<PAGE>
 
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                                 UNITED STATES
                      SECURITIES AND EXCHANGE COMMISSION
                            WASHINGTON, D.C. 20549
 
                               ----------------
 
                                   FORM 10-Q
 
                               ----------------
 
  [X]QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
     EXCHANGE ACT OF 1934.
 
               FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1998
 
                                      OR
 
  [_]TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
     EXCHANGE ACT OF 1934.
 
           FOR THE TRANSITION PERIOD FROM     , 19   TO     , 19   .
 
                        COMMISSION FILE NUMBER: 0-25482
 
                               ----------------
 
                         EQUALNET COMMUNICATIONS CORP.
            (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
 
                 TEXAS                                 76-0457803
     (STATE OF OTHER JURISDICTION                   (I.R.S. EMPLOYER
   OF INCORPORATION OR ORGANIZATION)             IDENTIFICATION NUMBER)
 
                          1250 WOOD BRANCH PARK DRIVE
                             HOUSTON, TEXAS 77079
         (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES, INCLUDING ZIP CODE)
 
                                (281) 529-4600
             (REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
 
                                      N/A
             (FORMER NAME, FORMER ADDRESS AND FORMER FISCAL YEAR,
                         IF CHANGED SINCE LAST REPORT)
 
                               ----------------
 
  Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
                               Yes [X]   No [_]
 
  There were 18,385,832 shares of the Registrant's $.01 par value common stock
outstanding as of November 20, 1998.
 
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<PAGE>
 
                          PART I FINANCIAL INFORMATION
 
ITEM 1. FINANCIAL STATEMENTS
 
                         EQUALNET COMMUNICATIONS CORP.
 
                          CONSOLIDATED BALANCE SHEETS
 
<TABLE>
<CAPTION>
                                                       JUNE 30,     SEPTEMBER
                                                         1998       30, 1998
                                                      -----------  -----------
                                                        (NOTE)     (UNAUDITED)
                       ASSETS
                       ------
<S>                                                   <C>          <C>
Current assets
  Cash and equivalents............................... $   459,581  $   415,668
  Accounts receivable, net of allowance for doubtful
   accounts of $1,034,253 at June 30, 1998 and
   $1,429,824 at September 30, 1998..................   5,839,284   12,979,776
  Due from agents....................................   1,596,590    1,100,009
  Advance on acquisition purchase price..............   3,014,000           --
  Prepaid expenses and other.........................     109,684      638,131
                                                      -----------  -----------
    Total current assets.............................  11,019,139   15,133,584
Property and equipment
  Computer equipment.................................  17,824,993   17,937,062
  Office furniture and fixtures......................   1,209,032    1,209,032
  Leasehold improvements.............................   1,177,592    1,185,012
                                                      -----------  -----------
                                                       20,211,617   20,331,106
  Accumulated depreciation and amortization..........  (4,837,626)  (5,691,472)
                                                      -----------  -----------
                                                       15,373,991   14,639,634
Customer acquisition costs, net of accumulated
 amortization of $14,381,407 at June 30, 1998 and
 $15,742,634 at September 30, 1998...................     355,984    7,395,221
Other assets.........................................   1,011,333      794,023
                                                      -----------  -----------
    Total assets..................................... $27,760,447  $37,962,462
                                                      ===========  ===========
</TABLE>
 
 
 
   Note: The balance sheet at June 30, 1998 has been derived from the audited
                       financial statements at that date.
 
                                       2
<PAGE>
 
                         EQUALNET COMMUNICATIONS CORP.
 
                          CONSOLIDATED BALANCE SHEETS
 
<TABLE>
<CAPTION>
                                                       JUNE 30,     SEPTEMBER
                                                         1998       30, 1998
                                                      -----------  -----------
                                                        (NOTE)     (UNAUDITED)
        LIABILITIES AND SHAREHOLDERS' EQUITY
        ------------------------------------
<S>                                                   <C>          <C>
Current Liabilities Not Subject to Compromise
  Payable to providers of long distance services..... $ 6,627,711  $ 1,911,316
  Accounts payable...................................   4,237,310    1,294,317
  Accrued expenses...................................   3,838,315      602,194
  Accrued sales taxes................................     205,108      849,752
  Notes payable to long distance provider............   1,183,059           --
  Debt in default....................................   5,752,535           --
  Debt in default to an Affiliate....................     400,000      400,000
  Contractual obligations with regard to receivable
   sales agreement...................................   2,334,710    3,856,203
  Notes Payable......................................          --    1,379,551
                                                      -----------  -----------
    Total Current Liabilities Not Subject to
     Compromise......................................  24,578,748   10,293,333
Current Liabilities Subject to Compromise (NOTE 2)...          --   15,198,185
                                                      -----------  -----------
    Total Current Liabilities........................  24,578,748   25,491,518
Deferred rent........................................     223,917           --
Notes Payable........................................          --    6,448,864
Convertible Debt.....................................          --    2,468,738
Shareholders' equity
 Preferred stock, $.01 par value 5,000,000 shares 
  authorized at June 30, 1998 
  Series A Convertible Preferred Stock (non-voting) 
   aggregate liquidation preference of $2.1 million; 
   Issued and outstanding shares--2,000 at June 30, 
   1998 and 2,000 at September 30, 1998 .............   2,000,000    2,000,000
  Series B Convertible Preferred Stock (voting)
   aggregate liquidation preference of $3.0 million;
   Issued and outstanding shares--3,000 at June 30,
   1998 and 3,000 at September 30, 1998..............   3,000,000    3,000,000
  Series C Convertible Preferred Stock (voting)
   aggregate liquidation preference of $5.3 million;
   Issued and outstanding shares--0 at June 30, 1998
   and 196,553 at September 30, 1998.................          --    5,400,000
  Series D Convertible Preferred Stock (voting), $.01
   par value, aggregate liquidation preference of
   $3.45 million at September 30, 1998; Issued and
   outstanding shares--0 at June 30, 1998 and 3,750
   at September 30, 1998.............................          --    1,889,000
  Common stock, $.01 par value                            217,935      217,935
  Authorized shares--50,000,000 at June 30, 1998 and
   September 30, 1998. Issued and outstanding
   21,385,832 at June 30, 1998 and 18,385,832 at
   September 30, 1998................................          --           --
  Treasury stock at cost; 400,447 shares at June 30,
   1998 and 3,400,447 at September 30, 1998..........    (817,153)  (2,506,153)
  Additional paid in capital.........................  37,063,468   37,513,468
  Stock warrants.....................................   1,763,240    2,511,077
  Deferred compensation..............................    (115,826)    (115,826)
  Retained deficit................................... (40,153,882) (46,356,159)
                                                      -----------  -----------
    Total shareholders' equity.......................   2,957,782    3,553,342
                                                      -----------  -----------
    Total liabilities and shareholders' equity....... $27,760,447  $37,962,462
                                                      ===========  ===========
</TABLE>
 
   Note: The balance sheet at June 30, 1998 has been derived from the audited
                       financial statements at that date.
 
                                       3
<PAGE>
 
                         EQUALNET COMMUNICATIONS CORP.
 
                     CONSOLIDATED STATEMENTS OF OPERATIONS
 
                                  (UNAUDITED)
 
<TABLE>
<CAPTION>
                                                       THREE MONTHS ENDED
                                                          SEPTEMBER 30,
                                                     ------------------------
                                                        1997         1998
                                                     -----------  -----------
<S>                                                  <C>          <C>
Revenues............................................ $ 8,327,219  $ 8,393,141
Cost of Revenues....................................   6,264,718    7,885,013
                                                     -----------  -----------
                                                       2,062,501      508,128
Selling, general and administrative expenses........   2,667,606    3,664,820
Depreciation and amortization.......................   1,112,200    2,215,623
                                                     -----------  -----------
Operating loss......................................  (1,717,305)  (5,372,315)
Other income (expense)
  Interest income...................................       1,130          860
  Interest expense..................................    (353,385)    (735,183)
  Miscellaneous.....................................     (27,337)      17,353
                                                     -----------  -----------
                                                        (379,592)    (716,970)
                                                     -----------  -----------
Loss before federal income taxes and reorganization
 costs..............................................  (2,096,897)  (6,089,285)
Benefit for federal income taxes....................          --           --
                                                     -----------  -----------
Loss before reorganization costs....................  (2,096,897)  (6,089,285)
Reorganization Costs................................          --      (71,658)
                                                     -----------  -----------
    Net loss........................................ $(2,096,897) $(6,160,943)
                                                     ===========  ===========
Preferred Stock Dividends...........................          --  $   (41,333)
Net loss available to Common shareholders........... $(2,096,897) $(6,202,276)
Net loss per share--basic and diluted............... $     (0.33) $     (0.30)
Weighted average number of shares...................   6,368,864   20,510,826
</TABLE>
 
 
                            See accompanying notes.
 
                                       4
<PAGE>
 
                         EQUALNET COMMUNICATIONS CORP.
 
                      CONSOLIDATED STATEMENT OF CASH FLOWS
 
                                  (UNAUDITED)
 
<TABLE>
<CAPTION>
                                                        THREE MONTHS ENDED
                                                          SEPTEMBER 30,
                                                     -------------------------
                                                        1997          1998
                                                     -----------  ------------
<S>                                                  <C>          <C>
OPERATING ACTIVITIES
Net loss...........................................  $(2,096,897) $ (6,160,943)
Adjustments to reconcile net loss to cash provided
 by (used in) operating activities
  Depreciation and amortization....................    1,112,200     2,215,623
  Provision for bad debt...........................      387,025       395,571
  Amortization of discount on convertible debt.....           --        15,179
  Interest charge on convertible debt issued at
   discount........................................           --       450,000
  Change in deferred rent..........................      (20,118)     (223,917)
  Compensation expense recognized for common stock
   issue...........................................       22,502            --
  Change in operating assets and liabilities:
    Accounts receivable............................    1,324,353    (2,871,407)
    Due from agents................................      405,737       496,581
    Prepaid expenses and other.....................      (62,758)     (528,447)
    Other assets...................................      (17,951)      141,760
    Accounts payable and accrued liabilities not
     subject to compromise.........................      (73,310)  (10,292,199)
    Accounts payable and accrued liabilities
     subject to compromise.........................           --    14,015,126
                                                     -----------  ------------
Net cash provided by (used in) operating
 activities........................................      980,783    (2,347,073)
INVESTING ACTIVITIES
Purchase of property and equipment.................      (50,420)     (119,489)
Purchase of customer accounts......................     (186,812)           --
Cash paid for acquisition..........................           --      (555,000)
Proceeds from sale of equipment....................           --        74,775
                                                     -----------  ------------
Net cash used in investing activities..............     (237,232)     (599,714)
FINANCING ACTIVITIES
Proceeds from long-term debt.......................           --     2,923,245
Repayments on long-term debt.......................           --    (4,541,864)
Proceeds from convertible debt.....................           --     2,800,000
Proceeds from exchange of common stock for
 preferred stock...................................           --       200,000
Proceeds from subordinated note payable............       22,203            --
Net repayments on revolving line of credit.........   (4,555,442)           --
Net proceeds on contractual obligations with regard
 to receivable sales agreement.....................    3,418,647     1,521,493
Repayments on capital lease obligations............      (21,000)           --
Proceeds from issuance of stock....................      350,000            --
                                                     -----------  ------------
Net cash provided by (used in) financing
 activities........................................     (785,592)    2,902,874
                                                     -----------  ------------
Net decrease in cash...............................      (42,041)      (43,913)
Cash, beginning of period..........................      828,478       459,581
                                                     -----------  ------------
Cash, end of period................................  $   786,437  $    415,668
                                                     ===========  ============
</TABLE>
 
                                       5
<PAGE>
 
                         EQUALNET COMMUNICATIONS CORP.
 
