##### Table of Contents



SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549


FORM 10-Q

(Mark One)

|  |  |                                                                                                                                                               
|- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------
|x |  | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE PERIOD ENDED JUNE 30, 2003                                    
|  |  |                                                                                                                                                               
|  |  | OR                                                                                                                                                            
|  |  |                                                                                                                                                               
|o |  | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM
_________________ TO _________________

COMMISSION FILE NUMBER: 000-28467

Z-TEL TECHNOLOGIES, INC.

(Exact name of Registrant as specified in its charter)


|                                                                        |  |                                                   
|----------------------------------------------------------------------- |  | --------------------------------------------------
|DELAWARE
(State or other jurisdiction of incorporation or organization) |  | 59-3501119
(I.R.S. Employer Identification Number)

601 SOUTH HARBOUR ISLAND BOULEVARD, SUITE 220
TAMPA, FLORIDA 33602
(813) 273-6261
(Address, including zip code, and
telephone number including area code, of
Registrants principal executive offices)

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: COMMON
STOCK, PAR VALUE $.01 PER SHARE, PREFERRED STOCK PURCHASE RIGHTS

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 o

The number of shares of the Registrants Common Stock outstanding as of
August 11, 2003 was approximately 35,344,534.





---

TABLE OF CONTENTS



|                                 |                                                                                                |                                                             |  |  |  |  |  | 
|-------------------------------- | ---------------------------------------------------------------------------------------------- | ----------------------------------------------------------- |  |  |  |  |  | 
|                                 |                                                                                                | Consolidated Balance Sheets                                
|                                 |                                                                                                | Consolidated Statements of Operations                      
|                                 |                                                                                                | Consolidated Statements of Changes in Stockholders Deficit
|                                 |                                                                                                | Consolidated Statements of Cash Flows                      
|                                 |                                                                                                | NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)     
|                                 | ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
|                                 | ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                            
|                                 | ITEM 4. CONTROLS AND PROCEDURES                                                               
|PART II                         
|                                 | ITEM 1. LEGAL PROCEEDINGS                                                                     
|                                 | ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                   
|                                 | ITEM 5. OTHER INFORMATION                                                                     
|                                 | ITEM 6. EXHIBITS, AND REPORTS ON FORM 8-K                                                     
|SIGNATURES                      
|Section 302 Certification of CEO
|Section 302 Certification of CFO
|Section 906 Certification of CEO
|Section 906 Certification of CFO



---



##### Table of Contents



TABLE OF CONTENTS

|           |                                                                                               |                                                                                                   |    |    |   | 
|---------- | --------------------------------------------------------------------------------------------- | ------------------------------------------------------------------------------------------------- | -- | -- | - | 
|PART I     |                                                                                               |                                                                                                   | 3  |   
|           | Item 1. Financial Statements                                                                  |                                                                                                   |    |   
|           |                                                                                               | Consolidated Balance Sheets at June 30, 2003 and December 31, 2002                                |    | 3  |  
|           |                                                                                               | Consolidated Statements of Operations for the three and six months ended June 30, 2003 and 2002   |    |    | 4 | 
|           |                                                                                               | Consolidated Statement of Changes in Stockholders Deficit for the six months ended June 30, 2003 |    |    | 5 | 
|           |                                                                                               | Consolidated Statements of Cash Flows for the six months ended June 30, 2003 and 2002             |    |    | 6 | 
|           |                                                                                               | Notes to Consolidated Financial Statements                                                        |    |    | 7 | 
|           | Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations |                                                                                                   |    | 14 |  
|           | Item 3. Quantitative and Qualitative Disclosures about Market Risk                            |                                                                                                   |    | 28 |  
|           | Item 4. Controls and Procedures                                                               |                                                                                                   |    | 28 |  
|PART II    |                                                                                               |                                                                                                   |    |   
|           | Item 1. Legal Proceedings                                                                     |                                                                                                   | 28 |   
|           | Item 4. Submission of Matters to a Vote of Security Holders                                   |                                                                                                   |    | 29 |  
|           | Item 5.
Other Information                                                                     |                                                                                                   |    | 30 |  
|           | Item 6. Exhibits, and Reports on Form 8-K                                                     |                                                                                                   |    | 30 |  
|Signatures |                                                                                               |                                                                                                   | 36 |   

2



---



##### Table of Contents






Z-Tel Technologies, Inc. and Subsidiaries
Consolidated Balance Sheets
(In thousands, except share data)
(Unaudited)

|                                                                                                                                                                                                               |                                                                                                                                             |                             |                                                                                                 |          |          |         |              |          |         |         | 
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------- | --------------------------- | ----------------------------------------------------------------------------------------------- | -------- | -------- | ------- | ------------ | -------- | ------- | ------- | 
|                                                                                                                                                                                                               |                                                                                                                                             |                             |                                                                                                 |          | June 30, |         | December 31,
|                                                                                                                                                                                                               |                                                                                                                                             |                             |                                                                                                 |          | 2003     |         | 2002        
|                                                                                                                                                                                                               |                                                                                                                                             |                             |                                                                                                 |          |          |         |             
|Assets                                                                                                                                                                                                         |                                                                                                                                             |                             |                                                                                                 |          |          |         |              |         
|Current assets:                                                                                                                                                                                                |                                                                                                                                             |                             |                                                                                                 |          |          |         |              |         
|                                                                                                                                                                                                               | Cash and cash equivalents                                                                                                                   |                             | $                                                                                               | 14,204   |          |         | $            | 16,037   |        
|                                                                                                                                                                                                               | Accounts receivable, net of allowance for doubtful
accounts of $16,445 and $17,401                                                          |                             |                                                                                                 | 33,946   |          |         |              | 26,749   |        
|                                                                                                                                                                                                               | Prepaid expenses and other current assets                                                                                                   |                             |                                                                                                 | 4,811    |          |         |              | 5,741    |        
|                                                                                                                                                                                                               |                                                                                                                                             |                             |                                                                                                 |          |          |         |              |         
|                                                                                                                                                                                                               |                                                                                                                                             | Total current assets        |                                                                                                 |          | 52,961   |         |              |          | 48,527  |        
|Property and equipment, net                                                                                                                                                                                    |                                                                                                                                             |                             | 42,989                                                                                          |          |          |         | 48,320       |         
|Intangible assets, net                                                                                                                                                                                         |                                                                                                                                             |                             | 3,201                                                                                           |          |          |         | 4,116        |         
|Other assets                                                                                                                                                                                                   |                                                                                                                                             |                             | 5,750                                                                                           |          |          |         | 5,748        |         
|                                                                                                                                                                                                               |                                                                                                                                             |                             |                                                                                                 |          |          |         |              |         
|                                                                                                                                                                                                               |                                                                                                                                             |                             | Total assets                                                                                    |          | $        | 104,901 |              |          | $       | 106,711 | 
|                                                                                                                                                                                                               |                                                                                                                                             |                             |                                                                                                 |          |          |         |              |         
|Liabilities, Mandatorily Redeemable Convertible Preferred
Stock and Stockholders Deficit                                                                                                                      |                                                                                                                                             |                             |                                                                                                 |          |          |         |              |         
|Current liabilities:                                                                                                                                                                                           |                                                                                                                                             |                             |                                                                                                 |          |          |         |              |         
|                                                                                                                                                                                                               | Accounts payable and accrued liabilities                                                                                                    |                             | $                                                                                               | 50,490   |          |         | $            | 51,771   |        
|                                                                                                                                                                                                               | Deferred revenue                                                                                                                            |                             |                                                                                                 | 20,646   |          |         |              | 10,172   |        
|                                                                                                                                                                                                               | Current portion of long-term debt
and capital lease obligations                                                                             |                             |                                                                                                 | 5,857    |          |         |              | 5,964    |        
|                                                                                                                                                                                                               |                                                                                                                                             |                             |                                                                                                 |          |          |         |              |         
|                                                                                                                                                                                                               |                                                                                                                                             | Total current liabilities   |                                                                                                 |          | 76,993   |         |              |          | 67,907  |        
|Long- term deferred revenue                                                                                                                                                                                    |                                                                                                                                             |                             | 6,616                                                                                           |          |          |         | 6,277        |         
|Long-term debt and capital lease obligations                                                                                                                                                                   |                                                                                                                                             |                             | 1,532                                                                                           |          |          |         | 4,180        |         
|                                                                                                                                                                                                               |                                                                                                                                             |                             |                                                                                                 |          |          |         |              |         
|                                                                                                                                                                                                               |                                                                                                                                             |                             | Total liabilities                                                                               |          |          | 85,141  |              |          |         | 78,364  | 
|                                                                                                                                                                                                               |                                                                                                                                             |                             |                                                                                                 |          |          |         |              |         
|Mandatorily redeemable convertible preferred stock, $.01 par value; 50,000,000
shares authorized; 8,855,089 issued; 8,800,922 and 8,855,089
outstanding (aggregate liquidation value of $151,603 and $145,503) |                                                                                                                                             |                             | 136,132                                                                                         |          |          |         | 127,631      |         
|                                                                                                                                                                                                               |                                                                                                                                             |                             |                                                                                                 |          |          |         |              |         
|Commitments and contingencies (Note 8)                                                                                                                                                                         |                                                                                                                                             |                             |                                                                                                 |          |          |         |              |         
|Stockholders deficit:                                                                                                                                                                                         |                                                                                                                                             |                             |                                                                                                 |          |          |         |              |         
|                                                                                                                                                                                                               | Common stock, $.01 par value; 150,000,000
shares authorized; 35,684,918 and 35,609,803 shares issued;
35,343,368 and 35,268,253 outstanding |                             |                                                                                                 | 357      |          |         |              | 356      |        
|                                                                                                                                                                                                               | Notes receivable from stockholders                                                                                                          |                             |                                                                                                 | (1,120   | )        |         |              | (1,589   | )      
|                                                                                                                                                                                                               | Additional paid-in capital                                                                                                                  |                             |                                                                                                 | 196,645  |          |         |              | 205,090  |        
|                                                                                                                                                                                                               | Accumulated deficit                                                                                                                         |                             |                                                                                                 | (311,866 | )        |         |              | (302,753 | )      
|                                                                                                                                                                                                               | Treasury stock, 341,550 shares at cost                                                                                                      |                             |                                                                                                 | (388     | )        |         |              | (388     | )      
|                                                                                                                                                                                                               |                                                                                                                                             |                             |                                                                                                 |          |          |         |              |         
|                                                                                                                                                                                                               |                                                                                                                                             | Total stockholders deficit |                                                                                                 |          | (116,372 | )       |              |          | (99,284 | )      
|                                                                                                                                                                                                               |                                                                                                                                             |                             |                                                                                                 |          |          |         |              |         
|                                                                                                                                                                                                               |                                                                                                                                             |                             | Total liabilities, mandatorily redeemable convertible preferred
stock and stockholders deficit |          | $        | 104,901 |              |          | $       | 106,711 | 
|                                                                                                                                                                                                               |                                                                                                                                             |                             |                                                                                                 |          |          |         |              |         

