
    46.7
    %Change in non-cash working capital
    
    
    (9.9
    )
    
    
    (8.4
    )
    
    
    (0.8
    )
    
    
    (1.5
    )
    
    
    17.9
    %
    
    
    (9.1
    )
    
    
    1137.5
    %Cash flow from operating activities
    
    
    3.6
    
    
    
    7.4
    
    
    
    8.4
    
    
    
    (3.8
    )
    
    
    (51.4
    )%
    
    
    (4.8
    )
    
    
    (57.1
    )%Change in short-term investments
    
    
    66.0
    
    
    
    45.1
    
    
    
    (0.1
    )
    
    
    20.9
    
    
    
    46.3
    %
    
    
    66.1
    
    
    
    (66100.0
    )%Acquisition of capital assets
    
    
    (14.0
    )
    
    
    (8.3
    )
    
    
    (13.3
    )
    
    
    (5.7
    )
    
    
    68.7
    %
    
    
    (0.7
    )
    
    
    5.3
    %Increase in deferred costs
    
    
    (0.5
    )
    
    
    
    
    
    
    (1.0
    )
    
    
    (0.5
    )
    
    
    
    
    
    
    0.5
    
    
    
    Acquisitions
    
    
    
    
    
    
    
    
    
    
    0.3
    
    
    
    
    
    
    
    
    
    
    
    (0.3
    )
    
    
    (100.0
    )%Net proceeds from disposal of capital assets
    
    
    
    
    
    
    2.9
    
    
    
    
    
    
    
    (2.9
    )
    
    
    
    
    
    
    
    
    
    
    Proceeds from sale of accounts receivable
    
    
    45.0
    
    
    
    
    
    
    
    
    
    
    
    45.0
    
    
    
    
    
    
    
    45.0
    
    
    
    Cash flow from investing activities
    
    
    96.5
    
    
    
    39.7
    
    
    
    (14.1
    )
    
    
    56.8
    
    
    
    143.1
    %
    
    
    110.6
    
    
    
    (784.4
    )%Change in Right-of-Way liability
    
    
    (0.4
    )
    
    
    (0.7
    )
    
    
    (0.3
    )
    
    
    0.3
    
    
    
    (42.9
    )%
    
    
    (0.1
    )
    
    
    33.3
    %Repurchase of long-term debt
    
    
    (104.8
    )
    
    
    
    
    
    
    
    
    
    
    (104.8
    )
    
    
    
    
    
    
    (104.8
    )
    
    
    Issuance of Common Shares
    
    
    
    
    
    
    
    
    
    
    5.4
    
    
    
    
    
    
    
    
    
    
    
    (5.4
    )
    
    
    (100.0
    )%Cash flow from financing activities
    
    
    (105.2
    )
    
    
    (0.7
    )
    
    
    5.1
    
    
    
    (104.5
    )
    
    
    14928.6
    %
    
    
    (110.3
    )
    
    
    (2162.7
    )%Net increase (decrease) in cash and
cash equivalents
    
    
    (5.1
    )
    
    
    46.4
    
    
    
    (0.6
    )
    
    
    (51.5
    )
    
    
    (111.0
    )%
    
    
    (4.5
    )
    
    
    750.0
    %
 Call-Net Enterprises Inc.
    