                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
                                  (UNAUDITED)
 
NOTE 1--MANAGEMENT'S REPRESENTATION
 
  The consolidated financial statements included herein have been prepared by
the management of Equalnet Communications Corp. (the "Company") without audit.
Certain information and note disclosures normally included in consolidated
financial statements prepared in accordance with generally accepted accounting
principles have been omitted. In the opinion of the management of the Company,
all adjustments considered necessary for fair presentation of the consolidated
financial statements have been included and were of a normal recurring nature,
and the accompanying consolidated financial statements present fairly the
financial position of the Company as of September 30, 1998, and the results of
operation and cash flows for the three months ended September 30, 1997 and
1998.
 
  It is suggested that these consolidated financial statements be read in
conjunction with the consolidated financial statements and notes for the three
years ended June 30, 1998, included in the Company's Annual Report on Form 10-
K for the year ended June 30, 1998, which was filed with the Securities and
Exchange Commission. The interim results are not necessarily indicative of the
results for a full year.
 
NOTE 2--CHAPTER 7 AND 11 FILING
 
  The Company's consolidated financial statements have been prepared in
accordance with statement of Position No. 90-7, "Financial Reporting by
Entities in Reorganization Under the Bankruptcy Code", and include disclosure
of liabilities subject to compromise. EqualNet Corporation ("EqualNet"), one
of the Company's operating subsidiaries, and EqualNet Wholesale Services, Inc.
("Wholesale"), a wholly owned non-operating subsidiary of EqualNet filed
voluntary petitions for relief under Chapter 11 ("Chapter 11") of the United
States Bankruptcy Code (the "Bankruptcy Code") on September 10, 1998 (the
"Petition Date") in the United States Bankruptcy Court for the Southern
District of Texas (the "Bankruptcy Court"), Houston, Texas. Under Chapter 11,
certain claims against EqualNet in existence prior to the filing of the
petitions for relief under the federal bankruptcy laws are stayed while
EqualNet continues business operations as a debtor-in-possession. These claims
are reflected in the September 30, 1998 balance sheet as "liabilities subject
to compromise." Additional claims (liabilities subject to compromise) may
arise subsequent to the filing date resulting from rejection of executory
contracts, including leases, and from the determination by the court (or
agreed to by parties in interest) of allowed claims for contingencies and
other disputed amounts.
 
  On October 2, 1998 Wholesale filed its motion to convert its bankruptcy
proceeding from a Chapter 11 reorganization to a Chapter 7 liquidation.
Pursuant to Sections 1107 and 1108 of the Bankruptcy Code, EqualNet as debtor-
in-possession, will continue to manage and operate EqualNet's assets and
business pending the confirmation of a reorganization plan and subject to the
supervision and orders of the Bankruptcy Court. The Company is currently
developing the reorganization plan and intends to submit the reorganization
plan for confirmation prior to the due date.
 
  As a debtor-in-possession, EqualNet is authorized to operate its business,
but may not engage in transactions outside of the normal course of business
without approval, after notice and hearing, of the Bankruptcy Court. A
creditors' committee was formed in October, 1998, which has the right to
review and object to business transactions outside the ordinary course.
 
  The consolidated financial statements do not purport to show (a) the
realizable value of assets on a liquidation basis or their availability to
satisfy liabilities; (b) ultimate pre-petition liability amounts that may be
allowed for claims or contingencies or the status or priority thereof; (c) the
effect of any changes that may be made to the capitalization of EqualNet; or
(d) the effect of any changes that may be made in EqualNet's business
operations. The outcome of these matters is not presently determinable.
 
                                       6
<PAGE>
 
                         EQUALNET COMMUNICATIONS CORP.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
  Although management intends that EqualNet will emerge from bankruptcy in a
prompt and expeditious manner during the third quarter of fiscal year 1999,
there can be no assurance of the timing or consummation of that
reorganization.
 
  In the event EqualNet's plan of reorganization is formulated and approved by
the Court, continuation of the Company's business is dependent upon the
success of future operations and the Company's ability to meet its obligations
as they become due. The Company's consolidated financial statements have been
prepared on a going concern basis, which contemplates continuity of
operations, realization of assets and liquidation of liabilities and
commitments in the normal course of business. The Chapter 11 filing by
EqualNet, as well as related circumstances and the losses from operations,
continue to raise substantial doubt about the Company's ability to continue as
a going concern. The consolidated financial statements included herein do not
include any adjustments relating to the commencement of EqualNet's bankruptcy
case or to reflect the possible future effects on the recoverability and
classification of assets or the amounts and classification of liabilities that
may result from the outcome of the uncertainty of the Company's ability to
continue as a going concern.
 
  The principal categories of claims classified as "Current Liabilities
Subject to Compromise" are identified below:
 
<TABLE>
      <S>                                                           <C>
      Payable to providers of long distance services............... $ 9,833,383
      Accounts payable.............................................   2,943,606
      Accrued expenses.............................................   1,238,137
      Notes Payable to long distance provider......................   1,183,059
                                                                    -----------
                                                                    $15,198,185
                                                                    ===========
</TABLE>
 
                                       7
<PAGE>
 
                         EQUALNET COMMUNICATIONS CORP.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
  The following condensed financial statements present the financial position
of EqualNet as of September 30, 1998 and the results of its operations and
cash flows for the three months ended September 30, 1998, and have been
prepared on the same basis as the Company's consolidated financial statements.
 
                             EQUALNET CORPORATION
                                 BALANCE SHEET
                                  (UNAUDITED)
 
<TABLE>
<CAPTION>
                                                             SEPTEMBER 30, 1998
                                                             ------------------
                                                                (UNAUDITED)
                          ASSETS
                          ------
<S>                                                          <C>
Current assets
  Cash and equivalents.....................................     $    130,125
  Accounts receivable, net of allowance for doubtful
   accounts of $1,256,401..................................        6,762,134
  Due from agents..........................................        1,100,009
                                                                ------------
Total current assets.......................................        7,992,268
Property and equipment
  Computer equipment.......................................        4,547,284
  Office furniture and fixtures............................        1,209,032
  Leasehold improvements...................................        1,185,012
                                                                ------------
                                                                   6,941,328
  Accumulated depreciation and amortization................       (4,324,879)
                                                                ------------
                                                                   2,616,449
Customer acquisition costs, net of accumulated amortization
 of $14,146,622 at September 30, 1998......................          166,984
Other assets...............................................          271,795
                                                                ------------
Total assets...............................................     $ 11,047,496
                                                                ============
<CAPTION>
           LIABILITIES AND SHAREHOLDERS' EQUITY
           ------------------------------------
<S>                                                          <C>
Current Liabilities Not Subject to Compromise
  Payable to providers of long distance services...........     $    640,189
  Accounts Payable.........................................          111,195
  Accrued Expenses.........................................          169,598
  Accrued sales taxes......................................          322,207
  Debt in Default to an Affiliate..........................          400,000
  Contractual obligations with regard to receivable sales
   agreement...............................................        2,238,029
  Intercompany Note Payable................................       10,000,000
                                                                ------------
    Total Current Liabilities Not Subject to Compromise....       13,881,218
Current Liabilities Subject to Compromise
  Payable to providers of long distance services...........     $  9,833,383
  Accounts payable.........................................        2,943,606
  Accrued expenses.........................................        1,238,137
  Notes Payable to long distance providers.................        1,183,059
  Intercompany Note Payable................................       26,987,358
                                                                ------------
    Total Current Liabilities Subject to Compromise........       42,185,543
                                                                ------------
    Total Current Liabilities..............................       56,066,761
Shareholders' equity
  Common Stock.............................................                1
  Retained deficit.........................................      (45,019,266)
                                                                ------------
Total shareholders' equity.................................      (45,019,265)
                                                                ------------
Total liabilities and shareholders' equity.................     $ 11,047,496
                                                                ============
</TABLE>
 
                                       8
<PAGE>
 
                         EQUALNET COMMUNICATIONS CORP.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
                             EQUALNET CORPORATION
 
                            STATEMENT OF OPERATIONS
 
                                  (UNAUDITED)
 
<TABLE>
<CAPTION>
                                                              THREE MONTHS ENDED
                                                              SEPTEMBER 30, 1998
                                                              ------------------
                                                                 (UNAUDITED)
<S>                                                           <C>
Revenues.....................................................    $ 4,923,858
Cost of Revenues.............................................      5,468,019
                                                                 -----------
                                                                    (544,161)
Selling, general and administrative expenses.................      2,645,878
Depreciation and amortization................................        454,741
                                                                 -----------
Operating loss...............................................     (3,644,780)
Other income (expense)
  Interest income............................................            860
  Interest expense...........................................        (65,184)
  Miscellaneous..............................................         17,359
                                                                 -----------
                                                                    (46,965)
                                                                 -----------
Loss before federal income taxes and other item..............     (3,691,745)
Benefit for federal income taxes.............................             --
                                                                 -----------
Loss before other item.......................................     (3,691,745)
Reorganization Costs.........................................        (71,658)
                                                                 -----------
Net loss.....................................................    $(3,763,403)
                                                                 ===========
</TABLE>
 
  Reorganization expenses, which represent professional fees, incurred during
the quarter ended September 30, 1998 totaled approximately $71,658.
 
