<PAGE>
 
               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 December 31, 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 of                (I.R.S. Employer 
 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 February 16, 1999.
<PAGE>

Part I   Financial Information
Item 1.  Financial Statements

 
                         EQUALNET COMMUNICATIONS CORP.
                          CONSOLIDATED BALANCE SHEETS
<TABLE> 
<CAPTION> 
 
 
                                                                         June 30,           December 31,
                                                                          1998                 1998
                                                                       -----------          -------------
                                                                           (Note)            (Unaudited)
<S>                                                                    <C>                   <C>     
Assets
Current assets
    Cash and equivalents                                               $   459,581            $         -
    Accounts receivable, net of allowance
      for doubtful accounts of $1,034,253 at June 30,
      1998 and $1,821,414 at December 31, 1998                           5,839,284              9,909,274
    Due from agents                                                      1,596,590                603,429
    Advance on acquisition purchase price                                3,014,000                      -
    Prepaid expenses and other                                             109,684                735,742
                                                                       -----------            ----------- 
Total current assets                                                    11,019,139             11,248,445
 
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              1,185,927
                                                                       -----------            ----------- 
                                                                        20,211,617             20,332,021
    Accumulated depreciation and amortization                           (4,837,626)            (6,546,152)
                                                                       -----------            ----------- 
                                                                        15,373,991             13,785,869
 
Customer acquisition costs, net of
    accumulated amortization of $14,381,407
    at June 30, 1998 and $17,240,636 at
    December 31, 1998                                                      355,984              6,297,219
Other assets                                                             1,011,333                688,346
                                                                       -----------            ----------- 
Total assets                                                           $27,760,447            $32,019,879
                                                                      ============            ===========
</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,                   December 31,
                                                                            1998                         1998
                                                                       --------------              ---------------
                                                                           (Note)                     (Unaudited)
<S>                                                                     <C>                           <C>   
Liabilities and shareholders'  equity
Current Liabilities Not Subject to Compromise
      Payable to providers of long distance services                    $   6,627,711                  $ 1,499,770
      Accounts  payable                                                     4,237,310                    4,605,200
      Accrued expenses                                                      3,838,315                    1,456,624
      Accrued sales taxes                                                     205,108                      994,244
      Notes payable to long distance providers                              1,183,059                            -
      Debt in default                                                       5,752,535                            -
      Debt in default to an Affiliate                                         400,000                            -
      Contractual obligations with regard to receivable
        sales agreement                                                     2,334,710                    2,189,446
      Notes Payable                                                                 -                    1,256,300
                                                                         ------------                  -----------
      Total Current Liabilities Not Subject to Compromise                  24,578,748                   12,001,584
Current Liabilities Subject to Compromise (NOTE 2)                                  -                   15,292,049
                                                                         ------------                  -----------
      Total current liabilities                                            24,578,748                   27,293,633
              
                  
 
Deferred rent                                                                 223,917                            -
Notes Payable                                                                       -                    6,626,056
Convertible Debt                                                                    -                    2,514,275
Shareholders' equity (deficit)
      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
          December 31, 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
          December 31, 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
          December 31, 1998                                                         -                    5,400,000
        Series D Convertible Preferred Stock (voting),
          $.01 par value, 
          aggregate liquidation preference of $3.50
          million; Issued and outstanding shares -
          0 at June 30, 1998 and 3,799 at 
          December 31, 1998                                                         -                    1,945,250
      
</TABLE>

                                       3
<PAGE>
                        EQUALNET COMMUNICATIONS CORP.

                         CONSOLIDATED BALANCE SHEETS

<TABLE> 
<CAPTION>               
                                                        June 30,    December 31,
                                                          1998          1998
                                                      ------------  ------------
                                                         (Note)      (Unaudited)
<S>                                                   <C>           <C> 
Common stock, $.01 par value                              217,935       217,935
  Authorized shares - 50,000,000 at June 30, 1998 
   and December 31, 1998. Issued and outstanding
   21,385,832 at June 30, 1998 and 18,385,832 at
   December 31, 1998.                                           -             -
  Treasury stock at cost; 400,447 shares at June 30,
   1998 at 3,400,447 at December 31, 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)  (54,379,836)
                                                     ------------  ------------
Total shareholders' equity (deficit)                    2,957,782    (4,414,085)
                                                     ------------  ------------
Total liabilities and shareholders' equity 
 (deficit)                                           $ 27,760,447  $ 32,019,879
                                                     ============  ============
</TABLE> 

Note: The balance sheet at June 30, 1998 has been derived from the audited 
      financial statements at that date.

                                       4
<PAGE>
 
                         EQUALNET COMMUNICATIONS CORP.
                     CONSOLIDATED STATEMENTS OF OPERATIONS
                                  (UNAUDITED)
 
<TABLE> 
<CAPTION> 
 
 
 
                                                                        Three Months Ended                  Six Months Ended
                                                                            December 31,                       December 31,
                                                                        1997            1998              1997            1998
                                                                     ----------      ----------        ----------     -----------  
 <S>                                                               <C>              <C>              <C>             <C>        
 Revenues                                                          $  6,481,336     $ 7,617,444      $ 14,808,555    $ 16,010,585
 Cost of Revenues                                                     4,728,835       9,464,319        10,993,553      17,349,333
                                                                     ----------      ----------        ----------      ----------   
                                                                      1,752,501      (1,846,875)        3,815,002      (1,338,748)
 Selling, general and administrative  expenses                        2,588,125       2,567,403         5,255,731       6,160,105
 Depreciation and amortization                                        1,043,588       2,914,273         2,155,788       5,129,896
                                                                     ----------      ----------        ----------      ---------- 
 Operating loss                                                      (1,879,212)     (7,328,551)       (3,596,517)    (12,628,749)
                                                              