The accompanying notes are an integral part of these consolidated financial
statements.

3



---



##### Table of Contents






Z-Tel Technologies, Inc. and Subsidiaries
Consolidated Statements of Operations
(In thousands, except share and per share data)
(Unaudited)

|                                           |                               |                                                                                 |            |                    |         |                  |            |        |        |      |            |        |         |   |            |        |         |  
|------------------------------------------ | ----------------------------- | ------------------------------------------------------------------------------- | ---------- | ------------------ | ------- | ---------------- | ---------- | ------ | ------ | ---- | ---------- | ------ | ------- | - | ---------- | ------ | ------- | -
|                                           |                               |                                                                                 |            | Three Months ended |         | Six Months Ended
|                                           |                               |                                                                                 |            | June 30,           |         | June 30,        
|                                           |                               |                                                                                 |            |                    |         |                 
|                                           |                               |                                                                                 |            | 2003               |         | 2002             |            | 2003   |        | 2002
|                                           |                               |                                                                                 |            |                    |         |                  |            |        |        |     
|Revenues                                   |                               | $                                                                               | 69,875     |                    |         | $                | 62,224     |        |        | $    | 130,151    |        |         | $ | 119,493    |       
|                                           |                               |                                                                                 |            |                    |         |                  |            |        |        |      |            |        |         |   |            |       
|Operating expenses:                        |                               |                                                                                 |            |                    |         |                  |            |        |        |      |            |        |         |   |            |       
|                                           | Network operations            |                                                                                 |            | 30,899             |         |                  |            | 18,046 |        |      |            | 57,028 |         |   |            | 46,065 |        
|                                           | Sales and marketing           |                                                                                 |            | 6,617              |         |                  |            | 2,480  |        |      |            | 11,111 |         |   |            | 7,034  |        
|                                           | General and administrative    |                                                                                 |            | 31,944             |         |                  |            | 31,367 |        |      |            | 58,850 |         |   |            | 60,639 |        
|                                           | Asset impairment charge       |                                                                                 |            |                   |         |                  |            | 1,129  |        |      |            |       |         |   |            | 1,129  |        
|                                           | Wholesale development costs   |                                                                                 |            |                   |         |                  |            |       |        |      |            |       |         |   |            | 1,018  |        
|                                           | Restructuring charge          |                                                                                 |            |                   |         |                  |            | 1,861  |        |      |            |       |         |   |            | 1,861  |        
|                                           | Depreciation and amortization |                                                                                 |            | 6,002              |         |                  |            | 6,003  |        |      |            | 12,029 |         |   |            | 11,582 |        
|                                           |                               |                                                                                 |            |                    |         |                  |            |        |        |      |            |        |         |   |            |       
|                                           |                               | Total operating expenses                                                        |            |                    | 75,462  |                  |            |        | 60,886 |      |            |        | 139,018 |   |            |        | 129,328 |  
|                                           |                               |                                                                                 |            |                    |         |                  |            |        |        |      |            |        |         |   |            |       
|                                           |                               | Operating income (loss)                                                         |            |                    | (5,587  | )                |            |        | 1,338  |      |            |        | (8,867  | ) |            |        | (9,835  | )
|                                           |                               |                                                                                 |            |                    |         |                  |            |        |        |      |            |        |         |   |            |       
|Nonoperating income (expense):             |                               |                                                                                 |            |                    |         |                  |            |        |        |      |            |        |         |   |            |       
|                                           | Interest and other income     |                                                                                 |            | 239                |         |                  |            | 307    |        |      |            | 1,164  |         |   |            | 1,484  |        
|                                           | Interest and other expense    |                                                                                 |            | (660               | )       |                  |            | (1,386 | )      |      |            | (1,410 | )       |   |            | (1,997 | )      
|                                           |                               |                                                                                 |            |                    |         |                  |            |        |        |      |            |        |         |   |            |       
|                                           |                               | Total nonoperating expense                                                      |            |                    | (421    | )                |            |        | (1,079 | )    |            |        | (246    | ) |            |        | (513    | )
|                                           |                               |                                                                                 |            |                    |         |                  |            |        |        |      |            |        |         |   |            |       
|                                           |                               | Net income (loss)                                                               |            |                    | (6,008  | )                |            |        | 259    |      |            |        | (9,113  | ) |            |        | (10,348 | )
|                                           |                               | Less mandatorily redeemable convertible
preferred stock dividends and accretion |            |                    | (4,667  | )                |            |        | (3,937 | )    |            |        | (8,904  | ) |            |        | (7,809  | )
|                                           |                               | Less deemed dividend related to beneficial
conversion feature                   |            |                    | (46     | )                |            |        | (46    | )    |            |        | (92     | ) |            |        | (92     | )
|                                           |                               |                                                                                 |            |                    |         |                  |            |        |        |      |            |        |         |   |            |       
|                                           |                               | Net loss attributable to common stockholders                                    |            | $                  | (10,721 | )                |            | $      | (3,724 | )    |            | $      | (18,109 | ) |            | $      | (18,249 | )
|                                           |                               |                                                                                 |            |                    |         |                  |            |        |        |      |            |        |         |   |            |       
|Weighted average common shares outstanding |                               |                                                                                 | 35,305,448 |                    |         |                  | 35,074,936 |        |        |      | 35,286,953 |        |         |   | 34,693,186 |       
|                                           |                               |                                                                                 |            |                    |         |                  |            |        |        |      |            |        |         |   |            |       
|Basic and diluted net loss per share       |                               | $                                                                               | (0.30      | )                  |         | $                | (0.11      | )      |        | $    | (0.51      | )      |         | $ | (0.53      | )     
|                                           |                               |                                                                                 |            |                    |         |                  |            |        |        |      |            |        |         |   |            |       

The accompanying notes are an integral part of these consolidated financial
statements.