    
    9
    
    
    Interim MD&A Q1 2004




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##### 



Cash Flow from Operating Activities Operating activities before changes in non-cash working capital provided $13.5
million of cash in the first quarter compared with $15.8 million and $9.2
million in each of the first and fourth quarters of 2003, respectively. Cash
flow from operating activities before changes in non-cash working capital
dropped relative to the first quarter of 2003 primarily because of a foreign
exchange related loss on operating activities of $2.1 million in the first
quarter of 2004 as compared to a foreign exchange related gain of $3.2 million
on operating activities in the first quarter of 2003. Cash flow from operating
activities before changes in non-cash working capital was higher in the first
quarter of 2004 as compared to the fourth quarter of 2003, due primarily to the
effects of a $2.5 million reduction in the foreign exchange related loss
related to operating activities between the first quarter of 2004 and the
fourth quarter of 2003. Cash Flow from Investing Activities Investment activities in the first quarter provided $96.5 million of cash
compared with $39.7 million in the first quarter of 2003 and a use of cash of
$14.1 million in the fourth quarter of 2003. During the quarter, the Company sold an additional $45.0 million of accounts
receivable under its accounts receivable securitization program. This program
is now fully utilized at $55.0 million and is providing funding to Call-Net at
an effective interest rate of approximately 6.0% Cash provided by investment activities was used to fund the repurchase of its
outstanding long-term debt. Cash Flow from Financing Activities Financing activities used $105.2 million in the quarter. The Company incurred
$0.4 million in costs in the first quarter associated with the repayment of a
right-of-way liability and used the remainder in the repurchase of its
outstanding long-term debt. During the quarter, the Company repurchased US$76.4 million face amount of
senior secured notes at a cost of $104.8 million. This repurchase will reduce
annual interest costs on long-term debt by US$8.1 million (approximately $10.6
million at quarter-end exchange rates). Call-Net continues to evaluate the
most effective use of capital and may make market purchases of senior secured
notes in the future, depending on market opportunities, capital requirements
and liquidity needs. Free Cash Flow In the first quarter, the Company generated $1.4 million in free cash flow.
The $10.3 million in interest and other financing costs and the $14.5 million
spent on capital assets and in an increase in deferred costs came entirely from
internally generated funds. These capital investments were made to expand
local services, improve existing systems, enhance cost efficiency, and
accommodate new products. The Company has also changed its definition of Free Cash Flow to include other
interest charges, servicing fees, late payment charges, and changes in deferred
costs (see the definition of Free Cash Flow under the Section entitled Non-GAAP
Measures on page 1 of this MDA). The Company believes that this provides
relevant Call-Net Enterprises Inc.
    
    
    10
    
    
    Interim MD&A Q1 2004




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##### 



information to understand its cash flow resources in any given period. For the
purpose of discussion and analysis, prior periods have been restated to conform
to the new definition. Free Cash Flow 2003
    
    2004(millions of Canadian dollars)
    
    Q1
    
    Q2
    
    Q3
    
    Q4
    
    Q1[Restated]EBITDA
    
    $
    24.5
    
    
    $
    23.7
    
    
    $
    23.0
    
    
    $
    24.9
    
    
    $
    26.5Interest expense on long-term debt and other interest
    
    
    (12.4
    )
    
    
    (11.2
    )
    
    
    (11.6
    )
    
    
    (9.6
    )
    
    
    (10.3
    )Cash income taxes paid
    
    
    (0.4
    )
    
    
    (1.2
    )
    
    
    (0.3
    )
    
    
    (0.1
    )
    
    
    (0.3
    )Net capital expenditures
    
    
    (5.4
    )
    
    
    (4.8
    )
    
    
    (12.8
    )
    
    
    (13.3
    )
    
    
    (14.0
    )Cash component of changes in deferred costs
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1.0
    )
    
    
    (0.5
    )Free cash flow
    
    
    6.3
    
    
    
    6.5
    
    
    
    (1.7
    )
    
    
    0.9
    
    
    
    1.4Change in non-cash working capital and other charges
    
    
    (4.3
    )
    
    
    0.4
    
    
    
    (4.9
    )
    
    
    (6.8
    )
    
    
    (12.3
    )Acquisitions
    
    
    
    
    
    
    
    
    
    
    (20.0
    )
    
    
    0.3
    
    
    
    Proceeds from sale of accounts receivable
    
    
    
    
    
    
    
    
    
    
    10.0
    
    
    
    
    
    
    
    45.0Change in Right-of-Way liability
    
    
    (0.7
    )
    
    
    (0.5
    )
    
    
    (0.7
    )
    
    
    (0.3
    )
    
    
    (0.4
    )Repurchase of long-term debt
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (104.8
    )Equity issued
    
    
    
    
    
    
    
    
    
    
    35.2
    
    
    
    5.4
    
    
    
    Change in cash & short term investments
    
    
    1.3
    
    
    