 Other income (expense)                                        
    Interest income                                                          33              16             1,163             876
    Interest expense                                                   (432,069)       (527,640)         (785,454)     (1,334,941)
    Miscellaneous                                                       132,765            (252)          105,428          17,101
                                                                     ----------      ----------        ----------      ---------- 
                                                                       (299,271)       (527,876)         (678,863)     (1,316,964)
                                                                     ----------      ----------        ----------      ---------- 
Loss before federal income taxes and reorganization costs            (2,178,483)     (7,856,427)       (4,275,380)    (13,945,713)
Benefit for federal income taxes                                              -               -                 -               -
                                                                     ----------      ----------        ----------      ---------- 
Loss before reorganization costs                                     (2,178,483)     (7,856,427)       (4,275,380)    (13,945,713)
Reorganization costs                                                          -         (71,000)                -        (142,658)
                                                                     ----------      ----------        ----------      ----------  
    Net loss                                                       $ (2,178,483)    $(7,927,427)     $ (4,275,380)   $(14,088,371)
                                                                     ==========      ==========        ==========      ========== 

Preferred stock dividends                                          $          -     $   (96,250)     $          -    $   (137,583)
Net loss available to Common shareholders                          $ (2,178,483)    $(8,023,677)     $ (4,275,380)   $(14,088,371)
Net loss per share - basic and diluted                             $      (0.35)    $     (0.44)     $      (0.68)   $      (0.73)
Weighted average number of shares                                     6,287,724      18,385,832         6,328,294      19,448,324

</TABLE>

                                       5
<PAGE>
 
                         EQUALNET COMMUNICATIONS CORP.
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                                  (UNAUDITED)

<TABLE> 
<CAPTION> 
 
                                                                                             Six Months Ended
                                                                                                December 31,
                                                                                         1997               1998
                                                                                      ------------      ------------   
<S>                                                                                  <C>                <C>     
OPERATING ACTIVITIES
Net loss                                                                             $  (4,275,380)    $ (14,088,371)
Adjustments to reconcile net income to
cash provided by (used in) operating activities
     Depreciation and amortization                                                       2,155,788         5,129,896
     Provision for bad debt                                                                754,225         4,062,811
     Amortization of discount on convertible debt                                                -            60,716
     Interest charge on convertible debt issued at discount                                150,000           450,000
     Change in deferred rent                                                                 9,573          (223,917)
     Compensation expense recognized for common stock issue                                 35,002                 -
     Change in operating assets and liabilities: 
         Accounts receivable                                                             2,972,843        (3,468,695)
         Due from agents                                                                   769,650           431,570
         Prepaid expenses and other                                                       (104,108)         (626,058)
         Other assets                                                                     (742,152)          247,438
         Accounts payable and accrued liabilities
           not subject to compromise                                                    (1,483,429)       (6,833,940)
         Accounts payable and accrued liabilities
           subject to compromise                                                                 -        14,108,990
                                                                                      ------------      ------------ 
Net cash provided by (used in) operating activities                                        242,012          (749,560)
 
INVESTING ACTIVITIES
Purchase of property and equipment                                                         (74,724)         (120,404)
Cash paid for acquisition                                                                        -          (555,000)
Proceeds from sale of equipment                                                                  -            74,775
                                                                                      ------------      ------------  
Net cash used in investing activities                                                      (74,724)         (600,629)
 
FINANCING ACTIVITIES
Proceeds from subordinated notes payable                                                   957,260         2,923,245
Net repayments on revolving line of credit                                              (4,555,442)                -
Net proceeds on contractual obligations with regard
   to receivable sales agreement                                                         2,317,276          (145,264)
Repayments on capital lease obligations                                                    (42,000)                -
Proceeds from issuance of stock                                                            350,000                 -
Proceeds from issuance of warrants                                                          42,740                 -
Repayments on long-term debt                                                                     -        (4,887,373)
Proceeds from convertible debt                                                                   -         2,800,000
Proceeds from exchange of Common Stock for Preferred Stock                                       -           200,000
                                                                                      ------------      ------------ 
Net cash provided by (used in) financing activities                                       (930,166)          890,608
                                                                                      ------------      ------------ 
Net decrease in cash                                                                      (762,878)         (459,581)
Cash, beginning of period                                                                  828,478           459,581
                                                                                      ------------      ------------ 
Cash, end of period                                                                  $      65,600     $           -
                                                                                      ============      ============ 

</TABLE>

                                       6
<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
          December 31, 1998, and the results of operation and cash flows for the
          three months and six months ended December 31, 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 December 31, 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 has filed its disclosure statement
          which includes its reorganization plan.  

                                       7
<PAGE>
 
          A Bankruptcy Court hearing to consider the disclosure statement for
          EqualNet's plan of reorganization is scheduled for March 1, 1999.

          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.

          Although management intends that EqualNet will emerge from bankruptcy
          in a prompt and expeditious manner during the third or fourth quarter
          of fiscal year 1999, there can be no assurance that a
          reorganization will be consummated.

          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, including the Company's Switches and acquired
          customer bases, 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" on the Company's consolidated balance sheet are
          identified below:

               Payable to providers of long distance services     $ 9,833,383
               Accounts payable                                     3,065,030
               Accrued expenses                                     1,210,577
               Notes Payable to long distance provider              1,183,059
                                                                  ----------- 
                                                                  $15,292,049
                                                                  ===========

                                       8
<PAGE>
 
          The following condensed financial statements present the financial
          position of EqualNet as of December 31, 1998 and the results of its
          operations and cash flows for the six months ended December 31,
          1998, and have been prepared on the same basis as the Company's
          consolidated financial statements.
 
