<PAGE>

-------------------------------------------------------------------------------
-------------------------------------------------------------------------------

                                 UNITED STATES
                      SECURITIES AND EXCHANGE COMMISSION
                            Washington, D.C. 20549

                               ----------------

                               FORM 10-Q/A

                            (Amendment No. 1)

                               ----------------

[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 or 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 31,974,369 shares of the Registrant's $.01 par value common stock
outstanding as of January 10, 2000.

-------------------------------------------------------------------------------
-------------------------------------------------------------------------------
<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.........................   5,000,000  14,665,000
</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) (56,699,586)
                                                       -----------  -----------
    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 and deemed
 distributions ......... $        --  $ (2,087,192) $        --  $ (2,457,329)
Net loss available to
 Common shareholders.... $(2,178,483) $(10,014,619) $(4,275,380) $(16,545,700)
Net loss per share--
 basic and diluted...... $     (0.35) $      (0.54) $     (0.68) $      (0.85)
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.

  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

                                       7
<PAGE>

                         EQUALNET COMMUNICATIONS CORP.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

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:

<TABLE>
      <S>                                                           <C>
      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
                                                                    ===========
</TABLE>

                                       8
<PAGE>

                         EQUALNET COMMUNICATIONS CORP.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


  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)

<TABLE>
<CAPTION>
                                                                   December 31,
                                                                       1998
                                                                   ------------
                                                                   (Unaudited)
                              ASSETS
<S>                                                                <C>
Current Assets
  Cash and equivalents............................................ $        --
  Accounts receivable, net of allowance for doubtful accounts of
   $1,457,160.....................................................   5,046,632
  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
                                                                   ===========

<CAPTION>
              LIABILITIES AND SHAREHOLDERS' DEFICIT
<S>                                                                <C>
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
                                                                   ===========
</TABLE>

                                       9
<PAGE>

                         EQUALNET COMMUNICATIONS CORP.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


                             EQUALNET CORPORATION

                            STATEMENT OF OPERATIONS

                                  (Unaudited)

<TABLE>
<CAPTION>
                                                                    Six Months
                                                                      Ended
                                                                   December 31,
                                                                       1998
                                                                   ------------
                                                                   (Unaudited)
<S>                                                                <C>
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
  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)
                                                                   -----------
</TABLE>

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

                                      10
<PAGE>

                         EQUALNET COMMUNICATIONS CORP.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


                             EQUALNET CORPORATION

                            STATEMENT OF CASH FLOWS

                                  (UNAUDITED)

<TABLE>
<CAPTION>
                                                                  Six Months
                                                                    Ended
                                                                 December 31,
                                                                     1998
                                                                 ------------
<S>                                                              <C>
OPERATING ACTIVITIES
Net loss........................................................ $ (7,841,797)
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
                                                                 ============
</TABLE>

NOTE 3--DIP FINANCING AND EXIT FACILITY

  Prior to filing for bankruptcy protection, EqualNet and RFC Capital
Corporation ("RFC") entered into an agreement whereby RFC agreed to amend
certain financing agreements with EqualNet to eliminate EqualNet's bankruptcy
filing as an event of default and, subject to bankruptcy court approval, to
continue to finance EqualNet's receivables under a debtor in possession
("DIP") facility. On 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.)

                                      11
<PAGE>

                         EQUALNET COMMUNICATIONS CORP.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

The Company does intend to raise the needed capital from outside investors and
provide EqualNet with the exit facility. If the Company is able to
successfully provide the exit facility, the Company would continue to own
EqualNet after the bankruptcy proceedings.

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):

<TABLE>
      <S>                                                               <C>
      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
                                                                        =======
</TABLE>

  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.

  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.

                                      12
<PAGE>

                         EQUALNET COMMUNICATIONS CORP.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


  The following results of operations have been prepared assuming the SA
Telecom acquisition occurred as of the beginning of the periods presented. The
pro forma operating results are not necessarily indicative of future operating
results nor of results that would have occurred had the acquisitions been
consummated as of the beginning of the periods presented.

<TABLE>
<CAPTION>
                                                           Six Months Ended
                                                             December 31,
                                                        -----------------------
                                                           1997        1998
                                                        ----------  -----------
                                                        (in thousands, except
                                                          per share amounts)
      <S>                                               <C>         <C>
      Revenues......................................... $   34,728  $    16,977
      Net income (loss)................................ $   (8,021) $   (13,970)
      Net loss per share............................... $    (1.27) $     (0.72)
                                                        ==========  ===========
</TABLE>

NOTE 5--DEBT

  Netco Acquisition Corp. ("Netco"), a wholly owned subsidiary of the Company,
defaulted on its note payable in the original principal amount of $6.05
million during the 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.

  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

                                      13
<PAGE>

                         EQUALNET COMMUNICATIONS CORP.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

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.