4



---



##### Table of Contents






Z-Tel Technologies, Inc. and Subsidiaries
Consolidated Statements of Changes in Stockholders Deficit
(In thousands, except share data)
(Unaudited)

|                                                                           |  |              |            |                  |  |              |     |             |  |          |        |               |  |         |         |       |  |   |          |   |  |   |      |   |  |   |          |  
|-------------------------------------------------------------------------- |  | ------------ | ---------- | ---------------- |  | ------------ | --- | ----------- |  | -------- | ------ | ------------- |  | ------- | ------- | ----- |  | - | -------- | - |  | - | ---- | - |  | - | -------- | -
|                                                                           |  | Common Stock |            | Notes Receivable |  | Additional   |     |             |  |          |        |               |  |         |         | Total
|                                                                           |  |              |            | from             |  | Paid-In      |     | Accumulated |  | Treasury |        | Stockholders'
|                                                                           |  | Shares       |            | Par Value        |  | Stockholders |     | Capital     |  | Deficit  |        | Stock         |  | Deficit
|                                                                           |  |              |            |                  |  |              |     |             |  |          |        |               |  |        
|Balance, December 31, 2002                                                 |  |              | 35,268,253 |                  |  | $            | 356 |             |  | $        | (1,589 | )             |  | $       | 205,090 |       |  | $ | (302,753 | ) |  | $ | (388 | ) |  | $ | (99,284  | )
|Exercise of stock options                                                  |  |              | 42,926     |                  |  |              | 1   |             |  |          |        |               |  |         | 59      |       |  |   |          |   |  |   |      |   |  |   | 60       |  
|Exercise of warrants                                                       |  |              | 25,714     |                  |  |              |    |             |  |          |        |               |  |         |         |       |  |   |          |   |  |   |      |   |  |   |         |  
|Conversion of mandatorily redeemable
convertible preferred stock to common |  |              | 6,475      |                  |  |              |    |             |  |          |        |               |  |         | 58      |       |  |   |          |   |  |   |      |   |  |   | 58       |  
|Repayment of notes receivable                                              |  |              |            |                  |  |              |     |             |  |          | 469    |               |  |         |         |       |  |   |          |   |  |   |      |   |  |   | 469      |  
|Mandatorily redeemable convertible preferred
stock dividends and accretion |  |              |            |                  |  |              |     |             |  |          |        |               |  |         | (8,562  | )     |  |   |          |   |  |   |      |   |  |   | (8,562   | )
|Net loss                                                                   |  |              |            |                  |  |              |     |             |  |          |        |               |  |         |         |       |  |   | (9,113   | ) |  |   |      |   |  |   | (9,113   | )
|                                                                           |  |              |            |                  |  |              |     |             |  |          |        |               |  |         |         |       |  |   |          |   |  |   |      |   |  |   |          |  
|Balance, June 30, 2003                                                     |  |              | 35,343,368 |                  |  | $            | 357 |             |  | $        | (1,120 | )             |  | $       | 196,645 |       |  | $ | (311,866 | ) |  | $ | (388 | ) |  | $ | (116,372 | )
|                                                                           |  |              |            |                  |  |              |     |             |  |          |        |               |  |         |         |       |  |   |          |   |  |   |      |   |  |   |          |  

The accompanying notes are an integral part of these consolidated financial
statements.

5



---



##### Table of Contents






Z-Tel Technologies, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
(In thousands)
(Unaudited)

|                                                                            |                                                                    |                                                   |                                                      |                                           |        |                  |         |        |         |         |         |  
|--------------------------------------------------------------------------- | ------------------------------------------------------------------ | ------------------------------------------------- | ---------------------------------------------------- | ----------------------------------------- | ------ | ---------------- | ------- | ------ | ------- | ------- | ------- | -
|                                                                            |                                                                    |                                                   |                                                      |                                           |        | Six months ended
|                                                                            |                                                                    |                                                   |                                                      |                                           |        | June 30,        
|                                                                            |                                                                    |                                                   |                                                      |                                           |        |                 
|                                                                            |                                                                    |                                                   |                                                      |                                           |        | 2003             |         | 2002  
|                                                                            |                                                                    |                                                   |                                                      |                                           |        |                  |         |       
|Cash
flows from operating activities:                                       |                                                                    |                                                   |                                                      |                                           |        |                  |         |       
|Net loss                                                                    |                                                                    | $                                                 | (9,113                                               | )                                         |        | $                | (10,348 | )     
|                                                                            |                                                                    |                                                   |                                                      |                                           |        |                  |         |       
|Adjustments to reconcile net loss to net cash used in operating activities: |                                                                    |                                                   |                                                      |                                           |        |                  |         |       
|                                                                            |                                                                    | Depreciation and amortization                     |                                                      |                                           | 12,029 |                  |         |        | 11,582  |        
|                                                                            |                                                                    | Provision for bad debts                           |                                                      |                                           | 6,268  |                  |         |        | 11,479  |        
|                                                                            |                                                                    | Asset impairment charge                           |                                                      |                                           |       |                  |         |        | 1,129   |        
|                                                                            |                                                                    | Expense charged for granting of stock options     |                                                      |                                           |       |                  |         |        | 151     |        
|                                                                            |                                                                    | Change in operating assets and liabilities:       |                                                      |                                           |        |                  |         |        |         |        
|                                                                            |                                                                    |                                                   | Increase in accounts receivable                      |                                           |        | (13,465          | )       |        |         | (13,437 | )      
|                                                                            |                                                                    |                                                   | (Increase) decrease in prepaid expenses              |                                           |        | 930              |         |        |         | (138    | )      
|                                                                            |                                                                    |                                                   | Increase in other assets                             |                                           |        | (29              | )       |        |         | (122    | )      
|                                                                            |                                                                    |                                                   | Decrease in accounts payable and accrued liabilities |                                           |        | (1,284           | )       |        |         | (2,760  | )      
|                                                                            |                                                                    |                                                   | Increase in deferred revenue                         |                                           |        | 10,813           |         |        |         | 7,246   |        
|                                                                            |                                                                    |                                                   |                                                      |                                           |        |                  |         |       
|                                                                            |                                                                    |                                                   |                                                      | Total adjustments                         |        |                  | 15,262  |        |         |         | 15,130  |  
|                                                                            |                                                                    |                                                   |                                                      |                                           |        |                  |         |       
|                                                                            |                                                                    |                                                   |                                                      | Net cash provided by operating activities |        |                  | 6,149   |        |         |         | 4,782   |  
|                                                                            |                                                                    |                                                   |                                                      |                                           |        |                  |         |       
|Cash
flows from investing activities:                                       |                                                                    |                                                   |                                                      |                                           |        |                  |         |       
|                                                                            |                                                                    | Purchases of property and equipment               |                                                      |                                           | (5,783 | )                |         |        | (11,769 | )      
|                                                                            |                                                                    | Principal repayments received on notes receivable |                                                      |                                           | 27     |                  |         |        |        |        
|                                                                            |                                                                    |                                                   |                                                      |                                           |        |                  |         |       
|                                                                            |                                                                    |                                                   |                                                      | Net cash used in investing activities     |        |                  | (5,756  | )      |         |         | (11,769 | )
|                                                                            |                                                                    |                                                   |                                                      |                                           |        |                  |         |       
|Cash
flows from financing activities:                                       |                                                                    |                                                   |                                                      |                                           |        |                  |         |       
|                                                                            | Payments on long-term debt and capital lease obligations           |                                                   |                                                      | (2,755                                    | )      |                  |         | (2,793 | )      
|                                                                            | Principal repayments received on notes receivable issued for stock |                                                   |                                                      | 469                                       |        |                  |         |       |        
|                                                                            | Proceeds from exercise of stock options and warrants               |                                                   |                                                      | 60                                        |        |                  |         | 1      |        
|                                                                            |                                                                    |                                                   |                                                      |                                           |        |                  |         |       
|                                                                            |                                                                    |                                                   |                                                      | Net cash used in financing activities     |        |                  | (2,226  | )      |         |         | (2,792  | )
|                                                                            |                                                                    |                                                   |                                                      |                                           |        |                  |         |       
|Net decrease in cash and cash equivalents                                   |                                                                    |                                                   | (1,833                                               | )                                         |        |                  | (9,779  | )     
|Cash and cash equivalents, beginning of period                              |                                                                    |                                                   | 16,037                                               |                                           |        |                  | 18,892  |       
|                                                                            |                                                                    |                                                   |                                                      |                                           |        |                  |         |       
|Cash and cash equivalents, end of period                                    |                                                                    | $                                                 | 14,204                                               |                                           |        | $                | 9,113   |       
|                                                                            |                                                                    |                                                   |                                                      |                                           |        |                  |         |       

The accompanying notes are an integral part of these consolidated financial
statements.

6



---



##### Table of Contents






Z-TEL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(ALL TABLES ARE IN THOUSANDS, EXCEPT FOR SHARE AND PER SHARE DATA)

1. NATURE OF BUSINESS

DESCRIPTION OF BUSINESS

Z-Tel Technologies, Inc. and subsidiaries (we or us) is a
telecommunications services provider incorporated in Delaware on January 15,
1998. We integrate access to local and long distance telephone networks with
proprietary advanced features and operational support systems to provide
innovative telecommunications services to consumers, businesses and other
communications companies. We provide both retail and wholesale services.

Our principal retail services are Z-LineHOME®, Z-LineBUSINESS® and Touch 1
Long Distance. Z-LineHOME and Z-LineBUSINESS are residential and business
versions, respectively, of our flagship offering, the Z-Line®. The Z-Line is
local telephone service, typically bundled with long distance and enhanced
features, including a suite of our proprietary Internet-accessible and
voice-activated functions. Z-Lines enhanced features include voicemail, Find
Me call forwarding and our recently introduced Personal Voice Assistant, or
PVA, which utilizes voice-recognition technology so that users can access a
secure, online address book from any phone using simple voice commands in order
to send voice emails, find contact information and dial numbers, among other
things.