                              EQUALNET CORPORATION
                                 BALANCE SHEET
                                  (UNAUDITED)
                                        
                                                                       
                                                            December 31, 1998
                                                               (Unaudited)

Assets
Current assets
  Cash and equivalents                                      $          -
  Accounts receivable, net of allowance for doubtful           5,046,632
   accounts of $1,457,160
  Due from agents                                                602,429
                                                            ------------
Total current assets                                           5,649,061
 
Property and equipment
  Computer equipment                                           4,547,284
  Office furniture and fixtures                                1,209,032
  Leasehold improvements                                       1,185,927
                                                            ------------
                                                               6,942,243
  Accumulated depreciation and amortization                   (4,516,454)
                                                            ------------
                                                               2,425,789
 
Other assets                                                     290,018
                                                            ------------
Total assets                                                $  8,364,868
                                                            ============
 
LIABILITIES AND SHAREHOLDERS' DEFICIT
Current Liabilities Not Subject to Compromise
  Payable to providers of long distance services            $    606,769
  Accounts Payable                                             1,806,015
  Accrued Expenses                                               306,384
  Accrued sales taxes                                            502,017
  Debt in Default to an Affiliate                                400,000
  Contractual obligations with regard to
   receivable sales agreement                                    650,761
  Intercompany Note Payable                                   10,000,000
                                                            ------------
     Total Current Liabilities Not Subject to Compromise      14,271,946
Current Liabilities Subject to Compromise
  Payable to providers of long distance services               9,833,383
  Accounts payable                                             3,065,030
  Accrued expenses                                             1,210,577
  Notes Payable to long distance providers                     1,183,059      
  Intercompany Note Payable                                   27,898,534
                                                            ------------
    Total Current Liabilities Subject to Compromise           43,190,583
                                                            ------------
    Total Current Liabilities                                 57,462,528
Shareholders' deficit
  Common Stock                                                         1
  Retained deficit                                           (49,097,660)
                                                            ------------
Total shareholders' deficit                                  (49,097,661)
                                                            ------------
Total liabilities and shareholders' deficit                 $  8,364,868
                                                            ============

                                       9
<PAGE>
 
                              EQUALNET CORPORATION
                            STATEMENT OF OPERATIONS
                                  (Unaudited)
                                        
                                                           Six Months Ended
                                                           December 31, 1998
                                                              (Unaudited)
 
Revenues                                                    $  8,868,886
Cost of Revenues                                              10,635,616
                                                            ------------
                                                              (1,766,730)   

Selling, general and administrative expenses                   4,354,885
Depreciation and amortization                                  1,374,892
                                                            ------------
Operating loss                                                (7,496,507)
Other income (expense)
  Interest income                                                    869
  Interest expense                                              (203,501)
  Miscellaneous                                                        -
                                                            ------------
                                                                (202,632)
                                                            ------------
Loss before federal income taxes and other item               (7,699,139)
Benefit for federal income taxes                                       -
                                                            ------------
Loss before other item                                        (7,699,139)
Reorganization Costs                                            (142,658)
                                                            ------------
Net loss                                                    $ (7,841,797)
                                                            ------------

Reorganization expenses, which represent professional fees, incurred during the
six months ended December 31, 1998 totaled approximately $142,658.

                                       10
<PAGE>
 
                             EQUALNET CORPORATION
                            STATEMENT OF CASH FLOWS
                                  (UNAUDITED)
 
                                                            Six Months
                                                               Ended
                                                         December 31, 1998
                                                         -----------------
OPERATING ACTIVITIES                                       $ (7,841,797)
Net loss
Adjustments to reconcile net loss to cash used in 
 operating activities
  Depreciation and amortization                               1,374,892
  Provision for bad debt                                      2,563,640
  Change in deferred rent                                      (223,917)
  Change in operating assets and liabilities:
    Accounts receivable                                      (1,770,989)
    Due from agents                                             432,658
    Other assets                                                188,983
    Accounts payable and accrued liabilities not subject 
     to compromise                                          (11,203,896)
    Accounts payable and accrued liabilities
     subject to compromise                                   15,020,165
                                                           ------------
Net cash used in operating activities                        (1,460,261)
 
INVESTING ACTIVITIES
Purchase of property and equipment                             (120,404)
                                                           ------------     
Net cash used in investing activities                          (120,404)
 
FINANCING ACTIVITIES
Net proceeds from intercompany note payable                   2,807,290
Net change on contractual obligations  with regard
 to receivable sales agreement                               (1,683,949)
                                                           ------------     
Net cash provided by financing activities                     1,123,341
                                                           ------------
Net decrease in cash                                           (457,324)
Cash, beginning of period                                       457,324
                                                           ------------
Cash, end of period                                        $          0
                                                           ============


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
          November 24, 1998, the bankruptcy court approved 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%).
 
          EqualNet will 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 sufficient commitments from outside sources. (See
          however Note 10 regarding contingent equity commitments.) The
          

                                       11
<PAGE>
 
          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.

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 transaction 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 for operating losses during the period the
          management agreement was effective.  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.  On December 23, 1998, the bankruptcy
          court in the SA Telecom case ruled in favor of SA Telecom and entered
          a judgment requiring USC Telecom to pay approximately $817,000 to SA
          Telecom.  The Company is appealing this decision and is also in
          settlement negotiations with SA Telecom.  The estimated amount of this
          liability has been 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):
               Cash paid                                             $ 3,569
               Fair value of preferred stock issued                    5,400
               Liabilities assumed                                     4,495
                                                                     -------
               Fair value of assets acquired (including intangibles) $13,464
                                                                     =======

          The Company booked an asset for customer acquisition costs of
          approximately $8.7 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) switching to the straight line method when the
          straight line method results in greater amortization over a five-year
          period.

                                       12
<PAGE>
 
          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.

          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 acquisitions been consummated as of the beginning of
          the periods presented.
 
                                     Six Months Ended
                                       December 31,
                                     1997         1998
                                  ----------   ----------
                                   (in thousands, except
                                    per share amounts)
 
          Revenues                  $34,728     $ 16,977
          Net income (loss)         $(8,021)    $(13,970)
          Net loss per share        $ (1.27)    $  (0.72)
                                    =======     ========

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 first quarter, due to failure to
          make the monthly payments beginning with the July 1998 payment.  These
          payment defaults were cured in September, 1998.  Since September,
          1998, the Company has been making interest-only payments on this loan
          under an 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 December 31, 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 at June 30, 1998. Effective December 31, 1998, the loan was
          modified to extend its maturity to July 31, 1999, and, therefore, the
          Company was not in default at the end of the current quarter.