                                       9
<PAGE>
 
                         EQUALNET COMMUNICATIONS CORP.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
                             EQUALNET CORPORATION
 
                            STATEMENT OF CASH FLOWS
 
                                  (UNAUDITED)
 
<TABLE>
<CAPTION>
                                                             THREE MONTHS ENDED
                                                             SEPTEMBER 30, 1998
                                                             ------------------
<S>                                                          <C>
OPERATING ACTIVITIES
Net loss...................................................     $(3,763,403)
Adjustments to reconcile net loss to cash used in operating
 activities
  Depreciation and amortization............................         454,741
  Provision for bad debt...................................         222,148
  Change in deferred rent..................................        (223,917)
  Change in operating assets and liabilities:
    Accounts receivable....................................      (1,144,998)
    Due from agents........................................         496,580
    Other assets...........................................         207,206
    Accounts payable and accrued liabilities not subject to
     compromise............................................     (13,181,802)
    Accounts payable and accrued liabilities subject to
     compromise............................................      14,015,126
                                                                -----------
Net cash provided by (used in) operating activities........      (2,918,319)
INVESTING ACTIVITIES
Purchase of property and equipment.........................        (119,489)
                                                                -----------
Net cash used in investing activities......................        (119,489)
FINANCING ACTIVITIES
Net proceeds from intercompany note payable................       2,807,290
Net change on contractual obligations with regard to
 receivable sales agreement................................         (96,681)
                                                                -----------
Net cash provided by financing activities..................       2,710,609
                                                                -----------
Net decrease in cash.......................................        (327,199)
Cash, beginning of period..................................         457,324
                                                                -----------
Cash, end of period........................................     $   130,125
                                                                ===========
</TABLE>
 
NOTE 3--DIP FINANCING AND EXIT FACILITY
 
  Prior to filing for bankruptcy protection, EqualNet and RFC Capital
Corporation ("RFC") entered into an agreement whereby RFC agreed to amend
certain financing agreements with EqualNet to eliminate EqualNet's bankruptcy
filing as an event of default and, subject to bankruptcy court approval, to
continue to finance EqualNet's receivables under a debtor in possession
("DIP") facility. On September 16, 1998, the bankruptcy court approved, on an
interim basis, the DIP financing which allowed EqualNet to continue to obtain
funds from RFC in the same manner as it did prior to the bankruptcy filing.
The financing cost of the DIP financing is prime rate plus seven percent (7%).
A final hearing to approve the DIP financing for the term of the bankruptcy
proceeding is scheduled for November 24, 1998.
 
  EqualNet may be required to seek additional financing to obtain the approval
of creditors of its plan of reorganization. The Company does not have the
capital to provide the exit facility and does not currently have any
commitments from outside sources. The Company does intend to raise the needed
capital from outside investors and provide EqualNet with the exit facility. If
the Company is able to successfully provide the exit facility, the Company
would continue to own EqualNet after the bankruptcy proceedings.
 
                                      10
<PAGE>
 
                         EQUALNET COMMUNICATIONS CORP.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
NOTE 4--SA TELECOM ACQUISITION
 
  On January 21, 1998, the Company signed an agreement with SA
Telecommunications, Inc. ("SA Telecom"), a switch based, long distance
telecommunications carrier serving customers primarily in Texas and California
to acquire certain assets and customer bases in exchange for a combination of
shares of stock, cash and assumption of certain liabilities. The transaction
was subject to certain conditions, including approval of the bankruptcy court
supervising the reorganization of SA Telecom under Chapter 11 of the United
States Bankruptcy Code. On March 9, 1998, the Company won approval from the
bankruptcy court. The purchase of SA Telecom was approved by the Company's
shareholders on June 30, 1998 for approximately $3.47 million in cash and
approximately $5.4 million of Series C Preferred Stock and the assumption of
approximately $4 million in debt, payable to Greyrock Business Credit, subject
to final closing adjustments. The Company's newly formed wholly owned
subsidiary, USC Telecom, Inc. ("USC Telecom"), acquired the SA Telecom assets
on July 23, 1998. Prior to the closing of this transaction and for the purpose
of providing for a smooth transition of the acquired customer base, the
Company and SA Telecom entered into a management agreement pursuant to which
the Company managed the operations of SA Telecom from April 1, 1998 until the
close of the transaction whereby the Company was responsible for any losses
from SA Telecom's operations on or after April 1, 1998. SA Telecom has
provided the Company with notice that the Company owes SA Telecom
approximately $732,395 for operating losses during the period the management
agreement was effective. The determination of operating losses under the
management agreement is subject to interpretation and the Company has disputed
the amount of operating losses as provided by SA Telecom. Additionally, SA
Telecom is disputing the final purchase price settlement and has requested
additional funding. It is most likely the Company and SA Telecom will settle
these disputes at the same time and it is not possible to anticipate the
outcome. Any additional amount paid by the Company, if any, is anticipated to
be recorded as additional purchase consideration.
 
  The Company accounted for the SA Telecom acquisition using the purchase
method of accounting. Accordingly, the results of operations of the acquired
business is included in the Company's consolidated results of operations from
the date of acquisition.
 
   Purchase consideration (in thousands):
<TABLE>
      <S>                                                               <C>
      Cash paid........................................................ $ 3,569
      Fair value of preferred stock issued.............................   5,400
      Liabilities assumed..............................................   4,095
                                                                        -------
      Fair value of assets acquired (including intangibles)............ $13,064
                                                                        =======
</TABLE>
 
  The Company booked an asset for customer acquisition costs of approximately
$8.3 million. This asset is being amortized by applying the estimated
attrition rate of the acquired customer base per month against the unamortized
balance of the previous month (declining balance method) over a five-year
period.
 
  The Company issued 196,553 shares of Series C Preferred Stock to SA Telecom
as part of the purchase price. The Series C Preferred Stock is convertible at
the holder's option into shares of the Company's common stock ("Common Stock")
at the rate of ten (10) shares of Common Stock per share of Series C Preferred
Stock, or an aggregate of 1,965,530 shares of Common Stock. The Series C
Preferred Stock has a liquidation preference equal to $27.50 (plus any accrued
but unpaid dividends) per share of Series C Preferred Stock.
 
                                      11
<PAGE>
 
                         EQUALNET COMMUNICATIONS CORP.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
  The following results of operations have been prepared assuming the SA
Telecom acquisition occurred as of the beginning of the periods presented. The
pro forma operating results are not necessarily indicative of future operating
results nor of results that would have occurred had the acquisition been
consummated as of the beginning of the periods presented.
 
<TABLE>
<CAPTION>
                                                           THREE MONTHS ENDED
                                                              SEPTEMBER 30,
                                                           --------------------
                                                             1997       1998
                                                           ---------  ---------
                                                             (IN THOUSANDS,
                                                                 EXCEPT
                                                           PER SHARE AMOUNTS)
      <S>                                                  <C>        <C>
      Revenues............................................ $  19,721  $   9,360
      Net income (loss)................................... $  (8,824) $  (6,043)
      Net loss per share.................................. $   (1.38) $   (0.29)
                                                           =========  =========
</TABLE>
 
NOTE 5--DEBT
 
  Netco Acquisition Corp. ("Netco"), a wholly owned subsidiary of the Company,
defaulted on its note payable in the original principal amount of $6.05
million during the quarter, due to failure to make the monthly payments
beginning with the July 1998 payment. These payment defaults were cured in
September, 1998. Subsequent to quarter-end, the Company has been making
interest-only payments on this loan under a verbal agreement with the lender.
The principal amount outstanding at June 30, 1998 is classified as Debt in
Default, a current liability. The principal amount outstanding as of September
30, 1998 of approximately $5.5 million is classified as a Note Payable and
considered to be a long-term liability to the extent principal payments are
due in more than one year.
 
  As of September 30, 1998, the Company was in default on its $0.4 million
cash flow bridge loan obtained from Netco Acquisition, LLC, an entity owned
50% by the Willis Group, LLC ("Willis Group"), an affiliate of the Company, as
no principal or interest payments have been made. The principal amount is
classified as Debt in Default to an Affiliate.
 
  EqualNet entered into an agreement with RFC, effective June 18, 1997, which
is essentially a receivable purchase arrangement which bases borrowing
capacity on a percentage of EqualNet's outstanding receivables up to a maximum
allowable amount of $10.0 million and allows for the lender to cease funding
of new receivables without prior written notice at the lender's option. The
program fee applied to the outstanding balance of net purchased receivables
was prime plus 4.5% per annum (13% at June 30, 1998), but changed to prime
plus 7% on September 17, 1998 (after the Chapter 11 filing). As of September
30, 1998, the amount owed to RFC under this agreement was approximately $2.2
million with a credit reserve of $144,000. This RFC agreement was extended on
July 19, 1998 and subsequently amended on a temporary basis on September 17,
1998. A hearing is scheduled in Bankruptcy Court on November 24, 1998, to
determine if the court will approve the RFC facility remaining in place during
EqualNet's bankruptcy.
 
  On July 23, 1998, the Company entered into a Loan and Security Agreement
with RFC which was subsequently amended on September 8, 1998 (the agreement as
amended, "RFC Loan"). RFC loaned the Company approximately $1.5 million.
Periodic monthly principal and interest payments of $14,812 are due commencing
on November 30, 1998. The balance due on the RFC Loan is payable on June 30,
2000. Interest is payable on the outstanding principal balance in an amount
equal to the prime lending rate plus 5.5%. The RFC Loan is secured by all of
the assets of the Company and the stock of EqualNet and USC Telecom. In
connection with the RFC Loan, the Company granted to RFC a warrant for the
purchase of up to 294,000 shares of Common Stock at the exercise price equal
to the arithmetic average of the closing price of the Common Stock on Nasdaq
for the three trading days immediately preceding the consummation of the RFC
Loan. The warrant expires
 
                                      12
<PAGE>
 
                         EQUALNET COMMUNICATIONS CORP.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
July 23, 2003. Proceeds from the RFC Loan were primarily used to retire a
portion of the Greyrock Business Credit loan. After taking into account the
discount associated with the warrants, the RFC Loan is recorded on the
Company's books at September 30, 1998 in the amount of $1,091,873.
 
  In connection with the July 23, 1998 SA Telecom acquisition, the Company
assumed a note payable to Greyrock Business Credit of approximately $4.0
million. In August 1998, this loan was paid off with the proceeds from various
RFC loans and the proceeds from a new $0.8 million loan from Greyrock. The
principal balance of the Greyrock $0.8 million loan is payable on February 28,
1999. The loan bears interest at a rate of prime plus 2.5% and is secured by
the assets of USC Telecom.
 
  In August 1998, USC Telecom entered into a receivables purchase arrangement
with RFC and used the proceeds of the initial funding of $2.1 million to pay
off a portion of the debt to Greyrock Business Credit ("Greyrock"), which was
assumed in the SA Telecom transaction. This facility is USC Telecom's primary
source of working capital. The maximum purchase commitment amount from RFC is
$4.0 million, and the program fee is prime rate plus 4.0%. The term of the
facility is two years from the funding date. As of September 30, 1998, the
amount owed to RFC under the USC Telecom agreement was approximately $1.6
million.
 