We offer our Z-LineHOME and Z-LineBUSINESS services in forty-seven states.
Z-LineBUSINESS is particularly suited to businesses having multiple,
geographically diverse locations. With us, these multi-location businesses
deal with a single telephone company instead of a myriad of local phone
companies. The majority of our Z-Line customers are in ten states.

Touch 1 Long Distance is a residential long distance telephone service. We
gained nearly all these customers in our acquisition of Touch 1 Communications,
Inc. in 2000. We offer Touch 1 Long Distance nationwide, but we do not
actively market this service.

At the wholesale level, we provide telephone and enhanced communications
services and operational support services to other companies for their use in
providing telephone and enhanced communications services to their own end-user
customers.

2. BASIS OF PRESENTATION

The accompanying unaudited consolidated financial statements have been
prepared by us in accordance with accounting principles generally accepted in
the United States of America for interim financial information and are in the
form prescribed by the Securities and Exchange Commission in instructions to
Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include
all of the information and footnotes for complete financial statements as
required by accounting principles generally accepted in the United States of
America. The interim unaudited financial statements should be read in
conjunction with our audited financial statements as of and for the year ended
December 31, 2002, included in our Annual Report on Form 10-K. In the opinion
of management, all adjustments considered necessary for a fair presentation
have been included. Operating results for the three and six months ended June
30, 2003 are not necessarily indicative of the results that may be expected for
the year ending December 31, 2003.

RECLASSIFICATION

Certain amounts in the consolidated statements of operations for the three
and six months ended June 30, 2002 have been reclassified to conform to the
presentation for three and six months ended June 30, 2003.

RECENT ACCOUNTING PRONOUNCEMENTS

In November 2002, the Emerging Issues Task Force (EITF) of the Financial
Accounting Standards Board (FASB) reached a consensus on EITF No. 00-21,
Accounting for Revenue Arrangements with Multiple Element Deliverables. The
Issue addresses how to account for arrangements that may involve the delivery
or performance of multiple products, services and/or rights to use assets.
Revenue arrangements with multiple deliverables should be divided into separate
units of accounting if the deliverables in the arrangement meet certain
criteria. Arrangement consideration should be allocated among the separate
units of accounting based on their relative fair values. The Issue also
supersedes certain guidance set forth in Staff Accounting Bulletin
No. 101 (SAB
101),

7



---



##### Table of Contents



Revenue Recognition in Financial Statements. The final consensus is
applicable to agreements entered into in quarters beginning after June 15,
2003, with early adoption permitted. Additionally, companies are permitted to
apply the consensus guidance to all existing arrangements as a cumulative
effect of a change in accounting principle. We adopted this new pronouncement
effective July 1, 2003.

In May 2003, the FASB issued SFAS No. 150, Accounting for Certain
Financial Instruments with Characteristics of Both Liabilities and Equity.
This statement establishes standards for how an issuer classifies and measures
certain financial instruments with characteristics of both liabilities and
equity. This statement is effective for financial instruments entered into or
modified after May 31, 2003, and otherwise is effective for our quarter
beginning July 1, 2003. This new pronouncement will have an impact on our
financial position, specifically the classification of our mandatorily
redeemable convertible preferred stock, and we are in the process of assessing
the impact.

In June 2003, the FASB issued SFAS 149, An Amendment of Statement 133 on
Derivative Instruments and Hedging Activities.This Statement amends and
clarifies financial accounting and reporting for hedging activities and
derivative instruments, including certain derivative instruments embedded in
other contracts. This Statement is effective for contracts entered into or
modified after June 30, 2003. The Company will adopt SFAS 149 in the third
quarter of 2003 and is currently evaluating the effect, if any, that its
adoption will have on its consolidated financial statements.

3. WHOLESALE SERVICES

In
February 2003, we executed an agreement allowing the resale of our local
wireline telecommunications services and provision of ancillary services with
Sprint Communications Company L.P. (Sprint). Under this agreement, we will
provide Sprint access to our web-integrated, enhanced communications platform
and operational support systems. This contract includes various per minute, per
line, and other charges that are being recorded as revenue as earned. We are
the primary obligor for expenses under the agreement and therefore, are
recording revenues using a gross presentation, consistent with the method used
for our wholesale services agreement with MCI. This method results in all per
line, per minute and certain direct costs being recorded as revenues and the
corresponding expenses recorded in the appropriate operating expense line. As a
result of this treatment, increases or decreases in pricing or volume that
include direct costs would have no impact on net income as the amount is
recorded in an equivalent amount in both revenue and expense. Our wholesale
services agreement with Sprint is non-exclusive in nature.

We are deferring $1.0 million of revenues for pre-contract payments by
recognizing this amount ratably over the life of the agreement. Additionally,
we received a $1.0 million payment that could potentially be returned to Sprint
as a bill credit, over several months, as a stimulus for the achievement of
reaching certain line-count thresholds. The stimulus payment would be recorded
as revenue only if Sprint does not achieve the required line thresholds upon
termination of the contract. As of June 30, 2003, we have recorded the $1.0
million stimulus payment as long-term deferred revenue.

As of June 30, 2003, under our contract with Sprint, we had approximately
$9.7 million of deferred revenue, of which $2.3 million is long-term deferred
revenue.

On November 1, 2002 we significantly amended the terms or our agreement
with MCI. This amendment was made as a result of MCIs bankruptcy filing on
July 21, 2002. The significant financial changes in this amendment are the
elimination of the $50 million limited-term technology license fee, increases
to various fees calculated on a per minute and per line basis, certain
additional fees for services provided, elimination of exclusivity clauses, a
reduction to the monthly minimum payments and forgiveness of certain amounts to
be repaid to MCI.

As of June 30, 2003, under our contract with MCI, we had recorded
approximately $9.6 million in deferred revenue, of which $4.3 million is
long-term deferred revenue. This deferred revenue is being recognized over the
term of the agreement and may be recognized earlier if the agreement is
terminated before its stated termination date.

4. ACCOUNTS RECEIVABLE AGREEMENT

In July 2000, we entered into an accounts receivable agreement with RFC
Capital Corporation, a division of Textron, Inc. (RFC), providing for the
sale of certain of our accounts receivable to RFC. RFC has agreed to purchase
up to $25.0 million of our accounts receivable. This agreement was extended for
one year under substantially similar terms in July 2003. The current agreement
expires in July 2004. The purchase of the receivables is at the option of RFC
and they utilize selection criteria to determine which receivables will be
purchased. We sold receivables to RFC at a 28% discount from inception of the
agreement through March 2002. Since March of 2002 we have sold our receivables
at a discount rate of 19%; this rate is negotiable and may change according to

8



---



##### Table of Contents



collection experience. The collection percentage for receivables sold to
RFC has been approximately 92% since the inception of the agreement. We receive
an additional payment from RFC for servicing the assets in an amount equal to
every dollar collected over the advance rate, less certain fees. The accounts
receivable agreement does not have a minimum receivable sales requirement.

We sold approximately $51.5 and $74.5 million of receivables to RFC, for
net proceeds of approximately $41.7 and $58.0 million, during the six months
ended June 30, 2003 and 2002, respectively. A net receivable servicing asset of
approximately $10.3 million is included in our accounts receivable balance at
June 30, 2003. We recorded costs related to the agreement of approximately $0.2
and $0.4 million for the three months ended June 30, 2003 and 2002,
respectively, and $0.4 and $0.7 million for the six months ended June 30, 2003
and 2002, respectively. Included in accounts payable and accrued liabilities
are advances for unbilled receivables in the amount of $1.0 million at June 30,
2003. We are responsible for the continued servicing of the receivables sold.

5. INTANGIBLE ASSETS

The change in the carrying amount of our major class of intangible assets
(as a result of our acquisition of Touch 1 in April of 2000) are as follows, as
we do not have any intangible assets that will not be amortized:

|                                           |  |               |       |              |  |                |       |  |  |   |       | 
|------------------------------------------ |  | ------------- | ----- | ------------ |  | -------------- | ----- |  |  | - | ----- | 
|                                           |  | June 30, 2003
|                                           |  |              
|                                           |  | Carrying      |       | Accumulated  |  | Net Intangible
|                                           |  | Amount        |       | Amortization |  | Assets        
|                                           |  |               |       |              |  |               
|Intangible assets subject to amortization: |  |               |       |              |  |                |       |  |  |   |       | 
|Customer related intangible assets         |  | $             | 9,145 |              |  | $              | 5,944 |  |  | $ | 3,201 | 

The following table presents current and expected amortization expense of
the existing intangible assets for the six months ended June 30, 2003 and for
each of the following periods:

|                                                                |      |   |     |       | 
|--------------------------------------------------------------- | ---- | - | --- | ----- | 
|Aggregate amortization expense:                                 |      |   |     |      
|For the six months ended June 30, 2003                          |      | $ | 915 |      
|Expected amortization expense for the remainder of 2003         |      |   | 915 |      
|Expected amortization expense for the years ending December 31, |      |   |     |      
|                                                                | 2004 |   | $   | 1,830 | 
|                                                                | 2005 |   |     | 456   | 

We did not record any impairment for the three or six months ended June
30, 2003.