          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 Chapter 11 filing).  As of December 31,
          1998, the amount owed to RFC under this agreement is approximately $.6
          million with a credit reserve of $ 30,000.  This RFC agreement was
          extended on July 19, 1998 and subsequently amended and approved by
          EqualNet's bankruptcy court on November 23, 1998.

                                       13
<PAGE>
 
          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 July
          23, 2003.  Proceeds from the RFC Loan were primarily used to retire a
          portion of the Greyrock Business Credit Loan which was owed by SA
          Telecom (see below).  After taking into account the discount
          associated with the warrants, the RFC Loan is recorded on the
          Company's books at December 31, 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
          $558,370 loan from Greyrock. The loan bears interest at a rate of
          prime plus 2.5% and is secured by the assets of USC Telecom.  The
          principal balance of the Greyrock loan is payable on February 22,
          1999.  The Company is currently unable to pay the principal balance
          and is in discussions with Greyrock related to amending the loan
          agreement.  There can be no assurance the Company will renegotiate
          repayment terms with Greyrock.  If Greyrock does not agree to amend
          its note, the Company will default on this obligation.

          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 December 31, 1998, the amount owed
          to RFC under the USC Telecom agreement was approximately $1.5 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 its
          maturity has been extended from January 31, 1999 to July 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.

                                       14
<PAGE>
 
          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 December 31,
          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 net conversion discount of $0.5 million is recorded to
          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 Company's 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).

          The Note Agreements are being submitted to the shareholders for
          approval and ratification at the annual meeting of the shareholders
          tentatively scheduled in May, 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 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 15%
          premium, all of the 2001 Notes and the 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 may not have adequate funds to
          effect any such redemption.  If the Company is required to effect such
          redemption, the Company may be forced to seek protection under the
          United States bankruptcy laws.

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.

                                       15
<PAGE>
 
          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 has 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 December 31,
          1998.  The Company has recorded $1.9 million of Series D Preferred
          Stock as of December 31, 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 plus the value of 44 shares issued
          as a dividend on November 15, 1998.


NOTE 7 -  INCOME TAXES

          The Company recorded a valuation allowance amounting to the entire net
          deferred tax asset balance at December 31, 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 December 31, 1998.

                                       16
<PAGE>
 
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.  In addition, the Company intends to
          continue its strategy to acquire distressed companies, substantially
          eliminate their overhead, and therefore recognize positive cash flow
          from the acquired assets.

          The Company recently completed the acquisitions of ACMI and BCI (see
          Note 10).  The Company expects to immediately generate a profit from
          the former BCI customer base.  The ACMI acquisition provides sales and
          marketing activities the Company needs to replace its eroding customer
          base.  ACMI is a network marketing company with over 2,500 agents who
          will be selling the Company's long distance and other
          telecommunications services.  The Company has also initiated an
          inbound telemarketing program using the distribution of debit cards as
          the mechanism to generate incoming calls.

          The Company intends to simplify its operations once EqualNet emerges
          from bankruptcy.  Eliminating the duplicate  costs associated with
          having two long distance carriers (i.e., USC Telecom and EqualNet)
          could be accomplished after the bankruptcy plan is consummated.  The
          Company has recently hired members of management who are capable of
          assessing long distance carrier costs and identifying alternatives to
          reduce the Company's cost of service.

          The Company continues to develop its strategy and is considering a
          number of alternatives including expanding its service offerings to
          include a number of  bundled telecommunications services.
 
          There can be no assurance the Company will have the capital resource
          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 must 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.
          EqualNet estimated its shortfall position to be approximately $11.6
          million at the end of the third MSARC period in October 1998.  As a
          result of the contract termination, EqualNet may 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.

                                       17
<PAGE>
 
          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 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.

          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, this contract requires an MSARC of
          $250,000 per month.  The Company believes it will meet this MSARC
          requirement 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 significant 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.

                                       18
<PAGE>
 
          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 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 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.

          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, 

                                       19
<PAGE>
 
          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 EqualNet, 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) $654,934 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 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.  On December 28, 1998, the court signed an order approving SA
          Telecom's claims in the amount of $812,772.  The Company and USC
          Telecom disputed the monetary claims asserted by SA Telecommunications
          in its demand and have filed a notice of appeal of the court's order
          in these proceedings.

          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. 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 additional
          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 has 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 EqualNet in these matters.
 

                                       20
<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.


NOTE 10 - SUBSEQUENT EVENTS

          The Company's Common Stock currently trades on Nasdaq.  If the Company
          fails to maintain the minimum bid price 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 a minimum of 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, the Nasdaq Stock Market, Inc. ("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 December 31, 1998, the Company was again not in compliance with
          Nasdaq's tangible net assets requirements.

          The Company submitted its plan to comply with the tangible assets
          requirements in January, 1999.  On February 4, 1999, Nasdaq held an
          oral hearing in the matter of the continued listing of the Company,
          and at such time the Company was in compliance with both the minimum
          bid price and the minimum market value of public float requirements.
          As of this date, Nasdaq has not ruled in the Company's continued
          listing.  If Nasdaq rules against the Company, the Company's common
          stock will immediately be delisted without any required notification
          to the Company.

          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"),
          such Nasdaq delisting could have an adverse effect on the liquidity of
          the Company's Common Stock.

                                       21
<PAGE>
 
          In January, 1999, the Company's newly formed wholly owned subsidiary,
          ACMI Acquisition Corp. ("ACMI Acquisition") acquired substantially all
          of the assets of Limit, LLC d/b/a ACMI ("ACMI"), a network marketing
          company with approximately 2,500 independent agents.  The Company
          issued 1 million shares of Common Stock to ACMI and ACMI Acquisition
          assumed a note payable of $1 million.  In addition, the Company is
          required to issue up to an additional 1.5 million shares of Common
          Stock if ACMI generates $670,000 per month of revenue from new
          customers within six (6) months of the closing date.  If new customer
          revenues are less than $670,000 per month at the end of the six (6)
          month period, then the number of additional shares issuable will be
          prorated based on the percentage of actual monthly revenue to
          $670,000.  In the event the Company's Common Stock's average closing
          price is below seventy-five cents (75c) per share for the period
          between 150 and 180 days after the closing date, additional Common
          Stock is issuable to ACMI.