  On September 2, 1998, the Company executed a loan agreement in favor of the
Willis Group in the amount of $241,106. The loan documented certain advances
which the Willis Group had made on the Company's behalf. The Willis Group loan
is secured by the assets of the Company and each of its subsidiaries. This
loan bears interest at 11% and matures on January 31, 1999.
 
  Effective July 31, 1998, the Company issued two 6% Senior Secured
Convertible Notes due in 2001 (the "2001 Notes") in the amount of $1.5 million
each to the Willis Group, an affiliate of the Company, and Genesee Fund
Limited--Portfolio B ("Genesee"), a British Virgin Islands corporation, both
accredited investors. The 2001 Notes are convertible into a variable number of
shares of the Company's Common Stock. The 2001 Notes bear interest at 6% and
interest payments are due each February 15, May 15, August 15 and November 15
commencing on November 15,1998. The 2001 Notes were issued with an original
issue discount ("OID") in an initial amount of $100,000 for each note.
 
  The 2001 Notes rank equally with all other unsubordinated debt obligations
of the Company. The Company's obligations under the 2001 Notes are secured by
certain collateral pursuant to security agreements. A holder of the 2001 Note
may require the Company to repurchase the 2001 Note if an event of default
occurs. Events of default include among other things, the Nasdaq delisting of
the Common Stock.
 
  In connection with the issuance of the 2001 Notes, the Company issued to
each of the Willis Group and Genesee a warrant ("Warrant") to purchase 333,116
shares of Common Stock at a purchase price of $0.9006 per share. The Warrants
expire on September 4, 2003. After taking into account the OID and an
allocation of the purchase price to the Warrants, the 2001 Notes are recorded
on the Company's September 30, 1998 Balance Sheet in the amount of $2.5
million. As explained below, the 2001 Notes are convertible to Common Stock at
a discount to market. The conversion discount of $0.45 million was recorded as
interest expense and paid in capital.
 
  Any holder of a 2001 Note may convert the 2001 Note, in whole or in part,
into shares of Common Stock at a conversion price per share equal to the
lesser of:
 
  The product of (1) the average of the lowest sales price of the Common
  Stock on Nasdaq for the five days immediately preceding the date of
  conversion and (2) 85% (subject to reduction pursuant to the terms of the
  2001 Notes); and
 
  $0.9006 (subject to reduction pursuant to the terms of the 2001 Notes).
 
                                      13
<PAGE>
 
                         EQUALNET COMMUNICATIONS CORP.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
  The 2001 Note agreements are being submitted to the shareholders for
approval and ratification at the annual meeting of the shareholders
tentatively scheduled in January, 1999. This is being done to comply with
rules of Nasdaq Stock Market that require such approval for any transaction
involving the issuance of common stock (or securities convertible into or
exercisable for common stock) equal to 20% or more of the issuer's outstanding
common stock for less than the market value of the common stock.
 
  If the 2001 Note agreements are not ratified by the shareholders at the
Meeting, the holders of the 2001 Notes and the Series D Preferred Stock will
have the right to require the Company to redeem, at a 115% premium, all of the
2001 Notes and the Series D convertible preferred stock ("Series D Preferred
Stock"). The payment of the entire principal amount of the 2001 Notes and the
entire value of the outstanding Series D Preferred Stock, and the 15% premium
thereon, would have a material adverse effect on the Company's financial
condition. The Company does not have adequate funds to effect any such
redemption.
 
NOTE 6--SERIES D PREFERRED STOCK
 
  In connection with the 2001 Notes transaction, the Company issued to certain
buyers, in the aggregate, approximately 3,750 shares of Series D Preferred
Stock in exchange for, in the aggregate, 3,000,000 shares of Common Stock and
exchange fees of, in the aggregate, $200,000. Each share of Series D Preferred
Stock will be entitled to receive dividends at a rate of $60 per share per
year, payable in cash or additional shares of Series D Preferred Stock.
 
  Holders of shares of Series D Preferred Stock have the right to convert each
of their shares into a number of shares of Common Stock equal to the quotient
of:
 
  the sum of (1) $1,000 (subject to adjustment pursuant to the Series D
  Preferred Stock documents), (2) accrued but unpaid dividends to the
  applicable conversion date on the share of Series D Preferred Stock being
  converted and (3) accrued but unpaid interest on the dividends on the share
  of Series D Preferred Stock being converted; and
 
an amount equal to the lesser of:
 
  the product of (1) the average of the lowest sales price of the Common
  Stock on Nasdaq for any five trading days during the 25 trading days
  immediately preceding the conversion date and (2) 85% (subject to downward
  adjustment, if applicable, pursuant to the Series D Preferred Stock
  documents); and
 
  $1.2281 (subject to reduction pursuant to the Series D Preferred Stock
  documents),
 
subject to adjustment pursuant to the anti-dilution provisions.
 
  The Company has the option to redeem any of the shares of Series D Preferred
Stock which have not been previously converted at a redemption price
determined by a formula which includes a substantial premium to the underlying
liquidation preference. The Series D Preferred Stock has a liquidation
preference equal to $1,000 (plus accrued and unpaid dividends plus interest
thereon) per share of Series D Preferred Stock.
 
  The Series D Preferred shareholders can require the Company to redeem all
shares if any of a number of events occur. The Series D Preferred shareholders
have agreed to waive certain redemption rights effective September 30, 1998,
to allow the Series D Preferred Stock to be classified as equity on the
Company's Balance Sheet as of September 30, 1998. The Company has recorded
$1.9 million of Series D Preferred Stock as of September 30, 1998. This amount
was equal to the exchange fees plus the product of 3,000,000 shares of Common
Stock exchanged in the transaction multiplied by the closing price per share
of Common Stock on the date of the exchange.
 
                                      14
<PAGE>
 
                         EQUALNET COMMUNICATIONS CORP.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
NOTE 7--INCOME TAXES
 
  The Company recorded a valuation allowance amounting to the entire net
deferred tax asset balance at September 30, 1998, due to operating losses
which give rise to uncertainty as to whether the deferred tax asset is
realizable. The Company has recorded no income tax benefit for the period
ended September 30, 1998.
 
NOTE 8--LIQUIDITY AND WORKING CAPITAL DEFICIT
 
  The Company's sole current source of capital is provided by receivable sales
agreements with RFC. The Company's two operating subsidiaries, EqualNet and
USC Telecom, have accounts receivable purchase agreements with RFC. Funding
under these agreements are based on specific accounts receivable eligibility
requirements with the primary factor being the collections history per
account. Funding percentages have declined during the quarter due to billing
delays, errors in bills and related collections problems.
 
  The Company continues to incur operating deficits and is exploring ways to
increase revenue and reduce operating costs. To operate profitably, the
Company must reduce its variable long-distance carrier costs, right-size and
make efficient its back office and administrative operations and increase
revenues by implementing new sales and marketing plans.
 
  There can be no assurance the Company will have the capital resources
necessary to implement these measures and return to profitability. It is
highly likely the Company will need additional capital to continue in business
during its restructuring phase.
 
NOTE 9--COMMITMENTS AND CONTINGENCIES
 
  At September 30, 1998 EqualNet had an agreement with AT&T which was
scheduled to expire in April 2000. The agreement covered the pricing of the
services and established minimum semi-annual revenue commitments ("MSARCs")
which had to be met to receive the contractual price and to avoid shortfall
penalties. The commitment with AT&T was segregated into components
differentiated by the type of traffic. At September 30, 1998, EqualNet had not
yet reached the completion of the term of the third MSARC. EqualNet estimated
its shortfall position to be approximately $11.6 million at the end of the
third MSARC period in October 1998. If the contract with AT&T is terminated
prior to the expiration of the full term, either by EqualNet or by AT&T for
non-payment, EqualNet will be liable for the total amount of the unsatisfied
MSARC for the period in which the discontinuance occurs and for 50% of the
MSARCs for each semi-annual period remaining in the contract tariff term,
which amounts to an estimate of $29.1 million.
 
  As a result of its bankruptcy filing, effective October 31, 1998, EqualNet
rejected its contract with AT&T. Any liabilities for MSARC relating to periods
after the rejection date will likely be treated in the bankruptcy as pre-
petition unsecured indebtedness. Due to the amount of EqualNet's secured
indebtedness (approximately $16.0 million), it is unlikely AT&T would realize
significant benefits even if it does assert its claim for additional MSARC
payments.
 
  On October 31, 1998, EqualNet entered into a switchless resale operator
agreement with U.S. Republic Communications, Inc. ("U.S. Republic"). As a
result of this agreement, EqualNet was able to replace its AT&T contract,
which was rejected in bankruptcy, with a wholesale carrier agreement with U.S.
Republic. This was a seamless transition for EqualNet's customers since U.S.
Republic provides its carrier services on the AT&T network. The term of the
agreement is month-to-month and there are no MSARC requirements. EqualNet's
cost of service is slightly better under the U.S. Republic contract than
EqualNet's previous AT&T agreement. EqualNet is required to prepay for
services provided by U.S. Republic and has entered into an agreement whereby
RFC remits funds directly to U.S. Republic initially up to $150,000 per week
limited to the total fundings otherwise available from RFC to EqualNet.
 
                                      15
<PAGE>
 
                         EQUALNET COMMUNICATIONS CORP.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
  In August, 1998, the Company executed a telecommunications services
agreement with Frontier Communications of the West, Inc. ("Frontier"). The
Company's operating subsidiaries are utilizing this switchless resale
agreement to provide services to a portion of their customers. Beginning in
December, 1998, the Company has a take-or-pay commitment to Frontier of
$250,000 per month. The Company believes it will meet its take-or-pay
commitment throughout the term of the agreement which extends to September,
2000. Frontier received a subordinated security interest in the customers of
the Company as collateral for the extension of credit under this agreement.
 
  From time to time the Company is involved in what it believes to be routine
litigation or other legal proceedings that may be considered as part of the
ordinary course of its business.
 
  On August 7, 1998, Robert H. Turner ("Turner") filed suit against the
Company, Mark A. Willis and Willis Group, LLC in the 61st District Court of
Harris County, Texas in case number 98-37682 alleging an unspecified amount of
damages based upon an alleged breach of his employment contract and other
claims. The Company vehemently denies any wrongdoing or liability in the
matter, and intends to vigorously defend itself in this action. Since no
discovery has taken place in this matter, it is impossible to state with any
degree of certainty the amount of damages, if any, that the Company may incur,
or if it will be successful in asserting any cross claims or counterclaims it
may have in connection with the employment of Turner.
 