6. PLAN TO REPURCHASE COMMON SOCK

In March 2003, our Board of Directors authorized the repurchase of up to
one million shares of our common stock for a twelve-month period. We have not
purchased any stock under this plan.

7. RELATED PARTY

In February 2003, we received the complete repayment of a loan in the
amount of approximately $0.5 million from one of our executive officers that is
also a member of our Board of Directors. This promissory note was originally
recorded as a reduction to stockholders deficit when issued.

8. COMMITMENTS AND CONTINGENCIES

We have disputed billings, access and transport charges from certain
inter-exchange carriers (IXCs) and incumbent local exchange carriers
(ILECs). We contend that the invoicing and billings of these particular
access charges were not in accordance with the interconnection, service level,
or tariff agreements entered between us and certain parties. We have not paid
the majority of these disputed amounts. We do not expense amounts where, in our
judgment we expect the dispute will be resolved in our favor. At June 30,
2003, we had total disputes of approximately $19.7 million, of which
approximately $5.5 million have been recorded as an expense in our statement of
operations.

For the customers of our wholesale clients provisioned using our company
code, we are the customer of record for the regional bell operating companies
wholesale billing. If one of our wholesale customers would default on ILEC
payments, become insolvent, or file

9



---



##### Table of Contents



bankruptcy it is very likely that the state commissions would require us
to continue providing services to the end user of our wholesale client for at
least a 90-day period.

9. RESTRUCTURING CHARGES

In April of 2002, we approved and implemented a restructuring to enhance
our future cash flows and operating earnings. The restructuring included a
reduction of force coupled with the closure of our North Dakota call centers
and our New York sales office. In accordance with EITF 94-3 the restructuring
costs were recognized as liabilities at the time management committed us to the
plan. Management determined that these costs provided no future economic
benefit to us.

The restructuring charge included employee termination expenses, lease
abandonment expenses and lease settlement costs. In addition, we agreed to a
settlement to exit the two leases for our call centers in North Dakota as of
July 1, 2002. We have recorded a lease abandonment charge representing the
future lease payments for our New York office as a liability and we are
scheduled to make monthly cash payments through August 2005. All other expenses
associated with this restructuring have been paid in full.

The following table shows the restructuring charges and related accruals
recognized under the plan and the effect on our consolidated financial
position:

|                             |  |             |      |            |  |             |      |       |  |   |     |   |  |   |        |  
|---------------------------- |  | ----------- | ---- | ---------- |  | ----------- | ---- | ----- |  | - | --- | - |  | - | ------ | -
|                             |  | Employee    |      | Lease      |  | Lease       |      |       |  |  
|                             |  | Termination |      | Settlement |  | Abandonment |      |       |  |  
|                             |  | Benefits    |      | Costs      |  | Costs       |      | Total
|                             |  |             |      |            |  |             |      |      
|Balance at January 1, 2002   |  | $           |     |            |  | $           |     |       |  | $ |    |   |  | $ |       |  
|Plan Charges                 |  |             | 913  |            |  |             | 325  |       |  |   | 623 |   |  |   | 1,861  |  
|Cash paid                    |  |             | (913 | )          |  |             | (325 | )     |  |   | (72 | ) |  |   | (1,310 | )
|                             |  |             |      |            |  |             |      |       |  |   |     |   |  |   |        |  
|Balance at December 31, 2002 |  |             |     |            |  |             |     |       |  |   | 551 |   |  |   | 551    |  
|Cash paid                    |  |             |     |            |  |             |     |       |  |   | (99 | ) |  |   | (99    | )
|                             |  |             |      |            |  |             |      |       |  |   |     |   |  |   |        |  
|Balance at June 30, 2003     |  | $           |     |            |  | $           |     |       |  | $ | 452 |   |  | $ | 452    |  
|                             |  |             |      |            |  |             |      |       |  |   |     |   |  |   |        |  

10. STOCK-BASED COMPENSATION

SFAS No. 123, Accounting for Stock-Based Compensation requires entities
to recognize as an expense, over the vesting period, the fair value of the
options or utilize the accounting for employee stock options used under
Accounting Principles Board (APB) Opinion No. 25. We apply the provisions of
APB Opinion No. 25 and consequently recognize compensation expense over the
vesting period for grants made to employees and directors only if, on the
measurement date, the market price of the underlying stock exceeds the exercise
price. We provide the pro forma net income and earnings per share disclosures
as required under SFAS No. 123 for grants made as if the fair value method
defined in SFAS No. 123 had been applied. We recognize expense over the vesting
period of the grants made to non-employees utilizing the Black-Scholes stock
valuation model to calculate the value of the option on the measurement date.

The following table illustrates, in accordance with the provisions of SFAS
No. 148, Accounting for Stock-Based Compensation  Transition and Disclosure,
an Amendment of SFAS 123, Accounting for Stock-Based Compensation, the effect
on net loss and earnings per share if we had applied the fair value recognition
provisions of SFAS No. 123, to stock-based employee compensation.

|                                                                                                    |           |   |                    |       |                  |   |        |       |      |   |         |       |   |   |         |       |  
|--------------------------------------------------------------------------------------------------- | --------- | - | ------------------ | ----- | ---------------- | - | ------ | ----- | ---- | - | ------- | ----- | - | - | ------- | ----- | -
|                                                                                                    |           |   | Three Months Ended |       | Six Months Ended
|                                                                                                    |           |   | June 30,           |       | June 30,        
|                                                                                                    |           |   |                    |       |                 
|                                                                                                    |           |   | 2003               |       | 2002             |   | 2003   |       | 2002
|                                                                                                    |           |   |                    |       |                  |   |        |       |     
|Net loss, as reported                                                                               |           | $ | (10,721            | )     |                  | $ | (3,724 | )     |      | $ | (18,109 | )     |   | $ | (18,249 | )    
|Total stock based employee compensation determined
under the fair value based method for all awards |           |   | (1,238             | )     |                  |   | (3,724 | )     |      |   | (4,397  | )     |   |   | (7,445  | )    
|                                                                                                    |           |   |                    |       |                  |   |        |       |      |   |         |       |   |   |         |      
|Net loss, pro forma                                                                                 |           | $ | (11,959            | )     |                  | $ | (7,448 | )     |      | $ | (22,506 | )     |   | $ | (25,694 | )    
|                                                                                                    |           |   |                    |       |                  |   |        |       |      |   |         |       |   |   |         |      
|Basic and Diluted Net Loss
Per Common Share                                                         |           |   |                    |       |                  |   |        |       |      |   |         |       |   |   |         |      
|As reported                                                                                         |           | $ | (0.30              | )     |                  | $ | (0.11  | )     |      | $ | (0.51   | )     |   | $ | (0.53   | )    
|                                                                                                    | Pro forma |   |                    | (0.34 | )                |   |        | (0.21 | )    |   |         | (0.64 | ) |   |         | (0.74 | )

10



---



##### Table of Contents



We calculated the fair value of each grant on the date of grant using the
Black-Scholes option pricing model. The following assumptions were used for
each respective period:

|                             |  |                    |      |                  |  |         |      |         |  |  |      |   |  |  |      |  
|---------------------------- |  | ------------------ | ---- | ---------------- |  | ------- | ---- | ------- |  |  | ---- | - |  |  | ---- | -
|                             |  | Three Months Ended |      | Six Months Ended
|                             |  | June 30,           |      | June 30,        
|                             |  |                    |      |                 
|                             |  | 2003               |      | 2002             |  | 2003    |      | 2002   
|                             |  |                    |      |                  |  |         |      |        
|Discount Rate                |  |                    | 2.5  | %                |  |         | 4.6  | %       |  |  | 2.6  | % |  |  | 4.6  | %
|Volatility                   |  |                    | 97.3 | %                |  |         | 92.6 | %       |  |  | 97.0 | % |  |  | 92.6 | %
|Average Option Expected Life |  | 5 years            |      | 5 years          |  | 5 years |      | 5 years

No options have expired and no dividends have been paid on common stock
since our inception.

11. COMPUTATION OF NET LOSS PER SHARE

Basic net loss per share is computed by dividing net loss attributable to
common stockholders by the weighted average number of common shares outstanding
during the period. Incremental shares of common stock equivalents were not
included in the calculation of net loss per share as the inclusion of such
equivalents would be anti-dilutive.