          In addition to the foregoing, ACMI is entitled to earn more Common
          Stock ("Earn Out Shares") if it attains certain performance measures
          based on sales at the end of each year over a three year period.  AMCI
          is not entitled to any Earn Out Shares if its revenues for an twelve
          month period are less than $2.5 million.

          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. Closing of the transaction was subject to
          the satisfactory completion of due diligence.  This transaction is
          currently being renegotiated and there can be no assurance it will
          ultimately close.

          On January 27, 1999, USC Telecom purchased substantially all of the
          assets of Brittan Communications International Corporation ("BCI")
          from BCI's secured lender in a foreclosure sale.  USC Telecom
          primarily acquired BCI's customer base which consisted of
          approximately 80,000 residential long distance telephone customers.
          In the transaction, USC Telecom assumed a $1.5 million term loan,
          BCI's obligation under its receivable funding agreement which had a
          net value of approximately $5 million on the closing date, and BCI's
          obligations under its billing agreement.  The Company also issued
          300,000 warrants to the secured lender which entitle the holder to
          purchase 300,000 shares of Common Stock at $1.33 per share during a
          five year period.

          On January 10, 1999, EqualNet filed a Disclosure Statement with the
          bankruptcy court which included a proposed plan of reorganization.
          Subsequently, EqualNet has been negotiating the terms of the
          reorganization with the committee of unsecured creditors.  Based on
          these negotiations, EqualNet filed an amended Disclosure Statement on
          February 9, 1999, which it believes contains  a reorganization plan
          that is acceptable to the unsecured creditors of EqualNet.  The
          revised reorganization plan proposes to pay $1.1 million plus issue $3
          million in Common Stock to EqualNet's unsecured creditors.  If the
          plan is approved, EqualNet will be relieved of approximately $15
          million in debt. The Company must raise at least $3 million in equity
          to consummate this plan. A bankruptcy court hearing is scheduled on
          March 1, 1999 to consider the disclosure statement for EqualNet's plan
          of reorganization. There can be no assurance that a reorganization
          plan will be confirmed.

          On January 21, 1999, the Company entered into a subscription agreement
          with Kevin Pirolo whereby Mr. Pirolo committed to purchase $2 million
          of Common Stock of the Company at a purchase price per share equal to
          90% of the average closing price of the shares of Common Stock for the
          ten (10) trading days prior to the date of the confirmation of the
          plan of reorganization of EqualNet.  This subscription is subject to
          the confirmation of  plan of reorganization of EqualNet and the
          continued listing of the Company's Common Stock on the Nasdaq National
          Market.

                                       22
<PAGE>
 
          On February 5, 1999, the Company entered into a subscription agreement
          with LaMonda Management Family Limited Partnership ("LaMonda").
          LaMonda has committed to purchase 500,000 shares of the Company's
          Common Stock, warrants to purchase 50,000 shares of Common Stock at
          $1.00 per share, warrants to purchase 50,000 shares of Common Stock at
          $1.50 per share, and warrants to purchase 50,000 shares of Common
          Stock at $2.00 per share for an aggregate purchase price of $.5
          million.  $75,000 of the subscription was funded on February 8, 1999,
          with the balance of the commitment to be funded on March 4, 1999.  The
          Company is obligated to furnish one-half of the consideration to
          Intelesis Group, Inc. in exchange for an equity interest in Intelesis 
          Group Inc.

                                       23
<PAGE>
 

NOTE 11 - FIXED ASSETS

          During fiscal year 1998, the Company acquired nine telecommunications
          switches (the "Switches") from the Willis Group, LLC ("Willis Group")
          for $7.6 million of aggregate consideration.  In a related
          transaction, the Company acquired Netco, a corporation controlled by
          the Willis Group, which held certain intangible rights related to the
          operation of the Switches and assets previously acquired by the Willis
          Group.  The Company acquired Netco for $5.6 million in aggregate
          consideration.  As a result of these two transactions, the Company
          recorded $13.2 million as its cost basis of the Switches and related
          network.  The Company incurred additional direct cost to purchase,
          install and implement the Switches and related network of
          approximately $1 million which have been capitalized as cost of the
          Switches and related network.

          Netco, the owner of the Switches, subsequently entered into an
          agreement with EqualNet whereby EqualNet assumed the operating
          responsibilities of the Switches.  EqualNet 

                                       24
<PAGE>
 
          incurred substantial costs in the fourth quarter of fiscal 1998 in
          extending the network's access to most of the large metropolitan areas
          in the United States in anticipation of a national marketing effort.
          This marketing effort did not produce a significant number of sales
          due to EqualNet's internal provisioning problems and the lack of
          sufficient capital. Utilization of the Switches and national network
          without sufficient traffic to support the fixed costs created negative
          operating margins and created an event that indicated the $14.2
          million asset might be impaired.

          In October, 1998, EqualNet completed the process of turning off the
          Switches and network in an effort to reduce significant fixed charges.
          At that time, the Company intended to reconfigure the network in Texas
          and Southern California to improve operating margins on customers
          located in those geographical areas.  The Company has not, however,
          completed this reconfiguration as it has not consummated certain
          carrier agreements which are needed to originate or terminate calls
          from the Switches.  The Company has started a program to partition or
          lease ports on the Switches to other carriers.  The Company has
          entered into one agreement to partition approximately 110 ports from
          its Texas Switches.  The entire network of Switches has over 1,400
          ports.

          At the end of calendar year 1998, the Company classified the Switches
          and network as operating assets and has supported the carrying value
          of the assets through a projected undiscounted cash flow analysis
          based on partitioning ports as discussed above.  Additionally, as part
          of the plan of reorganization and plan to return the Company to
          profitability, the Company will continue to evaluate the best economic
          use of the Switches and related network.  As part of this continued
          evaluation, the Company may elect to sell all or a portion of the
          Switches and related network.  Management believes that the carrying
          value of the assets will be realized through the operations of the
          assets or a combination of operating the assets and potential sale of
          the assets.  However, it is reasonably possible that the undiscounted
          cash flows may change in the near future resulting in the need to
          write-down those assets to fair value.