  On August 13, 1998, Steverson & Company, Inc. filed suit against the Company
in case number 704,244 in the County Civil Court at Law Number 2 of Harris
County Texas seeking damages in the amount of $22,892.78 plus attorneys fees
and court costs. The Company maintains that these charges were for temporary
services personnel utilized by EqualNet, and not the Company. The invoices are
addressed to EqualNet Communications, the former name of EqualNet Corporation
before its name change on November 28, 1994. The dates on the invoices run
from June 16, 1998 through August 11, 1998. EqualNet Holding Corp. did not
formally change its name to Equalnet Communications Corp. until June 30, 1998.
Due to the fact that these charges may be a claim in the bankruptcy
proceedings of EqualNet discussed below, it is impossible at this time to
state with any degree of certainty the ultimate exposure of either the Company
or EqualNet in this matter.
 
  On August 13, 1998, Centillion Data Systems, Inc. filed suit against
EqualNet in case number 49D029808CP001147 in the Superior Court of Marion
County, Indiana, seeking damages in the amount of $115,490.50 for billing and
other services allegedly provided to EqualNet, plus interest, attorneys fees
and court costs. The fact that these charges are a claim in the bankruptcy
proceedings of EqualNet discussed below make it impossible at this time to
state with any degree of certainty the ultimate exposure of either the Company
or EqualNet in this matter.
 
  On September 3, 1998, the Company received a demand from New Boston Systems
through their attorneys, Steadman & Steele, for the payment of placement fees
for personnel hired by EqualNet. Although New Boston System's engagement
letter was with the Company, the personnel it placed were hired as employees
of EqualNet. It is the position of the Company that any payment due to New
Boston Systems would be due from EqualNet and not the Company. The amount
claimed as due to New Boston Systems is $10,526.25.
 
  On September 15, 1998, Technigrafiks, Inc. filed suit against EqualNet dba
Creative Communications in case number 705,562 in the County Civil Court at
Law Number 1 of Harris County, Texas, seeking damages in the amount of $24,399
for the printing of plastic cards for debit card sales, plus interest,
attorneys fees and court costs. The fact that these charges are a claim in the
bankruptcy proceedings of EqualNet discussed below make it impossible at this
time to state with any degree of certainty the ultimate exposure of either the
Company or EqualNet in this matter.
 
                                      16
<PAGE>
 
                         EQUALNET COMMUNICATIONS CORP.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
  On September 17, 1998, KISS Catalog Ltd. filed suit against the Company as
assignee from Creative Communications International, Inc. of certain contract
rights from KISS Catalog Ltd. in case number 98 CIV. 6570 in the United States
District Court for the Southern District of New York, seeking payment of
$100,000 in license fees, attorneys fees, and any royalties which may be owing
under the license agreement. In 1996, the Company agreed to assume the
obligations under a merchandising license agreement, including the obligation
to make payments of royalties and license fees, with a minimum guarantee
royalty fee of $100,000 and a license fee of $150,000. Payments of the minimum
guarantee of $100,000 and $50,000 of the license fee were made. Payment of the
remaining $100,000 of the license fee has not been made.
 
  On September 17, 1998, Comerica Leasing Corporation filed suit in the 270th
District Court of Harris County, Texas in case number 98-44481 against the
Company and EqualNet for breach of a settlement agreement arising out of
previous litigation for the enforcement of equipment and office furnishings
leases filed on February 12, 1998 in the 157th District Court of Harris
County, Texas in case number 98-06841. A settlement agreement was entered into
by the parties dismissing the earlier litigation and adding the Company as an
obligor for the payment of the settlement amounts. The remaining amounts due
under the settlement agreement and remaining lease obligations represent an
amount in excess of $1,000,000.
 
  On September 21, 1998, Cyberserve, Inc., WSHS Enterprises, Inc. and William
Stuart (collectively "Bluegate") filed suit in the 215th District Court of
Harris County, Texas in case number 98-45115 against the Company, Willis
Group, LLC, Mark A. Willis, and Netco Acquisition LLC alleging damages for
breach of contract, breach of an employment agreement, fraud and fraud in the
inducement, statutory fraud in a stock transaction, tortious interference with
a contract, conspiracy, and quantum meruit. The matters complained of
originated with a letter of intent dated on or about October 28, 1997, wherein
the Company proposed the purchase of certain assets of Cyberserve, Inc. and
WSHS Enterprises, Inc. subject to the performance of due diligence by the
parties. Bluegate and certain of its shareholders had threatened to sue the
Company in the event the proposed transaction was not consummated
substantially in conformity with the terms set forth in the Letter of Intent.
The damages Bluegate alleges it incurred were as a result of, among other
things, the claimed modification of its business to its detriment in
anticipation of the integration of its operations with those of EqualNet. It
is impossible to determine with any degree of certainty what, if any,
liability the Company, or any of its subsidiaries, may incur in this matter.
The total amount of damages are unspecified, but include a demand for a cash
payment of $685,000, a sufficient number of shares of Common Stock of the
Company for the payment of $585,000, an additional 525,000 shares of Common
Stock, and other damages. The Company vehemently denies any wrongdoing or
liability in this matter and intends to vigorously defend itself against all
claims of the plaintiffs.
 
  On September 29, 1998, SA Telecommunications Incorporated asserted claims
pursuant to the Purchase Agreement against USC Telecom, Inc. and the Company
for (i) $732,395 in operating losses for the period from April 1 through July
22, 1998, (ii) $278,377 for damages for delayed or unbillable revenue through
USBI/ZPDI, (iii) reimbursement of $8,149 for switch site leases, (iv) payment
of Specified Network Contracts Liabilities (amount not specified), (v)
delivery of 5,358 shares of Series C Preferred Stock escrowed at closing, and
(vi) for return of certain leased equipment not owned by SA Telecommunications
but previously in its possession and allegedly removed by EqualNet or USC
Telecom. The Company and USC Telecom dispute each of the claims asserted by SA
Telecommunications in its demand.
 
  During the past several months, EqualNet and the Company have experienced
severe liquidity problems and have received numerous notices of default in
payment of trade creditors and other financial obligations. For example and
without providing an exhaustive list, EqualNet has received notice of default
of its agent agreements with Walker Direct, Inc., Future Telecom Networks,
Inc., Global Pacific Telecom, Inc. and others, making demand for the payment
of commissions due and for mediation pursuant to the terms of their agent
agreements. Netco Acquisition LLC presented a notice dated August 25, 1998
under the terms of the Tri-Party Agreement
 
                                      17
<PAGE>
 
                         EQUALNET COMMUNICATIONS CORP.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
and Assignment dated January 20, 1998 between Netco Acquisition LLC, EqualNet
Corporation and Cyberserve, Inc. alleging that EqualNet had defaulted in the
repayment of its $400,000 promissory note, and as a result, it was enforcing
its rights to foreclose on the web page customer base of EqualNet. In addition
EqualNet defaulted in making timely payments under the $1,183,059.03
promissory note payable to Sprint Communications Company L.P., in the timely
payments to AT&T Corp., Premier Communications and MCI WorldCom for carrier
services. In addition, EqualNet received notice it was in default of its lease
agreement with Caroline Partners Ltd., the landlord for the office space
occupied by the Company and its subsidiaries, and that the landlord had
exercised its right to offset rents due against the letter of credit EqualNet
had provided as a security deposit for the landlord's benefit. Norwest
Equipment Finance, Inc. has notified EqualNet of its default in the payment
for leased furniture currently being utilized by EqualNet in the operation of
its business. The remaining amount owed under such lease is in excess of
$100,000. The bankruptcy proceedings of EqualNet discussed below make it
impossible at this time to state with any degree of certainty the ultimate
exposure of either the Company or EqualNet in these matters.
 
  As a result of the liquidity problems listed in the foregoing paragraph and
other matters, on September 10, 1998, EqualNet filed for protection under
Chapter 11 of Title 11 of the United States Code, in case number 98-39561-H5-
11 in the United States District Court for the Southern District of Texas and
Wholesale filed for protection under Chapter 11 of Title 11 of the United
States Code, in case number 98-39560-H4-11 in the United States District Court
for the Southern District of Texas. On October 2, 1998, Wholesale filed a
motion seeking to convert its Chapter 11 reorganization proceeding to a
Chapter 7 liquidation proceeding. It is impossible to state at this time
whether or not EqualNet as a debtor in bankruptcy will be able to reorganize
its liabilities or to confirm a plan of reorganization in bankruptcy.
 
NOTE 10--SUBSEQUENT EVENTS
 
  The Company's Common Stock currently trades on the Nasdaq Stock Market
("Nasdaq"). If the Company fails to maintain the minimum bid price, the
minimum public float, or the minimum tangible assets requirements of Nasdaq,
the Common Stock could be subject to delisting therefrom. On September 30,
1998, Nasdaq notified the Company it would be delisted on December 31, 1998 if
its average closing bid price does not equal or exceed the $1.00 minimum bid
price requirement for ten consecutive trading days during the 90 day period
ending December 29, 1998. On October 8, 1998, Nasdaq also notified the Company
that it would be delisted if the market value of its public float was not
equal to or greater than $5.0 million for a minimum of ten consecutive trading
days during the period from October 9, 1998 to January 6, 1999.
 
  On October 16, 1998, based on the Company's financial position at June 30,
1998, Nasdaq also notified the Company that the Company was not in compliance
with Nasdaq's tangible net assets requirements. Nasdaq informed the Company
that failure to comply with this requirement could result in the removal of
the Company's stock from trading on the Nasdaq National Market. Nasdaq also
requested additional information regarding the Company's plan to achieve
compliance with Nasdaq National Market listing requirements. As of September
30, 1998, the Company was again not in compliance with Nasdaq's tangible net
assets requirement for listing of the Company's Common Stock for trading on
Nasdaq's National Markets.
 
  If the Company can not comply with Nasdaq's continued listing requirements
then the Company's common stock would be subject to being removed from trading
on the Nasdaq National Market, although trading in the Company's stock could
continue on the Over-the-Counter Bulletin Board of the National Association of
Securities Dealers (the "OTC"), which could have an adverse effect on the
liquidity of the Company's Common Stock.
 
  On October 24, 1998, the Company signed an agreement to acquire
substantially all of the assets of Limit, LLC d/b/a ACMI ("ACMI"), a network
marketing company with approximately 2,500 independent agents. The
 
                                      18
<PAGE>
 
                         EQUALNET COMMUNICATIONS CORP.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
Company intends to sell its telecommunication services through ACMI's agents.
The transaction which is subject to a number of items, including completion of
due diligence, is expected to be completed in early 1999. There can be no
assurance the transaction will close.
 