Net loss per share is calculated as follows:

|                                          |                                            |                                                                                     |                                              |                  |        |         |   |            |        |        |   |            |        |         |   |            |         |         |  
|----------------------------------------- | ------------------------------------------ | ----------------------------------------------------------------------------------- | -------------------------------------------- | ---------------- | ------ | ------- | - | ---------- | ------ | ------ | - | ---------- | ------ | ------- | - | ---------- | ------- | ------- | -
|                                          |                                            |                                                                                     |                                              |                 
|                                          |                                            | Three Months Ended                                                                  |                                              | Six Months Ended
|                                          |                                            | June 30,                                                                            |                                              | June 30,        
|                                          |                                            |                                                                                     |                                              |                 
|                                          |                                            | 2003                                                                                |                                              | 2002             |        | 2003    |   | 2002      
|                                          |                                            |                                                                                     |                                              |                  |        |         |   |           
|Basic and diluted net loss per
    share: |                                            |                                                                                     |                                              |                  |        |         |   |            |        |        |   |            |        |         |   |           
|                                          |                                            | Net income (loss)                                                                   |                                              | $                | (6,008 | )       |   | $          | 259    |        |   | $          | (9,113 | )       |   | $          | (10,348 | )      
|                                          |                                            | Less mandatorily redeemable convertible preferred
    stock dividends and accretion |                                              |                  | (4,667 | )       |   |            | (3,937 | )      |   |            | (8,904 | )       |   |            | (7,809  | )      
|                                          |                                            | Less deemed dividend related to beneficial
    conversion feature                   |                                              |                  | (46    | )       |   |            | (46    | )      |   |            | (92    | )       |   |            | (92     | )      
|                                          |                                            |                                                                                     |                                              |                  |        |         |   |            |        |        |   |            |        |         |   |           
|                                          |                                            |                                                                                     | Net loss attributable to common stockholders |                  | $      | (10,721 | ) |            | $      | (3,724 | ) |            | $      | (18,109 | ) |            | $       | (18,249 | )
|                                          |                                            |                                                                                     |                                              |                  |        |         |   |            |        |        |   |            |        |         |   |           
|                                          | Weighted average common shares outstanding |                                                                                     |                                              | 35,305,448       |        |         |   | 35,074,936 |        |        |   | 35,286,953 |        |         |   | 34,693,186 |        
|                                          |                                            |                                                                                     |                                              |                  |        |         |   |            |        |        |   |            |        |         |   |           
|                                          | Basic and diluted net loss per share       |                                                                                     | $                                            | (0.30            | )      |         | $ | (0.11      | )      |        | $ | (0.51      | )      |         | $ | (0.53      | )      
|                                          |                                            |                                                                                     |                                              |                  |        |         |   |            |        |        |   |            |        |         |   |           

The following table outlines the shares of common stock equivalents that
could potentially dilute basic earnings per share in the future but were not
included in the computation of diluted net loss per share:

|                                                                      |                                                               |  |            |            | 
|--------------------------------------------------------------------- | ------------------------------------------------------------- |  | ---------- | ---------- | 
|                                                                      |                                                               |  | June 30,  
|                                                                      |                                                               |  | 2003      
|                                                                      |                                                               |  |           
|Unexercised stock options                                             |                                                               |  | 12,849,745 |           
|Unexercised warrants                                                  |                                                               |  | 10,580,985 |           
|Mandatorily redeemable preferred stock convertible into common shares |                                                               |  | 29,025,530 |           
|                                                                      |                                                               |  |            |           
|                                                                      | Total potentially dilutive shares of common stock equivalents |  |            | 52,456,260 | 
|                                                                      |                                                               |  |            |           

12. LEGAL AND REGULATORY PROCEEDINGS

During June and July 2001, three separate class action lawsuits were filed
against us, certain of our current and former directors and officers (the
D&Os) and firms engaged in the underwriting (the Underwriters) of our
initial public offering of stock (the IPO). The lawsuits, along with
approximately 310 other similar lawsuits filed against other issuers arising
out of initial public offering allocations, have been assigned to a Judge in
the United States District Court for the Southern District of New York for
pretrial coordination. The lawsuits against us have been consolidated into a
single action. A consolidated amended complaint was filed

11



---



##### Table of Contents



on April 20, 2002. A Second Corrected Amended Complaint (the Amended
Complaint), which is the operative complaint, was filed on July 12, 2002.

The Amended Complaint is based on the allegations that our registration
statement on Form S-1, filed with the Securities and Exchange Commission
(SEC) in connection with the IPO, contained untrue statements of material
fact and omitted to state facts necessary to make the statements made not
misleading by failing to disclose that the underwriters allegedly had received
additional, excessive and undisclosed commissions from, and allegedly had entered into
unlawful tie-in and other arrangements with, certain customers to whom they
allocated shares in the IPO. The plaintiffs in the Amended Complaint assert
claims against us and the D&Os pursuant to Section 11 of the Securities Act of
1933 and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5
promulgated by the SEC thereunder. The plaintiffs in the Amended Complaint
assert claims against the D&Os pursuant to Sections 11 and 15 of the Securities
Act of 1933 and Sections 10(b) and 20(a) of the Securities Exchange Act of 1934
and Rule 10b-5 promulgated by the SEC thereunder. The plaintiffs seek an
undisclosed amount of damages, as well as pre-judgment and post-judgment
interest, costs and expenses, including attorneys fees, experts fees and
other costs and disbursements. Initial discovery has begun. We believe we are
entitled to indemnification from our Underwriters.

A memorandum of understanding has been reached by lawyers for the
plaintiffs, the issuers and insurers of the issuers. The memorandum sets forth
the terms of a proposed settlement, the principal components of which are (i) a
release of all claims against the issuers and their officers and directors,
(ii) the assignment by the issuers to the plaintiffs of certain claims the
issuers may have against the Underwriters and (iii) an undertaking by the
insurers to ensure the plaintiffs receive not less than $1 billion in
connection with claims against the Underwriters. Our board of directors has
approved the memorandum of understanding. To be binding, the settlement must
be approved by substantially all the issuers and thereafter submitted to and
approved by the court. The settlement will not be binding upon any plaintiffs
electing to opt-out of the settlement.

On September 20, 2002 one of our shareholders, Metropolitan Nashville
Employee Benefit Board (Metro Nashville), filed suit against us alleging that
we wrongfully and improperly delayed providing them with a stock certificate
and that during the time of such delay our stock price declined and they were
unable to sell or to take steps to protect the value of their shares. Metro
Nashville seeks compensatory damages in excess of $18 million, plus interest,
and punitive damages of $18 million. Discovery has begun. We believe the
lawsuit is without merit and intend to vigorously oppose the allegations.

On August 6, 2002, we filed a complaint against Southwestern Bell
Telephone Company (SWBT) before the Public Utility Commission of Texas
(PUCT), requesting that the PUCT enjoin SWBT from disconnecting our access to
customers in Texas on the basis of a billing dispute between the parties. The
billing dispute centered on whether we owed SWBT certain amounts for
alternatively billed service.  On August 23, 2002, the PUCT issued, in part, the injunctive relief
requested by us, making clear that service not be interrupted. On April 17,
2003, we entered into a settlement agreement with SWBT. The terms of the
settlement are confidential. We do not expect the settlement to have a
material effect on our financial condition or our results of our operations.

In the ordinary course of business, we are involved in legal and
regulatory proceedings, disputes and tax audits at the federal, state and local
level that are generally incidental to our operations. In addition, from time
to time, we are the subject of customer and vendor complaints filed with the
state utility commissions of the states in which they operate or the Federal
Communications Commission. Most complaints are handled informally and at this
time there are no formal proceedings pending. While there can be no assurance
of the ultimate disposition of incidental legal proceedings or customer
complaints, we do not believe their disposition will have a material adverse
effect on our consolidated results of operations or financial position.

13. SEGMENT REPORTING

We have two reportable operating segments: Retail Services and Wholesale
Services. Prior to April 2002 we had only one reportable segment, our retail
services segment.

The retail services segment includes our Z-LineHOME and Z-LineBUSINESS
services that provide bundled local and long-distance telephone services in
combination with enhanced communication features accessible through the
telephone, the Internet and certain personal digital assistants. We offer
Z-LineHOME and Z-LineBUSINESS in 47 states. Our customers are concentrated
primarily in metropolitan areas in 10 states for both our Z-LineHOME and
Z-LineBUSINESS services. The retail segment also includes our Touch 1
residential long-distance offering that is available nationwide.

12



---



##### Table of Contents



The wholesale services segment allows other telephone companies to offer
telephone exchange and enhanced services to residential and small business
customers using us as their primary platform for delivery. This service is
currently available in 47 states. Sprint is our primary customer for this
offering.