                                       25
<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 December 31, 1998 increased 17% to $7.6
  million compared to sales of $6.5 million for the same period of the prior
  year. Gross margin decreased during the current quarter to a deficit of $1.8
  million compared to a positive gross margin of $1.7 million for the same
  period of the prior year. The net loss for the three months ended December 31,
  1998, was $7.9 million and included no tax benefit.  The net loss for the
  corresponding period in the previous year was $2.2 million and included no tax
  benefit.  The net loss for the three month period ended December 31, 1998
  includes the write off of approximately $3.3 million of accounts receivable.

  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:

                                       26
<PAGE>
 
<TABLE>
<CAPTION>
                                                          Three Months Ended             Six Months Ended                       
                                                             December 31,                  December 31,                         
                                                          1997          1998             1997         1998                      
                                                        -------        -------         --------     --------                    
<S>                                                     <C>             <C>             <C>             <C>              
                                                        100.0%          100.0%          100.0%          100.0%                  
Cost of revenues                                         73.0%          124.2%           74.2%          108.4%                  
                                                       -------         -------         -------         ------- 
Gross margin                                             27.0%          (24.2%)          25.8%           (8.4%)                 
                                                                                                                                
Selling, general & administrative expenses               39.9%           33.7%           35.5%           38.5%                  
Depreciation and amortization                            16.1%           38.3%           14.6%           32.0%                  
                                                       -------         -------         -------         ------- 
                                                                                                                                
Operating income (loss)                                 (29.0%)         (96.2%)         (24.3%)         (78.9%)                  
 
Other income (expense)
  Interest income                                         0.0%            0.0%            0.0%            0.0%
  Interest expense                                       (6.6%)          (6.9%)          (5.3%)          (8.3%)
  Miscellaneous                                           2.0%            0.0%            0.7%            0.1%
                                                       -------         -------         -------         -------  
                                                         (4.6%)          (6.9%)          (4.6%)          (8.2%)
 
Loss before federal income taxes
and reorganization cost                                 (33.6%)        (103.1%)         (28.9%)         (87.1%)
 
Provision for federal income taxes                        0.0%            0.0%            0.0%            0.0%
                                                       -------         -------         -------         -------  
 
Net Loss before reorganization costs                    (33.6%)        (103.1%)         (28.9%)         (87.1%)
 
Reorganization costs                                      0.0%           (0.9%)           0.0%           (0.9%)
                                                       -------         -------         -------         -------  
Net Loss                                                (33.6%)        (104.0%)         (28.9%)         (88.0%)
                                                       =======         =======         =======         ======= 
</TABLE>

  Sales
  -----

  The Company's sales in the three months ended December 31, 1998 increased to
  $7.6 million compared to $6.5 million for the comparable period of the prior
  year.  For the six months ended December 31, 1998, sales increased 8.1% to
  $16.0 million compared to $14.8 million for the same period in the previous
  year.  During the current quarter, the Company reported sales of $3.8 million
  related to the customers acquired on July 23, 1998 from SA Telecom.  Excluding
  sales from the acquired customers, the Company's sales decreased 42.5% to $3.8
  million in the current quarter compared to $6.5 million for the comparable
  period of the prior year.  Total billable minutes for the quarter ended
  December 31, 1998 increased 100% to 40.4 million minutes from 20.2 million
  minutes for the same period of the prior year.  During the current quarter,
  24.1 million billable minutes were attributable to the SA Telecom customers.
  Total billable minutes for the six month period ended December 31, 1998
  increased 59.7% to 79.4 million minutes from 49.7 million in the same period
  last year.

  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.

                                       27
<PAGE>
 
  Cost of Sales

  The cost of sales for the three months ended December 31, 1998, increased
  102.1% to $9.5 million compared to $4.7 million for the comparable period of
  the prior year. The current quarter increase was primarily attributable to a
  write off of accounts receivable in the current quarter of $3.3 million.  Cost
  of sales for the six months ended December 31, 1998 increased 57.8% to $17.3
  million compared to $11.0 million for the same period last year.  Excluding
  the accounts receivable write off, cost of sales as a percentage of sales
  increased to 80.9% for the three months ended December 31, 1998, from 73.0%
  for the corresponding period in the previous year.  The primary cause of this
  increase of cost of sales as a percentage of sales, relates to lower rates per
  billed minute for the acquired SA Telecom customer base as compared to the
  Company's historical customer base.

  The Company's cost of long-distance (which is a component of cost of sales)
  increased as a percentage of sales to 69.0% and 70.9% from 52.0% and 53.4% for
  the three and six months ended December 31, 1998 and 1997, respectively.  The
  increase in the percentage in the fiscal year is the result of the costs
  associated with the Company's network of switches ("Network") and higher costs
  related to SA Telecom customers.  The cost of long distance for the SA Telecom
  customer base was 73% of sales for the current quarter.  The total long
  distance costs during the first and second quarters of fiscal 1999 of $6.1 and
  $5.3 million, respectively, includes approximately $1.7 and $.2 million,
  respectively, related to the Network.

  Commission expense as a percent of sales decreased to 1.8% for the second
  quarter of fiscal 1999, compared to 6.9%  for the second quarter of fiscal
  1998.  EqualNet discontinued paying commissions as a result of rejecting its
  agent agreements in its bankruptcy case.  Commission expenses as a percent of
  sales for the six months ended December 31, 1998 was 5.0% as compared to 7.2%
  in the prior period.

  Billing expense as a percentage of sales decreased to 4.7% for the three
  months ended December 31, 1998 compared to 8.1%  for the same period in the
  previous year and 5.9% for the six months ended December 31, 1998 compared to
  8.3% in the same period in fiscal 1998.  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 16.0% and 41.9% of the
  Company's revenues for the three months ended December 31, 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 and six months ended
  December 31, 1998 was  48.1% and 25.6%, respectively, as compared to 5.7%  and
  5.1%, respectively, for the three and six months ended December 31, 1997.  The
  increase resulted from a $3.3 million write off of accounts receivable in the
  current quarter.

