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WCG's 3Q Earnings reports is a mixed bag. There's some very good news, fair news and somewhat disappointing news.

1. The reported loss before the extraordinary gain on the debt repurchase of $492.0 million contains a number of one-time items which reduced income by $188 million. Excluding these items the reported loss for the quarter would have been about $304 million, excluding the gain on the debt repurchase. These items were:

- A $150 million non-cash charge to establish a reserve allowance for equipment held for resale. This includes the real estate the Company has chosen to sell and other surplus equipment;

- A $30 million charge for the cancellation of capital projects and severance for the 400 personnel released at the beginning of July. I estimate that about $20+ million of this amount was a non-cash charge;

- An $11.3 million charge for the writedown of goodwill at Williams Broadband;

- A $42 million writedown in the value of certain investments (marketable securities); and

- A $45 million gain recognized on the sale of ATL.

Network Revenues:

Recurring network revenues increased by nearly 7% on a sequential basis from the second quarter to $271.1 million. (WCG did not record any revenue from dark fiber during the quarter.) This is at the low end of the management's range of $268-$304 million for the quarter. During the quarter WCG completed the disconnection of dotcom customers. At the Kaufmann conference Scott Schubert, CFO of WCG, stated that 95% of the Company's revenues were from investment grade customers and only 5% from "High Risk" customers. At the end of the second quarter about 85% of WCG's revenues were from investment grade customers. The reason for the substantial improvement can be seen in the Provision for Doubtful Accounts which jumped to approximately $12 million at the Network segment during the 3rd quarter. This represents the cost of turning off the dotcom customers. This is a non-cash charge and presumeably represents the final purge of these customers.

In line with revenues coming in at the low-end of the projected range, the Company has reduced its projection for recurring network revenue for the fourth quarter to the following range: $300-$325 million from the previous $327-$382 million.

While this is somewhat disappointing, in light of the flat to declining revenue streams being reported at BRW, T, Q and LVLT, WCG's performance in the third quarter is a major bright spot. In addition compared to its competitors, WCG's estimate that its revenues will show sequential growth of 10%-20% in the 4th quarter is extremely significant. All-in-all in light of economic conditions, WCG's ability to continue to show solid revenue growth must be viewed as a strong positive.

Expenses:

Operating expenses at the Network continued to improve. While recurring revenues increased by $17 million from the second quarter of 2001, operating expenses declined by nearly $1.0 million. In other words revenues were up, expenses were down. For the quarter the gross margin at the network rose from 12.2% in the second quarter of 2001 to 18.1%. IMO a more important measure of network perfomance is the year-over-year gross margin on incremental revenues. In the first quarter of 2001 the incremental gross margin was 35.5%. This meant that on each additional $1.00 of revenue from Q1:2000 to Q1:2001 the gross margin was 35.5%. In the second quarter the incremental gross margin was 44.2%. For the third quarter the incremental gross margin was 64.4%. This means that on each additional dollar of revenue, the gross margin is about 65%. This margin is typical of a built-out network.

The impact of the improving gross margin can be seen on EBITDA. For the third quarter network operating EBITDA improved to a loss of $15 million from a loss of $20 million in the second quarter, which included an $8 million settlement (i.e. excluding the settlement 2nd quarter network operating EBITDA would have been a loss of $28 million.) Thus excluding the one-time gain in the second quarter, network operating EBITDA improved by $13 million from the 2nd qtr to the 3rd qtr on a $17 million increase in revenue.

WCG is now projecting that on revenue of $300-$325 million in the 4th quarter network operating EBITDA will improve to a range of a loss of $10 million to breakeven. However based on third quarter results a revenue increase of $29-$50 million should result in an improvement of EBITDA of about $15-$32 million. This implies that WCG will either breakeven on EBITDA for the entire 4th quarter or could even show positive EBITDA of as much as $20 million for the 4th quarter. In any event WCG will be EBITDA positive for the month of November.

Written by David L. ahl (Securities Analyst).

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