We evaluate the performance of each business unit based on operating
income, exclusive of adjustments for special items. Special items are
transactions or events that are included in our reported consolidated results
but are excluded from segment results due to managements belief that they are
nonrecurring or nonoperational in nature. It is also important to understand when
viewing our segment results that we only record direct expenses in our
wholesale services segment and, therefore, all employee benefits, occupancy,
insurance, and other indirect or overhead related expenses are reflected in the
retail services segment. We are in the process of reviewing and possibly
adopting a methodology for internal reporting purposes that would allocate
these indirect and overhead related expenses to the respective units or
possibly separating these expenses from the reported segments. The following
summarizes the financial information concerning our reportable segments for the
periods presented:

The following tables summarize the financial information concerning our
reportable segments for the periods presented:

|                              |  |                                  |        |                                  |  |              |        |          |  |          |        |              |  |  |        |   |  |  |       |  |  |  |        | 
|----------------------------- |  | -------------------------------- | ------ | -------------------------------- |  | ------------ | ------ | -------- |  | -------- | ------ | ------------ |  |  | ------ | - |  |  | ----- |  |  |  | ------ | 
|                              |  | Three Months ended June 30, 2003 |        | Three Months ended June 30, 2002
|                              |  |                                  |        |                                 
|                              |  | Retail                           |        | Wholesale                        |  |              |        |          |  | Retail   |        | Wholesale    |  |  |        |  
|                              |  | Services                         |        | Services                         |  | Consolidated |        | Services |  | Services |        | Consolidated
|                              |  |                                  |        |                                  |  |              |        |          |  |          |        |             
|Revenues                      |  |                                  | 53,971 |                                  |  |              | 15,904 |          |  |          | 69,875 |              |  |  | 55,571 |   |  |  | 6,654 |  |  |  | 62,225 | 
|Segment results               |  |                                  | (2,850 | )                                |  |              | 3,265  |          |  |          | 415    |              |  |  | (963   | ) |  |  | 2,313 |  |  |  | 1,350  | 
|Depreciation and amortization |  |                                  | 5,380  |                                  |  |              | 622    |          |  |          | 6,002  |              |  |  | 5,666  |   |  |  | 337   |  |  |  | 6,003  | 
|Capital expenditures          |  |                                  | 2,432  |                                  |  |              | 223    |          |  |          | 2,655  |              |  |  | 2,698  |   |  |  | 2,777 |  |  |  | 5,475  | 

All 2003
and 2002 consolidated segment results reconcile to the consolidated
financial information above with the exception of the segment results reconciled
below:

|                                              |  |                    |        |                    |  |  |        |  
|--------------------------------------------- |  | ------------------ | ------ | ------------------ |  |  | ------ | -
|                                              |  | Three months ended |        | Three months ended
|Reconciliation of segment results to net loss |  | June 30, 2003      |        | June 30, 2002     
|                                              |  |                    |        |                   
|Consolidated segment operating loss           |  |                    | 415    |                    |  |  | 1,350  |  
|Retroactive reduction to network access rate  |  |                    |       |                    |  |  | 8,981  |  
|Asset impairment charge                       |  |                    |       |                    |  |  | (1,129 | )
|Restructuring charge                          |  |                    |       |                    |  |  | (1,861 | )
|Depreciation and amortization                 |  |                    | (6,002 | )                  |  |  | (6,003 | )
|Interest and other income                     |  |                    | 239    |                    |  |  | 307    |  
|Interest and other expense                    |  |                    | (660   | )                  |  |  | (1,386 | )
|                                              |  |                    |        |                    |  |  |        |  
|Net
income (loss)                             |  |                    | (6,008 | )                  |  |  | 259    |  
|                                              |  |                    |        |                    |  |  |        |  

|                              |  |                                |         |                                |  |              |        |          |  |          |         |              |  |  |         |  |  |  |        |  |  |  |         | 
|----------------------------- |  | ------------------------------ | ------- | ------------------------------ |  | ------------ | ------ | -------- |  | -------- | ------- | ------------ |  |  | ------- |  |  |  | ------ |  |  |  | ------- | 
|                              |  | Six Months ended June 30, 2003 |         | Six Months ended June 30, 2002
|                              |  |                                |         |                               
|                              |  | Retail                         |         | Wholesale                      |  |              |        |          |  | Retail   |         | Wholesale    |  |  |         | 
|                              |  | Services                       |         | Services                       |  | Consolidated |        | Services |  | Services |         | Consolidated
|                              |  |                                |         |                                |  |              |        |          |  |          |         |             
|Revenues                      |  |                                | 101,287 |                                |  |              | 28,864 |          |  |          | 130,151 |              |  |  | 112,839 |  |  |  | 6,654  |  |  |  | 119,493 | 
|Segment results               |  |                                | (7,097  | )                              |  |              | 10,259 |          |  |          | 3,162   |              |  |  | 13,946  |  |  |  | 853    |  |  |  | 14,799  | 
|Depreciation and amortization |  |                                | 10,798  |                                |  |              | 1,231  |          |  |          | 12,029  |              |  |  | 11,245  |  |  |  | 337    |  |  |  | 11,582  | 
|Capital expenditures          |  |                                | 5,297   |                                |  |              | 486    |          |  |          | 5,783   |              |  |  | 3,988   |  |  |  | 7,781  |  |  |  | 11,769  | 
|Identifiable assets           |  |                                | 135,146 |                                |  |              | 19,852 |          |  |          | 154,998 |              |  |  | 100,076 |  |  |  | 10,489 |  |  |  | 110,565 | 

All 2003
and 2002 consolidated segment results reconcile to the
consolidated financial information above with the exception of the
segment results reconciled below:

|                                              |  |                  |         |                  |  |  |         |  
|--------------------------------------------- |  | ---------------- | ------- | ---------------- |  |  | ------- | -
|                                              |  | Six months ended |         | Six months ended
|Reconciliation of segment results to net loss |  | June 30, 2003    |         | June 30, 2002   
|                                              |  |                  |         |                 
|Consolidated segment operating loss           |  |                  | 3,162   |                  |  |  | 14,799  |  
|Retroactive reduction to network access rates |  |                  |        |                  |  |  | (8,981  | )
|Asset impairment charge                       |  |                  |        |                  |  |  | (1,129  | )
|Wholesale development costs                   |  |                  |        |                  |  |  | (1,081  | )
|Restructuring charge                          |  |                  |        |                  |  |  | (1,861  | )
|Depreciation and amortization                 |  |                  | (12,029 | )                |  |  | (11,582 | )
|Interest and other income                     |  |                  | 1,164   |                  |  |  | 1,484   |  
|Interest and other expense                    |  |                  | (1,410  | )                |  |  | (1,997  | )
|                                              |  |                  |         |                  |  |  |         |  
|Net loss                                      |  |                  | (9,113  | )                |  |  | (10,348 | )
|                                              |  |                  |         |                  |  |  |         |  

13



---



##### Table of Contents



14. SUBSEQUENT EVENTS

On July 27, 2003 we renewed our accounts receivable agreement with RFC
under substantially similar terms. This agreement terminates on July 27, 2004.

On
August 7, 2003, we amended our wholesale services agreement with MCI to terminate the
agreement on December 31, 2003. This will result in the acceleration of
recognition of approximately $5.6 million of unrecognized revenue, as of June
30, 2003, that was being deferred through December 31, 2004 to be recognized
ratably from the amendment date through December 31, 2003.




ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

You should read the following discussion together with the consolidated
financial statements and related notes and other sections of this Quarterly
Report on Form 10-Q. This discussion contains forward-looking statements that
involve risks and uncertainties. Our actual results may differ materially from
those projected in the forward-looking statements as a result of various other
factors. Factors that may affect our results of operations include, but are not
limited to, our limited operating history and cumulative losses, uncertainty of
customer demand, rapid expansion, potential software failures and errors, power
failures, potential network and interconnection failure, dependence on local
exchange carriers, dependence on third party vendors, dependence on key
personnel, dependence on key wholesale customers, uncertainty of government
regulation, legal and regulatory uncertainties, and competition. We disclaim
any obligation to update information contained in any forward-looking
statement. In addition to these factors, other factors that could affect our
financial results are described in our Annual Report on Form 10-K, filed with
the Securities and Exchange Commission on March 30, 2003.

OVERVIEW

We provide advanced, integrated telecommunications services targeted to
residential and small business subscribers. We offer local and long distance
telephone services in combination with enhanced communication features
accessible through the telephone, the Internet and certain personal digital
assistants.

We began providing our services on a wholesale basis to other carriers
during the first quarter of 2002. This service provides other companies with
the ability to provide local, long-distance and enhanced telephone services to
residential and small business customers by utilizing our telephone exchange
services, enhanced services platform, infrastructure and back-office
operations. The nature of our business is evolving, and we have a limited
operating history.

CONSOLIDATED RESULTS OF OPERATIONS

The following is a discussion of significant changes in our results of
operations, which occurred in the three and six months ended June 30, 2003
compared to the same period in the prior year. The following table summarizes
the approximate changes in selected operating items and includes dollar
changes, percentage changes and percentage of revenues to facilitate our
discussions that follow.