  For the nine month period ended September 30, 1998, ACMI had gross revenues
of approximately $1 million and earnings before interest, taxes, and
depreciation of approximately $0.2 million. As of the same date, ACMI's book
basis in its assets was approximately $1 million.
 
  The Company will initially issue 2.5 million shares of Common Stock to ACMI
and assume a note payable of $1 million in exchange for substantially all of
the assets of ACMI. ACMI may repurchase the assets from the Company if certain
events occur post closing. Under the agreement, ACMI may receive additional
shares of Common Stock if the average closing price per share of Common Stock
is less than $0.75 for the period between 150 and 180 days after the closing
date. At the end of each year for the three years subsequent to closing, ACMI
is also entitled to receive additional shares of Common Stock if it meets
certain targeted performance measures. The Company also has the right to
unwind the transaction if ACMI is unable to sell 10,000 new long distance
accounts within the six month period after closing.
 
  On October 19, 1998, the Company signed an agreement with S4 Communications
Corporation ("S4") to acquire all of the equity interest of S4. S4 is a
provider of telecommunications services in the Chicago, Illinois area. S4 has
monthly gross revenues of approximately $.27 million and is marginally
profitable. Closing of the transaction is subject to the completion of due
diligence, which is expected to be completed in late 1998. There can be no
assurance the transaction will ultimately close.
 
  The Company will initially issue 642,666 shares of Common Stock and issue a
$.24 million note in exchange for the stock of S4. S4 shareholders have the
opportunity to receive another 400,000 shares of Common Stock if certain
events occur during the six month period prior to the closing date. The number
of shares issued in this transaction will be adjusted upward if the average
daily closing price of the Company's Common Stock for the three month period
ending on December 31, 1998 is less than $1 per share.
 
                                      19
<PAGE>
 
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
 
  The following discussion of operations and financial condition of the
Company should be read in conjunction with the Financial Statements and Notes
thereto included elsewhere in this Quarterly Report on Form 10-Q. Special
Note: Certain statements set forth below constitute "forward-looking
statements" within the meaning of Section 27A of the Securities Act of 1933,
as amended, and the Securities Exchange Act of 1934, as amended. See "Special
Note Regarding Forward-Looking Statements" and "Cautionary Statements".
 
 Results of Operations
 
  Sales for the three months ended September 30, 1998 increased 1% to $8.4
million compared to sales of $8.3 million for the same period of the prior
year. Gross margin decreased during the current quarter to $0.5 million
compared to $2.1 million for the same period of the prior year. The net loss
for the three months ended September 30, 1998, was $6.2 million and included
no tax benefit. The net loss for the corresponding period in the previous year
was $2.1 million and included no tax benefit.
 
  The following table sets forth for the fiscal periods indicating the
percentages of total sales represented by certain items reflected in the
Company's consolidated statements of income:
 
<TABLE>
<CAPTION>
                                                     THREE MONTHS THREE MONTHS
                                                        ENDED        ENDED
                                                       9/30/97      9/30/98
                                                     ------------ ------------
   <S>                                               <C>          <C>
   Revenues.........................................    100.0%       100.0%
   Cost of revenues.................................     75.2%        93.9%
                                                        -----        -----
   Gross margin.....................................     24.8%         6.1%
   Selling, general and administrative expenses.....     32.0%        43.6%
   Depreciation and amortization....................     13.4%        26.4%
                                                        -----        -----
   Operating income (loss)..........................    (20.6%)      (63.9%)
   Other income (expense)
     Interest expense...............................     (4.2%)       (8.7%)
     Miscellaneous..................................     (0.3%)        0.0%
                                                        -----        -----
                                                         (4.5%)       (8.7%)
                                                        -----        -----
   Loss before federal income taxes and
    reorganization costs............................    (25.1%)      (72.6%)
   Provision for federal income taxes...............      0.0%         0.0%
                                                        -----        -----
   Net loss before reorganization costs.............    (25.1%)      (72.6%)
   Reorganization costs.............................       --         (0.8%)
                                                        -----        -----
   Net loss.........................................    (25.1%)      (73.4%)
                                                        =====        =====
</TABLE>
 
 Sales
 
  The Company's sales in the three months ended September 30, 1998 increased
to $8.4 million compared to $8.3 million for the comparable period of the
prior year. During the current quarter, the Company reported sales of $3.5
million related to the customers acquired on July 23, 1998 from SA Telecom.
Excluding sales from the acquired customers, the Company's sales decreased
40.9% to $4.9 million in the current quarter compared to $8.3 million for the
comparable period of the prior year. Total billable minutes for the quarter
ended September 30, 1998 increased 32.2% to 39.0 million minutes from 29.5
million minutes for the same period of the prior year. During the current
quarter, 22.2 million billable minutes were attributable to the SA Telecom
customers.
 
  The decline in revenues and billable minutes of the Company's historical
customer base, exclusive of the SA Telecom customers, was the result of the
continued rate of attrition for existing customers and a decline in sales and
marketing efforts. The Company's continuing liquidity problems during this
time frame have not allowed for the funding of any significant marketing
activities.
 
 
                                      20
<PAGE>
 
 Cost of Sales
 
  The cost of sales for the three months ended September 30, 1998, increased
25.4% to $7.9 million compared to $6.3 million for the comparable period of
the prior year. The current quarter increase was primarily attributable to
costs associated with the Company's network of switches ("Network") which were
marginally utilized. Cost of sales as a percentage of sales increased to 93.9%
for the three months ended September 30, 1998, from 75.2% for the
corresponding period in the previous year. The primary cause of the increase
was the costs associated with the Network.
 
  The Company's cost of long-distance (which is a component of cost of sales)
increased as a percentage of sales to 72.7% from 54.5% for the three months
ended September 30, 1998, and 1997, respectively. The increase in the
percentage in the first quarter of fiscal 1999, is the result of the costs
associated with the Network and transitional costs related to the transfer of
SA Telecom customers to a different provider. The total long distance costs
during the current quarter of $6.1 million includes approximately $1.7 million
related to the Network.
 
  Commission expense as a percent of sales increased to 7.8% for the first
quarter of fiscal 1999, compared to 7.4% for the first quarter of fiscal 1998.
 
  Billing expense as a percentage of sales decreased to 6.9% for the three
months ended September 30, 1998 compared to 8.4% for the same period in the
previous year. This is a result of the small number of SA Telecom customers
billing through Local Exchange Carriers ("LECs") as compared to the high
percentage of LEC billings by the Company's historical customer base. Billings
through the LECs represented 25.1% and 45.7% of the Company's revenues for the
three months ended September 30, 1998, and 1997, respectively. The cost of
billing through LECs is generally greater than billing customers directly.
 
  Bad debt expense as a percentage of sales for the three months ended
September 30, 1998 was 5.0% of sales, which was the same percentage for the
three months ended September 30, 1997.
 
 Selling, General and Administrative Expenses
 
  Selling, general and administrative expenses increased 37.0% to $3.7 million
for the three months ended September 30, 1998, from $2.7 million for the same
period of the prior year. Selling, general and administrative expenses
increased as a percentage of sales to 43.6% for the three months ended
September 30, 1998, from 32.0% for the same period of the prior year. The
increase in selling, general and administrative expenses as a percentage of
sales relates primarily to the substantial increase in the size of the
Company's infrastructure during the last quarter of fiscal 1998.
 
  Salary expense increased $330,577 for the quarter ended September 30, 1998,
compared to the same quarter of the previous year. Most of this increase
related to the addition of former SA Telecom employees.
 
  During the comparative three month periods, departmental direct expenses
increased $566,000 and administrative costs increased by $80,000. The increase
in departmental expenses resulted in part from an increase in legal and
professional fees, registration fees associated with USC Telecom, and other
one-time charges. Lease expense over the comparative periods increased
approximately $90,000.
 
 Depreciation and Amortization
 
  Depreciation and amortization increased 50.0% to $2.2 million for the
quarter ended September 30, 1998, as compared to $1.1 million for the same
period in the previous year. The increase relates to current quarter costs for
depreciation on the Network of $0.6 million and amortization of the SA Telecom
customer acquisition costs of $1.1 million. The Company did not own either of
these assets during the same period of the prior year.
 
 
                                      21
<PAGE>
 
 Liquidity and Capital Resources
 
  The Company utilized $2.3 million in cash flow from operations for the three
months ended September 30, 1998, compared to generating $1.0 million for the
same period of the prior year. Cash flow deficits in the current quarter were
attributable to operating losses incurred by the Company.
 
  Cash used in investing activities totaled $600,000 for the three months
ended September 30, 1998, compared to $237,000 for the same period of the
previous year. The primary use of cash for investing activities during the
period ended September 30, 1998, was for cash paid in connection with the SA
Telecom acquisition.
 
  Net cash generated in financing activities was $2.9 million for the three
months ended September 30, 1998, compared to the utilization of $0.8 million
for the same period of the previous year. The majority of this amount was
generated from the proceeds received from the issuance of the 2001 Notes. The
Company's declining revenue base, and the resulting reduction in receivables,
have resulted in a significant decrease in funds available under the Company's
receivables funding arrangement.
 
  EqualNet is seeking bankruptcy court approval for the DIP financing (see
Note 3 to the Consolidated Financial Statements). If the approval is not
obtained, it is unlikely EqualNet will have the necessary liquidity to
continue its business.
 
  As more fully described in Note 5 to the Consolidated Financial Statements,
the Company is submitting to its shareholders for approval of the 2001 Note
and Series D Preferred Stock transactions. If these transactions are not
approved, the shareholders have the right to require the Company to redeem the
2001 Notes and Series D Preferred Stock. The Company does not have adequate
funds to effect such redemption.
 
  As discussed in the notes to the financial statements, the Company has
significant potential additional liabilities which might result from the
bankruptcy proceedings or reorganization. The Company currently does not have
the capital to settle these potential future liabilities. The Company will
continue to seek additional capital should these liabilities materialize.
However, no assurance can be made that such capital will be available to meet
these potential obligations and the Company may be required to seek additional
protection under the bankruptcy laws.
 
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
 
  No significant change.
 
                                      22
<PAGE>
 
                          PART II--OTHER INFORMATION
 
ITEM 1. LEGAL PROCEEDINGS
 
  From time to time the Company is involved in what it believes to be routine
litigation or other legal proceedings that may be considered as part of the
ordinary course of its business.
 
  EqualNet has committed to make certain payments to AT&T for usage incurred
in prior periods. EqualNet defaulted in the timely payment of those payments
during the fourth fiscal quarter of 1998, and began to enter into a series of
short term, alternative payment agreements with AT&T for the payment of
amounts due to AT&T for current usage with any surplus to be applied to the
arrearage amounts.
 