  Selling, General and Administrative Expenses

  Selling, general and administrative expenses of $2.6 million for the three
  months ended December 31, 1998 was approximately the same amount incurred in
  the same period of the prior year.  Selling, general and administrative
  expenses decreased as a percentage of sales to 33.7%  for the three months
  ended December 31, 1998, from 39.9% for the same period of the prior year. The
  decrease in selling, general and administrative expenses as a percentage of
  sales relates to the increase in the Company's revenues during the current
  three month period.  For the six months ended December 31, 1998, selling,
  general and administrative expenses increased to 38.5% of sales from 35.5% of
  sales for the same period last year.

                                       28
<PAGE>
 
  Salary expense decreased  $155,973  for the quarter ended December 31, 1998,
  compared to the same quarter of the previous year and increased by $174,604
  for the six months ended December 31, 1998 versus the same period in 1997.

  During the comparative three month periods, departmental direct expenses
  including reorganization costs increased $424,000.  Departmental expenses
  increased by $990,000 during the six month period ended December 31, 1998
  compared to the same period last year.  The increase in departmental expenses
  resulted in part from an increase in legal and professional fees associated
  with EqualNet's bankruptcy and other transactions and registration fees
  associated with USC Telecom.

  Depreciation and Amortization

  Depreciation and amortization increased 179.3% to $2.9 million for the quarter
  ended December 31, 1998, as compared to $1.0  million for the same period in
  the previous year.  Depreciation and amortization expense increased 138.0% for
  the six month period ended December 31, 1998 over the same period of 1997.
  The increase relates to current quarter costs for depreciation of the Network
  of $0.6 million and amortization of the SA Telecom customer acquisition costs
  of $1.3 million.  The Company did not own either of these assets during the
  same period of the prior year.

  Liquidity and Capital Resources

  The Company utilized $749,560 in cash flow from operations for the six months
  ended December 31, 1998, compared to generating $242,000 for the same period
  of the prior year. Cash flow deficits in the current six months were
  attributable to operating losses incurred by the Company.

  Cash used in investing activities totaled $600,629 for the six months ended
  December 31, 1998, compared to $74,724 for the same period of the previous
  year.  The primary use of cash for investing activities during the period
  ended December 31, 1998, was for cash paid in connection with the SA Telecom
  acquisition.

  Net cash generated in financing activities was $.9 million for the six months
  ended December 31, 1998, compared to the utilization of $0.9 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 decrease in funds available under the Company's receivables
  funding arrangement.

  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.

  The conversion to the IDI system has created a significant number of billing
  problems including delays in mailing bills, duplicate charges, and issues
  related to matching call detail records with customer accounts. The delay in
  billing and corrections of bills issued in error have resulted in significant
  problems in the Company's ability to collect receivables. This has created
  severe cash flow problems for the Company. Although the Company is addressing
  and correcting these problems, there can be no assurance these issues will be
  resolved in a timely manner.

  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.

                                       29
<PAGE>
 
  YEAR 2000 READINESS DISCLOSURE

  The Company's Year 2000 ("Y2K") project is intended to address potential
  processing errors in computer programs that use two digits, rather than four,
  to define the applicable year.  The Company is providing Y2K disclosure
  because its assessment of Y2K issues is not complete and because if these
  issues are not resolved by its software vendors and its underlying carriers
  (i.e., MCI Worldcom, AT&T, Frontier and others), it will have material adverse
  consequences to the Company.

  State of Readiness

  The Company's Y2K issues relate primarily to its internal billing systems, the
  Network and the systems of its third party carriers.  The Company uses two
  billing systems, the Costguard system developed by IDI, which utilizes
  Microsoft's SQL Server software, and a system internally developed by BCI with
  a Novell platform. The Company believes the BCI billing system is Y2K
  compliant, however, the Costguard system is not Y2K compliant.  The Company is
  relying on IDI and Microsoft to modify these systems to be Y2K compliant.
  Each of these companies is developing system modifications to be Y2K
  compliant. The Company does monitor the progress of its software vendors and
  anticipates receiving Y2K compliant versions of its billing software no later
  than September 30, 1999.

  The Company's Network comprises nine switches manufactured by Siemens Telecom
  Networks ("Siemens").  These switches utilize software that is not currently
  Y2K compliant.  The Company has received a commitment from Siemens that it
  will provide Y2K compliant software prior to the end of the calendar year
  1999.

  The Company provides its customers with long distance telephone services
  through resale agreements with AT&T, Frontier Communications, MCI Worldcom and
  Qwest Communications.  These are very large public companies with the
  resources necessary to develop and maintain Y2K compliant systems.  The
  Company monitors Y2K development activities of these companies primarily
  through their public disclosures concerning Y2K.

  The Company is in the process of auditing its existing computer hardware for
  Y2K compliance and making required changes.

  Costs

  To date, the Company has not expended any money to deal with Y2K issues.  It
  does, however, anticipate purchasing software updates from its third party
  billing system vendors to update its system to be Y2K compliant.  Although the
  Company has not received quotes from these vendors, it does not believe its
  Y2K software upgrade costs will exceed $100,000.  The Company is not obligated
  to bear any costs related to the Y2K compliant costs being incurred by its
  underlying carriers.

  Risks

  The Company is engaged in the long distance telecommunications business and,
  therefore, connects directly with hundreds of other carriers.  While many
  carriers have announced plans to assess and remediate their networks, there is
  risk that some carriers will not address or resolve Y2K issues.  Failure of
  these carriers to resolve Y2K issues could result in disruption of service to
  the Company's customers or the inability to bill for services.  These problems
  could result in the Company either losing its customers or misbilling its
  customers for long distance services until the problem is remediated.