  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:

                                      14
<PAGE>

                         EQUALNET COMMUNICATIONS CORP.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


    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--PREFERRED STOCK

 Series A Preferred Stock

  During fiscal year 1998 the Company issued 2,000 shares of Series A
Convertible Preferred Stock ("Series A Preferred") valued at $2,000,000 and
had 2,030 and 2,000 shares of Series A Preferred with a stated value of $1,000
per share outstanding at June 30, 1999 and 1998, respectively. Series A
Preferred dividends are cumulative at the rate of $60.00 per year, payable
quarterly in either cash or additional shares of Series A Preferred. The
Series A Preferred resolution has been amended effective October 28, 1998 to
include conversion features such that the Series A Preferred is convertible at
a discounted price. A deemed distribution approximating $1.3 million was
recorded during the current quarter. Per the amended resolutions, the Holders
of Series A have the right to convert their shares into the Company's common
stock based upon a formula which, subject to the Company's continued listing
on a national exchange, will not be less than $0.75 per share of common stock
adjusted 31 days (and adjusted again every six months afterwards) after
shareholder approval of the Company's proposed reverse stock split to 75% of
the average closing price of the Company's common stock for the five previous
trading days; the proposed reverse stock split has been submitted for
shareholder approval in the Company's 1999 Annual Shareholder Meeting proxy
statement. Should the Company be delisted from all national exchanges, the
conversion floor is removed and the conversion formula of 85% of the Average
Market Price (as defined by the Series A Preferred Stock Designation) has no
lower conversion price per share limit. The Series A Preferred has a $1,000
liquidation preference plus accrued and unpaid dividends over the Company's
common stock. The Company is prohibited from declaring or paying dividends on
its common stock unless all accrued dividends on the Series A Preferred have
been paid. The Series A Preferred is redeemable at a rate of $1,000 per share
at the option of the holder when certain events, which are in control of the
Company, occur such as the Company's inability to convert preferred shares
into common shares. Series A Preferred ranks senior to the Company's other
series of preferred stock in liquidation preference. Dividend payments for the
Series A Preferred was waived by the holders through February 22, 1999.

 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

                                      15
<PAGE>

                         EQUALNET COMMUNICATIONS CORP.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

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. A deemed
distribution of approximately $0.7 million was recorded in the current
quarter.

  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.

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.

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

                                      16
<PAGE>

                         EQUALNET COMMUNICATIONS CORP.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

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.

  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.


                                      17
<PAGE>

                         EQUALNET COMMUNICATIONS CORP.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

  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.

  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

                                      18
<PAGE>

                         EQUALNET COMMUNICATIONS CORP.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

arising out of previous litigation for the enforcement of equipment and office
furnishings leases filed on February 12, 1998 in the 157th District Court of
Harris County, Texas in case number 98-06841. A settlement agreement was
entered into by the parties dismissing the earlier litigation and adding the
Company as an obligor for the payment of the settlement amounts. The remaining
amounts due under the settlement agreement and remaining lease obligations
represent an amount in excess of $1,000,000.

  On September 21, 1998, Cyberserve, Inc., WSHS Enterprises, Inc. and William
Stuart (collectively "Bluegate") filed suit in the 215th District Court of
Harris County, Texas in case number 98-45115 against the Company, Willis
Group, LLC, Mark A. Willis, and Netco Acquisition LLC alleging damages for
breach of contract, breach of an employment agreement, fraud and fraud in the
inducement, statutory fraud in a stock transaction, tortious interference with
a contract, conspiracy, and quantum meruit. The matters complained of
originated with a letter of intent dated on or about October 28, 1997, wherein
the Company proposed the purchase of certain assets of Cyberserve, Inc. and
WSHS Enterprises, Inc. subject to the performance of due diligence by the
parties. Bluegate and certain of its shareholders had threatened to sue the
Company in the event the proposed transaction was not consummated
substantially in conformity with the terms set forth in the Letter of Intent.
The damages Bluegate alleges it incurred were as a result of, among other
things, the claimed modification of its business to its detriment in
anticipation of the integration of its operations with those of EqualNet. It
is impossible to determine with any degree of certainty what, if any,
liability 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

                                      19
<PAGE>

                         EQUALNET COMMUNICATIONS CORP.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

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.

  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.

  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

                                      20
<PAGE>

                         EQUALNET COMMUNICATIONS CORP.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

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. ACMI 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.

  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.

                                      21
<PAGE>

                         EQUALNET COMMUNICATIONS CORP.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


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 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.

                                      22
<PAGE>

                         EQUALNET COMMUNICATIONS CORP.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

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, excluding preferred stock dividends
and deemed distributions 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:

<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

                                      23
<PAGE>

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.

 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

                                      24
<PAGE>

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.

  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.

                                      25
<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.

  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.

                                      26
<PAGE>

  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.

                                      27
<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

  $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

                                      28
<PAGE>

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.

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,

                                      29
<PAGE>

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 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.

                                      30
<PAGE>

  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 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.

                                      31
<PAGE>

Item 6. Exhibits and Reports on Form 8-K

  a. Exhibits

<TABLE>
<CAPTION>
 Exhibit
   No.   Description
 ------- -----------
 <C>     <S>
   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 (filed previously).
</TABLE>

                                       32
<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
                                          -------------------------------------
                                          Mitchell H. Bodian, Chief Executive
                                           Officer (duly
                                          authorized officer and principal
                                           financial officer)

Date: April 24, 2000

                                       33