  On August 7, 1998, Robert H. Turner ("Turner") filed suit against the
Company, Mark A. Willis and Willis Group, LLC in the 61st District Court of
Harris County, Texas in case number 98-37682 alleging an unspecified amount of
damages based upon an alleged breach of his employment contract and other
claims. The Company vehemently denies any wrongdoing or liability in the
matter, and intends to vigorously defend itself in this action. Since no
discovery has taken place in this matter, it is impossible to state with any
degree of certainty the amount of damages, if any, that the Company may incur,
or if it will be successful in asserting any cross claims or counterclaims it
may have in connection with the employment of Turner.
 
  On August 13, 1998, Steverson & Company, Inc. filed suit against the Company
in case number 704,244 in the County Civil Court at Law Number 2 of Harris
County Texas seeking damages in the amount of $22,892.78 plus attorneys fees
and court costs. The Company maintains that these charges were for temporary
services personnel utilized by EqualNet, and not the Company. The invoices are
addressed to Equal Net Communications, the former name of EqualNet Corporation
before its name change on November 28, 1994. The dates on the invoices run
from June 16, 1998 through August 11, 1998. EqualNet Holding Corp. did not
formally change its name to Equalnet Communications Corp. until June 30, 1998.
Due to the fact that these charges may be a claim in the bankruptcy
proceedings of EqualNet discussed below, it is impossible at this time to
state with any degree of certainty the ultimate exposure of either the Company
or EqualNet in this matter.
 
  On August 13, 1998, Centillion Data Systems, Inc. filed suit against
EqualNet in case number 49D029808CP001147 in the Superior Court of Marion
County, Indiana, seeking damages in the amount of $115,490.50 for billing and
other services allegedly provided to EqualNet, plus interest, attorneys fees
and court costs. The fact that these charges are a claim in the bankruptcy
proceedings of EqualNet discussed below make it impossible at this time to
state with any degree of certainty the ultimate exposure of either the Company
or EqualNet in this matter.
 
  On September 3, 1998, the Company received a demand from New Boston Systems
through their attorneys, Steadman & Steele, for the payment of placement fees
for personnel hired by EqualNet. Although New Boston System's engagement
letter was with the Company, the personnel it placed were hired as employees
of EqualNet. It is the position of the Company that any payment due to New
Boston Systems would be due from EqualNet and not the Company. The amount
claimed as due to New Boston Systems is $10,526.25.
 
  On September 15, 1998, Technigrafiks, Inc. filed suit against EqualNet dba
Creative Communications in case number 705,562 in the County Civil Court at
Law Number 1 of Harris County, Texas, seeking damages in the amount of $24,399
for the printing of plastic cards for debit card sales, plus interest,
attorneys fees and court costs. The fact that these charges are a claim in the
bankruptcy proceedings of EqualNet discussed below make it impossible at this
time to state with any degree of certainty the ultimate exposure of either the
Company or EqualNet in this matter.
 
  On September 17, 1998, KISS Catalog Ltd. filed suit against the Company as
assignee from Creative Communications International, Inc. of certain contract
rights from KISS Catalog Ltd. in case number 98 CIV. 6570 in the United States
District Court for the Southern District of New York, seeking payment of
$100,000 in license fees, attorneys fees, and any royalties which may be owing
under the license agreement. In 1996, the Company agreed to assume the
obligations under a merchandising license agreement, including the obligation
to make payments of royalties and license fees, with a minimum guarantee
royalty fee of $100,000 and a license fee of $150,000. Payments of the minimum
guarantee of $100,000 and $50,000 of the license fee were made. Payment of the
remaining $100,000 of the license fee has not been made.
 
                                      23
<PAGE>
 
  On September 17, 1998, Comerica Leasing Corporation filed suit in the 270th
District Court of Harris County, Texas in case number 98-44481 against the
Company and EqualNet for breach of a settlement agreement arising out of
previous litigation for the enforcement of equipment and office furnishings
leases filed on February 12, 1998 in the 157th District Court of Harris
County, Texas in case number 98-06841. A settlement agreement was entered into
by the parties dismissing the earlier litigation and adding the Company as an
obligor for the payment of the settlement amounts. The remaining amounts due
under the settlement agreement and remaining lease obligations represent an
amount in excess of $1,000,000.
 
  On September 21, 1998, Cyberserve, Inc., WSHS Enterprises, Inc. and William
Stuart (collectively "Bluegate") filed suit in the 215th District Court of
Harris County, Texas in case number 98-45115 against the Company, Willis
Group, LLC, Mark A. Willis, and Netco Acquisition LLC alleging damages for
breach of contract, breach of an employment agreement, fraud and fraud in the
inducement, statutory fraud in a stock transaction, tortious interference with
a contract, conspiracy, and quantum meruit. The matters complained of
originated with a letter of intent dated on or about October 28, 1997, wherein
the Company proposed the purchase of certain assets of Cyberserve, Inc. and
WSHS Enterprises, Inc. subject to the performance of due diligence by the
parties. Bluegate and certain of its shareholders had threatened to sue the
Company in the event the proposed transaction was not consummated
substantially in conformity with the terms set forth in the Letter of Intent.
The damages Bluegate alleges it incurred were as a result of, among other
things, the claimed modification of its business to its detriment in
anticipation of the integration of its operations with those of EqualNet. It
is impossible to determine with any degree of certainty what, if any,
liability the Company, or any of its subsidiaries, may incur in this matter.
The total amount of damages are unspecified, but include a demand for a cash
payment of $685,000, a sufficient number of shares of Common Stock of the
Company for the payment of $585,000, an additional 525,000 shares of Common
Stock, and other damages. The Company vehemently denies any wrongdoing or
liability in this matter and intends to vigorously defend itself against all
claims of the plaintiffs.
 
  On September 29, 1998, SA Telecommunications Incorporated asserted claims
pursuant to the Purchase Agreement against USC Telecom, Inc. and the Company
for (i) $732,395 in operating losses for the period from April 1 through July
22, 1998, (ii) $278,377 for damages for delayed or unbillable revenue through
USBI/ZPDI, (iii) reimbursement of $8,149 for switch site leases, (iv) payment
of Specified Network Contracts Liabilities (amount not specified), (v)
delivery of 5,358 shares of Series C Preferred Stock escrowed at closing, and
(vi) for return of certain leased equipment not owned by SA Telecommunications
but previously in its possession and allegedly removed by EqualNet or USC
Telecom. The Company and USC Telecom dispute each of the claims asserted by SA
Telecommunications in its demand.
 
  During the past several months, EqualNet and the Company have experienced
severe liquidity problems and have received numerous notices of default in
payment of trade creditors and other financial obligations. For example and
without providing an exhaustive list, EqualNet has received notice of default
of its agent agreements with Walker Direct, Inc., Future Telecom Networks,
Inc., Global Pacific Telecom, Inc. and others, making demand for the payment
of commissions due and for mediation pursuant to the terms of their agent
agreements. Netco Acquisition LLC presented a notice dated August 25, 1998
under the terms of the Tri-Party Agreement and Assignment dated January 20,
1998 between Netco Acquisition LLC, EqualNet Corporation and Cyberserve, Inc.
alleging that EqualNet had defaulted in the repayment of its $400,000
promissory note, and as a result, it was enforcing its rights to foreclose on
the web page customer base of EqualNet. In addition EqualNet defaulted in
making timely payments under the $1,183,059.03 promissory note payable to
Sprint Communications Company L.P., in the timely payments to AT&T Corp.,
Premier Communications and MCI WorldCom for carrier services. In addition,
EqualNet received notice it was in default of its lease agreement with
Caroline Partners Ltd., the landlord for the office space occupied by the
Company and its subsidiaries, and that the landlord had exercised its right to
offset rents due against the letter of credit EqualNet had provided as a
security deposit for the landlord's benefit. Norwest Equipment Finance, Inc.
has notified EqualNet of its default in the payment for leased furniture
currently being utilized by EqualNet in the operation of its business. The
remaining amount owed under such lease is in excess of $100,000. The
bankruptcy proceedings of EqualNet discussed below make it impossible at this
time to state with any degree of certainty the ultimate exposure of either the
Company or EqualNet in these matters.
 
                                      24
<PAGE>
 
  As a result of the liquidity problems listed in the foregoing paragraph and
other matters, on September 10, 1998, EqualNet filed for protection under
Chapter 11 of Title 11 of the United States Code, in case number 98-39561-H5-
11 in the United States District Court for the Southern District of Texas and
Wholesale filed for protection under Chapter 11 of Title 11 of the United
States Code, in case number 98-39560-H4-11 in the United States District Court
for the Southern District of Texas. On October 2, 1998, Wholesale filed a
motion seeking to convert its Chapter 11 reorganization proceeding to a
Chapter 7 liquidation proceeding. It is impossible to state at this time
whether or not EqualNet as a debtor in bankruptcy will be able to reorganize
its liabilities or to confirm a plan of reorganization in bankruptcy.
 
ITEM 2. CHANGES IN SECURITIES
 
  On July 23, 1998, the Company issued to RFC a warrant for the purchase of
294,000 shares of Common Stock at an exercise price of approximately $1.83 per
share, subject to adjustment (the "RFC Warrant"). The RFC Warrant is
exercisable for five years. The RFC Warrant was issued in connection with a
loan transaction pursuant to which the Company received a loan in the
aggregate amount of approximately $1.5 million.
 
  Effective July 31, 1998, the Company issued two 6% Senior Secured
Convertible Notes due in 2001 (the "2001 Notes") in the amount of $1.5 million
each to Willis Group LLC and Genesee Fund Limited-Portfolio B ("Genesee"),
both accredited investors. The 2001 Notes are convertible into a variable
number of shares of the Company's Common Stock. Ownership percentage upon
conversion is currently limited to no more than 4.9% of the outstanding shares
of Common Stock. The 2001 Notes bear interest at 6% and interest payments are
due each February 15, May 15, August 15 and November 15 commencing on November
15, 1998; such interest may be paid in the form of cash or by the issuance of
additional notes.
 
  Any holder of a 2001 Note may convert the 2001 Note, in whole or in part,
into shares of Common Stock at a conversion price per share equal to the
lesser of:
 
  the product of (1) the average of the lowest sales price of the Common
  Stock on Nasdaq for the five days immediately preceding the date of
  conversion and (2) 85% (subject to reduction pursuant to the terms of the
  2001 Notes); and
 
  $0.9006 (subject to reduction pursuant to the terms of the 2001 Notes).
 