    6.4
    
    
    
    17.9
    
    
    
    (0.5
    )
    
    
    (71.1
    )
 Liquidity and Capital Resources Call-Net used liquidity in the first quarter to reduce a portion of its
long-term debt. Cash, cash equivalents and short-term investments decreased by
$71.1 million as the Company bought back senior secured notes at a cost of
$104.8 million and offset it partially through the sale of an additional $45.0
million of accounts receivable under its accounts receivable securitization
program. Cash Reconciliation (millions ofCanadian dollars)Cash & short-term investments December 31, 2003
    
    $
    150.1Free cash flow
    
    
    1.4Interest income and other expenseChange in non-cash working capital and other charges
    
    
    (12.3
    )Proceeds from equity issue
Proceeds from sale of accounts receivable
    
    
    45.0Repurchase of long-term debt
    
    
    (104.8
    )Net, other items
    
    
    (0.4
    )Cash and short-term investments, March 31, 2004
    
    $
    79.0
 Cash, cash equivalents and short-term investments are generally invested in
liquid Canadian dollar denominated securities with maturities no greater than
one year and
having one of the two highest ratings by either the Standard and Poors Rating
Group or Moodys Investors Service, Inc. Call-Net Enterprises Inc.
    
    
    11
    
    
    Interim MD&A Q1 2004




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##### 



Changes in non-cash working capital of $9.9 million were comprised of the
release of reserves described under the heading Other Expenses on page 8 of
this MD&A, payment of 2003 performance bonuses and a decrease in other accrued
liabilities, offset partly by an increase in accrued interest on the long-term
debt. Financial Position At March 31, 2004, Call-Net had current assets of $125.5 million and current
liabilities of $131.6 million. Net working capital was a negative $6.1
million, a decline from the positive $92.3 million at December 31, 2003  a
direct consequence of the decision to repurchase a portion of its long-term
debt. The Companys current ratio stood at 1.0 at quarter-end. Accounts
receivable stood at 31 days of sales. Financial Position Summary Change fromPrior Year-End(millions of Canadian dollars)
    
    Mar 31, 2004
    
    Dec 31, 2003
    
    $
    
    %[Restated]Cash and cash equivalents
    
    
    51.4
    
    
    
    56.5
    
    
    
    (5.1
    )
    
    
    (9.0
    )%Short-term investments
    
    
    27.6
    
    
    
    93.6
    
    
    
    (66.0
    )
    
    
    (70.5
    )%Total cash and short-term investments
    
    
    79.0
    
    
    
    150.1
    
    
    
    (71.1
    )
    
    
    (47.4
    )%Accounts receivable & other current assets
    
    
    46.5
    
    
    
    91.6
    
    
    
    (45.1
    )
    
    
    (49.2
    )%Total current assets
    
    
    125.5
    
    
    
    241.7
    
    
    
    (116.2
    )
    
    
    (48.1
    )%Capital and other assets
    
    
    571.1
    
    
    
    597.4
    
    
    
    (26.3
    )
    
    
    (4.4
    )%Total assets
    
    
    696.6
    
    
    
    839.1
    
    
    
    (142.5
    )
    
    
    (17.0
    )%Current liabilities
    
    
    131.6
    
    
    
    149.4
    
    
    
    (17.8
    )
    
    
    (11.9
    )%Long-term debt
    
    
    292.3
    
    
    
    387.1
    
    
    
    (94.8
    )
    
    
    (24.5
    )%Other long-term liabilities
    
    
    48.6
    
    
    
    49.1
    
    
    
    (0.5
    )
    
    
    (1.0
    )%Shareholders equity
    
    
    224.1
    
    
    
    253.5
    
    
    
    (29.4
    )
    
    
    (11.6
    )%Total liabilities and shareholders equity
    
    
    696.6
    
    
    
    839.1
    
    
    
    (142.5
    )
    
    
    (17.0
    )%Current ratio
    
    
    1.0
    
    
    
    1.6
    
    
    
    (0.6
    )Accounts Receivable(days sales outstanding)
    