                                       30
<PAGE>
 
  The Company's Network has an $11 million book basis as recorded on its
  consolidated balance sheet at December 31, 1998.  If Siemens is unable to
  develop and provide the Company with Y2K compliant software, the value of the
  Network will be substantially impaired.

  The billing system utilized by the Company has been developed by third party
  vendors and currently is not Y2K compliant.  Without these billing systems,
  the Company cannot bill its customers or collect for services.  The inability
  of these systems to function after 1999 would severely impair the Company's
  ability to continue its business.

  Contingency Plans

  The Company is monitoring its Y2K issues relating to the progress being made
  by its software vendors, Siemens and its underlying carriers.  The Company
  does not have any significant internally developed software required to
  conduct its business, therefore, it does not require significant internal
  assessment or development plans.  The Company anticipates being Y2K compliant
  by the end of 1999, but cannot control issues that involve other carriers and
  outside vendors.  The Company is monitoring Y2K issues of its carriers and
  software vendors and, to the extent the Company becomes aware of Y2K
  compliance problems of those companies, it intends to move its client base to
  Y2K compliant carriers or purchase Y2K compliant software.  There can be no
  assurance that the Company will be able to utilize the services of any Y2K
  compliant carrier or acquire Y2K compliant software needed to utilize its
  Network or bill or service its clients.


ITEM 3.    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

  No significant change.

                                       31
<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.

  On September 29, 1998, SA Telecommunications Incorporated ("SA Telecom")
  asserted claims pursuant to the Purchase Agreement against USC Telecom, Inc.
  and the Company for (i) $654,934 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 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. On December 28, 1998, the court signed an order
  approving SA Telecom's claims in the amount of approximately $812,772.  The
  Company and USC Telecom disputed each of the claims asserted by SA
  Telecommunications in its demand and have filed a notice of appeal of the
  court's order in these proceedings.

  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 Capital Corporation 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 Company's
       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

                                       32
<PAGE>
 
       $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 LLC 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
  LLC 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

       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 agreed to enter into an Amendment Agreement, to be dated as of
  July 31, 1998, with MCM Partners, the holder of the Company's Series A
  Convertible Preferred Stock. Under the Amendment Agreement, MCM Partners will
  waive its right to receive existing accrued and unpaid dividends on the Series
  A Preferred in consideration for an amendment to the terms of the Series A
  Preferred Stock to be submitted for approval by the Company's shareholders at
  the annual meeting of shareholders with respect to fiscal year 1998.

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<PAGE>
 
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 will 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.  Although the Company has no
  current funding sources, it believes it can attract additional funding if it
  is able to reduce the liabilities of EqualNet through the plan of
  reorganization.  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.

  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

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<PAGE>
 
  continue to maintain relationships with S4 Communications, MCI WorldCom,
  Frontier and U.S Republic.  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 carrier contains 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.   In December,
  1998 EqualNet converted its billing system to CostGuard ENTERPRISE, an
  industrial class rating, billing and customer care system built on a Microsoft
  SQL Server database platform. This system was purchased from Info Directions,
  Inc., "IDI" and should 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 file 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. The conversion to the IDI system has created numerous billing
  problems including delays in mailing bills, billing errors and issues related
  to matching call detail records with customer accounts. The Company is
  currently correcting these problems. However, there can be no assurance that
  the IDI billing system will fully meet EqualNet's current and on going needs
  or that the initial billing problems can be resolved. If the IDI system fails
  to provide the expected results, EqualNet may need to invest in other
  alternative billing systems.

  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 December
  31, 1998, the market price for 

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<PAGE>
 
  the Common Stock as reported by The Nasdaq Stock Market has ranged from a high
  of $3.25 per share to a low of $.18 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 currently
  meets the minimum bid price and minimum public float requirements of Nasdaq.
  It does not, however, meet the minimum tangible net worth requirement.  The
  Company submitted a plan in January, 1999 which estimated that the Company
  would meet the tangible net worth requirement after the consummation of a
  bankruptcy plan of EqualNet.  A Nasdaq hearing was held on February 4, 1999 to
  consider said plan.  As of the date hereof, Nasdaq has not made a final
  decision concerning the Company's listing on Nasdaq's National Market.  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

      Exhibit No.        Description
      -----------        -----------
           3.1        Articles of Incorporation of the Registrant, as amended
                      (incorporated by reference to Exhibit 3.1 to Amendment No.
                      1 to the Registrant's Registration Statement on Form S-1
                      Registration No. 33-88742; filed on February 13, 1995).

           3.2        Statement of Resolution Establishing Series of Shares
                      (Series A Convertible Preferred Stock) (incorporated by
                      reference to Annex B to the Company's Schedule 14A filed
                      with the Commission on February 17, 1998).

           3.3        Statement of Resolution Establishing Series of Shares
                      (Series B Senior Convertible Preferred) (incorporated by
                      reference to Annex G to the Company's Schedule 14A filed
                      with the Commission on June 15, 1998).

           3.4        Statement of Resolution Establishing Series of Shares
                      (Series C Convertible Preferred Stock) (incorporated by
                      reference to Annex A to the Company's Schedule 14A filed
                      with the Commission on June 15, 1998).

           3.5        Form of Statement of Resolution of Board of Directors
                      Establishing and Designating Series D Convertible
                      Preferred Stock and Fixing the Rights and Preferences of
                      such Series (incorporated by reference to exhibit 10.26 to
                      the Company's Annual Report on Form 10-K for the fiscal
                      year ended June 30, 1998, filed with the Commission on
                      October 13, 1998).

           3.6        Bylaws of the Registrant (incorporated by reference to
                      Exhibit 3.2 of the Registrant's Registration Statement on
                      Form S-1 (Registration No. 33-88742), filed with the
                      Commission on January 24, 1995).

          27.1        Financial Data Schedule


                                       36
<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 COMMUNICATIONS CORP.

                              /s/  Mitchell H. Bodian
  Date: 2/16/99             -------------------------------------------
                            Mitchell H. Bodian, Chief Executive Officer
                            (duly authorized officer and principal 
                            financial officer)

                                       37