  In connection with the issuance of the 2001 Notes, the Company issued to
each of Willis Group and Genesee a warrant (each, a "Warrant," and
collectively, the "Warrants") to purchase 333,116 shares of Common Stock at a
purchase price of $0.9006 per share, subject to adjustments. The Warrants are
exercisable for five years. In addition, the Company issued to Willis Group
and Advantage Fund Limited, an accredited investor, 3,750 shares of its Series
D Convertible Preferred Stock ("Series D Preferred").
 
  Each share of Series D Preferred will be entitled to receive dividends at a
rate of $60.00 per share per year, payable if declared by the Board of
Directors. Any dividends that accrue on the Series D Preferred may be paid, at
the Company's option (subject to certain limitations), in cash or, in whole or
in part, by issuing additional shares of Series D Preferred. Under the terms
of the Series D Preferred, the Company cannot declare or distribute any
dividends to holders of Common Stock unless all dividends on the Series D
Preferred have been paid.
 
  Holders of shares of Series D Preferred will have the right to convert each
of their shares into a number of shares of Common Stock equal to the quotient
of:
 
  the sum of (1) $1,000 (subject to adjustment pursuant to the Series D
  Preferred documents), (2) accrued but unpaid dividends to the applicable
  conversion date on the share of Series D Preferred being converted and (3)
  accrued but unpaid interest on the dividends on the share of Series D
  Preferred being converted; and
 
                                      25
<PAGE>
 
  an amount equal to the lesser of:
 
    the product of (1) the average of the lowest sales price of the Common
    Stock on Nasdaq for any 5 trading days during the 25 trading days
    immediately preceding the conversion date and (2) 85% (subject to
    downward adjustment, if applicable, pursuant to the Series D Preferred
    documents); and
 
    $1.2281 (subject to reduction pursuant to the Series D Preferred
    documents), subject to adjustment pursuant to the anti-dilution
    provisions.
 
  The 2001 Notes, the Warrants and the Series D Preferred were issued in
exchange for aggregate consideration of $3,000,000 and 3,000,000 shares of
Common Stock. The Company has reserved an aggregate of 13,043,468 shares of
Common Stock for issuance upon conversion of the 2001 Notes and the Series D
Preferred and exercise of the Warrants and 294,000 shares of Common Stock for
issuance upon the exercise of the RFC Warrant.
 
  The Company believes that the offering and sale of each of the 2001 Notes,
the Series D Preferred, the Warrants and the RFC Warrant is exempt from
registration under Section 4(2) of the Securities Act of 1933, as amended.
 
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
 
  The Company has not made the dividend payments required under the Series A
Preferred Stock agreement. The holder of the stock has agreed to amend the
Series A Preferred Stock agreement. If said agreement is approved by the
Company's shareholders at the next shareholder meeting, the Company will no
longer be in default on the Series A Preferred Stock.
 
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
 
  None.
 
ITEM 5. OTHER INFORMATION
 
SPECIAL NOTE REGARDING FORWARD--LOOKING STATEMENTS:
 
  This Quarterly Report on Form 10-Q includes "forward-looking statements"
within the meaning of Section 27A of the Securities Act of 1933, as amended,
and Section 21E of the Securities Exchange Act of 1934, as amended (the
"Exchange Act"). All statements other than statements of historical facts
included in this report, including without limitation, statements regarding
the Company's financial position, business strategy, products, products under
development, markets, budgets and plans and objectives of management for
future operations, are forward-looking statements. Although the Company
believes that the expectation of such forward-looking statements are
reasonable, it can give no assurance that such expectations will prove to have
been correct. Important factors that could cause actual results to differ
materially from the Company's expectations ("Cautionary Statements") are
disclosed under "Cautionary Statements" and elsewhere in this Report,
including, without limitation, in conjunction with the forward-looking
statements included in this Report. All subsequent written and oral forward-
looking statements attributable to the Company, or persons on its behalf, are
expressly qualified in their entirety by the Cautionary Statements.
 
CAUTIONARY STATEMENTS:
 
  See "Special Note Regarding Forward-Looking Statements".
 
  No Assurance Of Additional Necessary Capital--EqualNet and Wholesale filed
for Chapter 11 protection in September of 1998. The Company may need
additional capital to obtain the creditor's approval of a plan of
reorganization for EqualNet. In addition, it is likely that additional capital
may be needed to fund operating deficits of the Company's other subsidiaries
during the foreseeable future. There can be no assurances that the Company
will be able to obtain the necessary capital or sufficiently reduce EqualNet's
liabilities to continue to operate the Company.
 
                                      26
<PAGE>
 
  Attrition Rates--In the event the Company experiences attrition rates in
excess of those anticipated either as a result of increased provisioning times
by its underlying carrier, the purchase of poorly performing traffic, or the
inability to properly manage the existing customer base, additional charges
that affect earnings may be incurred.
 
  Dependence On Independent Marketing Agents--USC Telecom has a small internal
sales force and obtains the majority of its new customers from independent
marketing agents ("Agents"). USC Telecom's near-term ability to expand its
business depends upon whether it can continue to maintain favorable
relationships with existing Agents and recruit and establish new relationships
with additional Agents. No assurances can be made as to the willingness of the
existing Agents to continue to provide new orders to USC Telecom or as to USC
Telecom's ability to attract and establish relationships with new Agents.
 
  Dependence On Other Facilities-Based Carriers--The Company, even though it
now owns nine switches, depends upon other carriers to provide the
telecommunications services that it resells to its customers and the detailed
information upon which it bases its customer billings. The Company's near-term
ability to expand its business partially depends upon whether it can continue
to maintain relationships with MCI WorldCom, Frontier, U.S Republic and
Sprint. The loss of the telecommunications services that the Company receives
from any of these vendors could have a material adverse effect on the
Company's results of operations and financial condition.
 
  Carrier Commitments--The Company and EqualNet have significant commitments
with certain carriers to resell long-distance services. The Company's contract
with its carriers contain clauses that could materially and adversely impact
the Company should the Company incur a shortfall in meeting its commitments.
 
  To the extent that these carriers are considered to be utilities in
EqualNet's bankruptcy proceeding, these carriers will be entitled to adequate
assurance of payment for carrier services after September 10, 1998, the
Bankruptcy Filing Date. Adequate assurance may be in the form of cash deposits
or advance payments in an amount determined by the court as sufficient to
provide these carriers with adequate assurance of payment. The failure to
provide adequate assurance of payment for future services would give these
carriers the right to discontinue to provide such services. Current sources of
funds from operations and working capital may not be sufficient to provide the
amount of adequate assurance of payment required by these carriers. There can
be no assurance that EqualNet will be able to secure funding for the amount of
any adequate assurance that may be required of EqualNet.
 
  Billing System Problems--EqualNet converted to a new customer management,
billing and rating system--AMS, purchased from Platinum Communications in
March 1998. Unlike NetBase (the system used for most of fiscal year 1998 prior
to conversion), AMS has capabilities required for switch-based data gathering,
rating and billing. The conversion coincided with the acquisition of a new
customer base (SA Telecom) and a migration to a switch based environment,
considerable billing errors and delays occurred. Additionally, there are
aspects of AMS that could require continuing support from Platinum
Communications. This reliance upon an outside source for billing system
troubleshooting has slowed the conversion recovery process. As of November 13,
1998 EqualNet is engaged in a conversion to CostGuard ENTERPRISE, an
industrial class rating, billing and customer care system built on a Microsoft
SQL Server database platform. The Company should complete this conversion in
December, 1998. This system is being purchased from Info Directions, Inc.,
"IDI" and is expected to dramatically improve rating speed and billing
accuracy. Also, EqualNet expects to be able to more readily extract meaningful
data and management reports from CostGuard. The system design is flexible
enough to respond to rapid changes in the telecommunications marketplace. In
fiscal year 1998, EqualNet recorded a write-off of $270,000 for NetBase and
estimated the useful life of AMS to be approximately one year until the
CostGuard system can be implemented. The new system, CostGuard, will cost
$272,000 initially, then $68,000 per year in subsequent years for ongoing
support and software upgrades. There can be no assurance that the IDI billing
system will fully meet EqualNet's current and on going needs. If the IDI
system fails to provide the expected results, EqualNet may need to invest in
other alternative billing systems.
 
                                      27
<PAGE>
 
  Relationships With State Regulatory Agencies--EqualNet's and USC Telecom's
intrastate long-distance telecommunications operations are subject to various
state laws and regulations, including prior certification, notification or
registration requirements. EqualNet and USC Telecom must generally obtain and
maintain certificates of public convenience and necessity from regulatory
authorities in most states in which it offers service. Any failure to maintain
proper certification in jurisdictions in which either of these companies
provide a significant amount of intrastate long-distance service could have a
material adverse effect on the Company's business.
 
  Volatility Of Securities Prices--Historically, the market price of the
Common Stock has been highly volatile. During the period July 1, 1997, to
September 30, 1998, the market price for the Common Stock as reported by The
Nasdaq Stock Market has ranged from a high of $3.25 per share to a low of
$.281 per share. There can be no assurance that the market price of the Common
Stock will remain at any level for any period of time or that it will increase
or decrease to any level. Changes in the market price of the Common Stock may
bear no relation to the Company's actual operational or financial results.
 
  In addition, if the Company fails to maintain the minimum bid price ($1.00
per share) or the minimum net tangible assets ($4.0 million) requirements of
Nasdaq, the Common Stock would be subject to delisting by Nasdaq. On September
30, 1998, Nasdaq notified the Company that it would be delisted if the closing
bid price for its Common Stock is not equal to or greater than $1.00 for a
minimum of ten consecutive trading days during the period from October 1, 1998
to December 29, 1998. On October 8, 1998, Nasdaq also notified the Company
that it would be delisted if the market value of its public float was not
equal to or greater than $5.0 million for a minimum of ten consecutive trading
days during the period from October 9, 1998 to January 6, 1999. On October 8,
1998, Nasdaq notified the Company that it would be delisted if it does not
submit an acceptable plan to increase its minimum net tangible assets from the
present level to the $4 million requirement. The Company anticipates
submitting this plan in January, 1999. There can be no assurance the Common
Stock will continue to be listed on Nasdaq.
 
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
 
  a. Exhibits
 
   27.1 Financial Data Schedule
 
  b. Reports on Form 8-K
 
   The Company filed a Current Report on Form 8-K on September 10, 1998,
  reporting under item 3.
 
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<PAGE>
 
                                   SIGNATURES
 
  Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
 
                                          EQUALNET HOLDING CORP.
 
       November 20, 1998                  /s/ David L. Kerr
Date: _________________________           -------------------------------------
                                          David L. Kerr, Interim Chief
                                          Financial Officer
                                          (duly authorized officer and
                                           principal financial officer)
 
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