    
    31
    
    
    
    32
    
    
    
    (1.0
    )Net debt to net capitalization
    
    
    54
    %
    
    
    53
    %
    
    
    
    
    
    
    1
    %
 Capital assets and other assets decreased $26.3 million to $571.1 million at
March 31, 2004 from the 2003 year-end. This decrease was primarily due to the
fact that Call-Nets depreciation and amortization expense continues to
substantially exceed the amount spent on capital additions. Long-term debt decreased by $94.8 million to $292.3 million resulting from a
reduction in senior secured notes of $100.8 million as a consequence of the
long-term debt repurchase, offset by an increase of $6.0 million associated
with a weakening Canadian dollar over the reporting period. Other long-term liabilities, composed of right-of-way liability, deferred fibre
maintenance charge, lease exit costs and asset retirement obligations,
decreased by $0.5 million to $48.6 million as a result of the continuing
amortization of certain of these liabilities. The Companys net debt to net capitalization ratio remained relatively
unchanged at 54% at the end of the first quarter, as compared to 53% at the end
of 2003. Call-Net Enterprises Inc.
    
    
    12
    
    
    Interim MD&A Q1 2004




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##### 



Outstanding Share Data Call-Net has an authorized share capital consisting of an unlimited number of
common shares, class B non-voting shares (class B shares) and preferred shares. As at April 30, 2004, 4,187,494 common shares, 31,565,527 class B shares and
one preferred share were issued and outstanding. Outlook Call-Nets 2004 outlook has not changed since it released its fourth quarter,
2003 results. Call-Net expects continued growth in its consumer and business
solutions revenue, offset somewhat by continued decline in carrier services
revenue. Top line revenue growth should be modest, up 1% to 5% over 2003. In the consumer marketCall-Net will focus on attracting home phone service
customers. While the percentage growth of new lines may slow, the Company
expects to add more home phone service customers in 2004 than it did in 2003.
Consumer revenue will also be stabilized by continued reductions in local
churn. The business marketwill remain highly competitive, especially in the large
corporate and mid-sized market segments. As with the consumer market, per-unit
long distance and data prices will continue to decline in 2004, offset by
increases in volume, success in the local market and in delivering IP Enabled
Solutions. The wholesale or carrier marketis expected to face declines in the per unit
price of service. Call-Net is committed to maintaining a profitable carrier
service operation despite wholesale revenue declines throughout 2004. Carrier charges should remain below 50% of revenue as the result of the
Companys ongoing efforts in network optimization. Much of the reduction in
costs associated with lower carrier charges will be redeployed into customer
acquisition programs. As a result, EBITDA is expected to grow at 5% to 10%
2003. Call-Net expects to continue to be cash flow self-sufficient, generating more
in EBITDA in 2004 than it spends in interest, capital and taxes. Call-Net continues to expect that capital expenditures in 2004 will be in the
range of 6% of revenue, of which approximately one half will be spent on
improvements and approximately one half on growth, including the expansion of
the Companys co-location footprint from 134 to 148 centres, the installation
of new local switching equipment and the purchase of other capital equipment to
support local customer growth. Regulatory Environment Call-Net continues to pursue regulatory reforms to lower carrier costs and
remove operational barriers to competition in the telecommunications industry.
These initiatives have met with some success.  
    
    On January 27, 2004, the CRTC released a decision (CRTC 2004-4)
responding to Call Nets Application to Promote Local Competition filed
in May 2003. In its decision, the CRTC granted Call-Nets request to
extend the winback no contact period from three months to 12 months.
The CRTC also Call-Net Enterprises Inc.
    
    
    13
    
    
    Interim MD&A Q1 2004




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##### 



agreed to implement a limited consumer education program
to inform consumers about the existence of local competition. The CRTC
did not agree to Call-Nets request for a temporary discount on loop
charges.
    
    On the same date, the CRTC also released a decision (CRTC 2004-5)
in which it ordered the ILECs to unbundle several components of their
Ethernet access and transport services and to make them available to
Call-Net and other competitors on an interim basis.
    
    On March 16, 2004, the CRTC released a decision (CRTC 2004-18)
directing Bell Canada to issue rebates for co-location power
retroactive adjustments to Call-Net and other eligible co-locators in
its territory, for the period from November 29, 2000 to September 11,
2002. Call-Net remains committed to offering Canadians a competitive choice when it
comes to telecommunications services. Call-Net will continue to pursue changes
to the regulatory regime necessary in order to ensure that it can continue to
compete fairly and efficiently against the ILECs. These efforts include
on-going proceedings to set the terms and conditions for unbundling of the
ILECs ADSL and Ethernet services. In addition, Call-Net is engaged in a
number of follow-up proceedings resulting from the price cap decision to expand
the categories of carrier services that are subject to the cost plus 15% price
regime, including three additional components of DNA. New Accounting Policies Stock-Based Compensation and Other Stock-Based Payments During 2003, the CICA made changes to Section 3870 of the Handbook,
Stock-Based Compensation and Other Stock-Based Payments, requiring that equity
instruments awarded to employees be measured and expensed using the fair value
method. The main impact of this change is to require the Company to record
compensation expense relating to the award of stock options to employees. The
Company has previously disclosed this information in the notes to the financial
statements. The Company has adopted this change effective January 1, 2004 on a
retroactive basis with restatement of prior periods. The result of this change
is reflected in operating expense in the consolidated statements of operations
and deficit and contributed surplus on the consolidated balance sheets. The
effect of prior-period restatements is a decrease to net income of $0.4 million
and a decrease in both basic and diluted earnings per share of $0.01 each for
the three-months ended March 31, 2003 and an increase to the deficit of $2.9
million as at December 31, 2003. The fair value of stock options is estimated at the grant date using the
Black-Scholes options pricing model. This model requires the input of a number
of assumptions including dividend yields, expected stock price volatility,
expected time until exercise and risk-free interest rates. Although the
assumptions used reflect managements best estimates, they involve
uncertainties based on market conditions generally outside of the control of
the Company. Asset Retirement Obligations Effective January 1, 2004, the Company retroactively adopted the new CICA
Handbook Section 3110, Asset Retirement Obligations, which establishes
standards for the recognition, measurement and disclosure of liabilities for
asset retirement obligations and the associated retirement costs. This section
applies to legal obligations associated with the retirement of tangible
long-lived assets that results Call-Net Enterprises Inc.
    
    
    14
    
    
    Interim MD&A Q1 2004




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##### 



from their acquisition, lease construction,
development or normal operation. The offset to the initial asset retirement
obligation is an increase in the carrying amount of the related long-lived
asset. Over time, the liability is accreted to its future value, and the asset
is depreciated over the useful life of the related asset. Upon settlement of
the liability, an entity either settles the obligation for its recorded amount
or incurs a gain or loss upon settlement. This standard is effective on a
retroactive basis with restatement of prior periods. As at January 1, 2003,
the Company recorded a liability of $2.2 million for the estimated costs of
retiring fibre optic cable and leasehold improvement assets at the maturity of
the facility leases. The Company also recorded asset retirement costs of $1.8 million as at January
1, 2003 to its fibre optic cable and leasehold improvement assets. The Company
recorded a charge to the January 1, 2003 deficit of $0.4 million for the
cumulative effects of the standard and has increased its depreciation expense
for the year ended December 31, 2003 by $0.5 million ($0.1 million for the
three months ended March 31, 2003). The following table details the changes in
the asset retirement liability: January 1, 2004
    
    $
    2.4Accretion charges recorded in depreciation expense
    
    
    0.1March 31, 2004
    
    $
    2.5
 The adjustment to the fibre optic cable and leasehold improvement assets in
respect of asset retirement costs is depreciated into income over the remaining
life of the assets, on a straight-line basis. For the three months ended March
31, 2004, depreciation expense was $0.1 million. Additional Information Additional information relating to Call-Net, including Call-Nets Annual
Information Form (AIF), is available on SEDAR at www.sedar.com. Call-Net Enterprises Inc.
    
    
    15
    
    
    Interim MD&A Q1 2004