14



---



##### Table of Contents



|                                          |                               |                                                                                 |      |                            |       |           |      |               |      |                        |      |       |       |      |        |         |           |   |       |       |        |   |       |       |       |  
|----------------------------------------- | ----------------------------- | ------------------------------------------------------------------------------- | ---- | -------------------------- | ----- | --------- | ---- | ------------- | ---- | ---------------------- | ---- | ----- | ----- | ---- | ------ | ------- | --------- | - | ----- | ----- | ------ | - | ----- | ----- | ----- | -
|                                          |                               |                                                                                 |      | For the three months ended |       | Amount    |      | Percentage    |      |                        |      |       |       |      |        |        
|                                          |                               |                                                                                 |      | June 30,                   |       | Change    |      | Change        |      | Percentage of Revenues
|                                          |                               |                                                                                 |      |                            |       | Favorable |      | Favorable     |      |                       
|                                          |                               |                                                                                 |      | 2003                       |       | 2002      |      | (Unfavorable) |      | (Unfavorable)          |      | 2003  |       | 2002
|                                          |                               |                                                                                 |      |                            |       |           |      |               |      |                        |      |       |       |     
|                                          |                               |                                                                                 |      | (In Millions)             
|Results
of Operations:                    |                               |                                                                                 |      |                            |       |           |      |               |      |                        |      |       |       |      |        |         |           |   |       |       |        |   |       |      
|Revenues                                  |                               | $                                                                               | 69.9 |                            |       | $         | 62.2 |               |      | $                      | 7.7  |       |       |      | 12.4   | %       |           |   | 100.0 | %     |        |   | 100.0 | %    
|                                          |                               |                                                                                 |      |                            |       |           |      |               |      |                        |      |       |       |      |        |         |           |   |       |       |        |   |       |      
|Operating expenses:                       |                               |                                                                                 |      |                            |       |           |      |               |      |                        |      |       |       |      |        |         |           |   |       |       |        |   |       |      
|                                          | Network operations            |                                                                                 |      | 30.9                       |       |           |      | 18.0          |      |                        |      | (12.9 | )     |      |        | (71.7)  | %         |   |       | 44.2  | %      |   |       | 28.9  | %    
|                                          | Sales and marketing           |                                                                                 |      | 6.6                        |       |           |      | 2.5           |      |                        |      | (4.1  | )     |      |        | (164.0) | %         |   |       | 9.4   | %      |   |       | 4.0   | %    
|                                          | General and administrative    |                                                                                 |      | 31.9                       |       |           |      | 31.4          |      |                        |      | (0.5  | )     |      |        | (1.6)   | %         |   |       | 45.6  | %      |   |       | 50.5  | %    
|                                          | Asset impairment              |                                                                                 |      |                           |       |           |      | 1.1           |      |                        |      | 1.1   |       |      |        | 100     | %         |   |       |      | %      |   |       | 1.8   | %    
|                                          | Restructuring charge          |                                                                                 |      |                           |       |           |      | 1.9           |      |                        |      | 1.9   |       |      |        | 100     | %         |   |       |      | %      |   |       | 3.1   | %    
|                                          | Depreciation and amortization |                                                                                 |      | 6.0                        |       |           |      | 6.0           |      |                        |      |      |       |      |        |        | %         |   |       | 8.6   | %      |   |       | 9.6   | %    
|                                          |                               |                                                                                 |      |                            |       |           |      |               |      |                        |      |       |       |      |        |         |           |   |       |       |        |   |       |      
|                                          |                               | Total operating expenses                                                        |      |                            | 75.4  |           |      |               | 60.9 |                        |      |       | (14.5 | )    |        |         | (23.8)    | % |       |       | 107.9  | % |       |       | 97.9  | %
|                                          |                               |                                                                                 |      |                            |       |           |      |               |      |                        |      |       |       |      |        |         |           |   |       |       |        |   |       |      
|                                          |                               | Operating income (loss)                                                         |      |                            | (5.5  | )         |      |               | 1.3  |                        |      |       | (6.8  | )    |        |         | (523.1)   | % |       |       | (7.9)  | % |       |       | 2.1   | %
|                                          |                               |                                                                                 |      |                            |       |           |      |               |      |                        |      |       |       |      |        |         |           |   |       |       |        |   |       |      
|Nonoperating income (expense):            |                               |                                                                                 |      |                            |       |           |      |               |      |                        |      |       |       |      |        |         |           |   |       |       |        |   |       |      
|                                          | Interest and other income     |                                                                                 |      | 0.2                        |       |           |      | 0.3           |      |                        |      | (0.1  | )     |      |        | (33.3)  | %         |   |       | 0.3   | %      |   |       | 0.5   | %    
|                                          | Interest and other expense    |                                                                                 |      | (0.7                       | )     |           |      | (1.4          | )    |                        |      | 0.7   |       |      |        | 50.0    | %         |   |       | (1.0) | %      |   |       | (2.3) | %    
|                                          |                               |                                                                                 |      |                            |       |           |      |               |      |                        |      |       |       |      |        |         |           |   |       |       |        |   |       |      
|                                          |                               | Total nonoperating expense                                                      |      |                            | (0.5  | )         |      |               | (1.1 | )                      |      |       | 0.6   |      |        |         | 54.5      | % |       |       | (0.7)  | % |       |       | (1.8) | %
|                                          |                               |                                                                                 |      |                            |       |           |      |               |      |                        |      |       |       |      |        |         |           |   |       |       |        |   |       |      
|                                          |                               | Net income (loss)                                                               |      |                            | (6.0  | )         |      |               | 0.2  |                        |      |       | (6.2  | )    |        |         | (3,100.0) | % |       |       | (8.6)  | % |       |       | 0.3   | %
|                                          |                               | Less mandatorily redeemable convertible
preferred stock dividends and accretion |      |                            | (4.6  | )         |      |               | (3.9 | )                      |      |       | (0.7  | )    |        |         | (17.9)    | % |       |       | (6.6)  | % |       |       | (6.3) | %
|                                          |                               | Less deemed dividend related to beneficial
conversion feature                   |      |                            | (0.1  | )         |      |               | (0.1 | )                      |      |       |      |      |        |         |          | % |       |       | (0.1)  | % |       |       | (0.2) | %
|                                          |                               |                                                                                 |      |                            |       |           |      |               |      |                        |      |       |       |      |        |         |           |   |       |       |        |   |       |      
|                                          |                               | Net loss attributable to common stockholders                                    |      | $                          | (10.7 | )         |      | $             | (3.8 | )                      |      | $     | (6.9  | )    |        |         | (181.6)   | % |       |       | (15.3) | % |       |       | (6.1) | %
|                                          |                               |                                                                                 |      |                            |       |           |      |               |      |                        |      |       |       |      |        |         |           |   |       |       |        |   |       |      
|EBITDA                                    |                               | $                                                                               | 0.5  |                            |       | $         | 7.3  |               |      | $                      | (6.8 | )     |       |      | (93.2) | %       |           |   | 0.7   | %     |        |   | 11.7  | %    
|                                          |                               |                                                                                 |      |                            |       |           |      |               |      |                        |      |       |       |      |        |         |           |   |       |       |        |   |       |      
|Cash
Flow Data:                           |                               |                                                                                 |      |                            |       |           |      |               |      |                        |      |       |       |      |        |         |           |   |       |       |        |   |       |      
|Net cash provided by operating activities |                               | $                                                                               | 1.0  |                            |       | $         | 3.7  |               |      | $                      | (2.7 | )     |       |      | (73.0) | %       |           |   | *     |       |        |   | *     |      
|Net cash used in investing activities     |                               |                                                                                 | (2.6 | )                          |       |           | (6.3 | )             |      |                        | 3.7  |       |       |      | 58.7   | %       |           |   | *     |       |        |   | *     |      
|Net cash used in financing activities     |                               |                                                                                 | (1.2 | )                          |       |           | (1.2 | )             |      |                        |     |       |       |      |       | %       |           |   | *     |       |        |   | *     |      
|                                          |                               |                                                                                 |      |                            |       |           |      |               |      |                        |      |       |       |      |        |         |           |   |       |       |        |   |       |      
|Net decrease in cash and cash equivalents |                               | $                                                                               | (2.8 | )                          |       | $         | (3.8 | )             |      | $                      | 1.0  |       |       |      | 26.3   | %       |           |   | *     |       |        |   | *     |      
|                                          |                               |                                                                                 |      |                            |       |           |      |               |      |                        |      |       |       |      |        |         |           |   |       |       |        |   |       |      



---

|* |  | Not meaningful
|- |  | --------------

15



---



##### Table of Contents



|                                          |                               |                                                                                 |       |                          |       |           |       |               |       |                        |      |       |      |      |      |       |       |    |       |      |       |    |       |      |       |   
|----------------------------------------- | ----------------------------- | ------------------------------------------------------------------------------- | ----- | ------------------------ | ----- | --------- | ----- | ------------- | ----- | ---------------------- | ---- | ----- | ---- | ---- | ---- | ----- | ----- | -- | ----- | ---- | ----- | -- | ----- | ---- | ----- | --
|                                          |                               |                                                                                 |       | For the six months ended |       | Amount    |       | Percentage    |       |                        |      |       |      |      |      |      
|                                          |                               |                                                                                 |       | June 30,                 |       | Change    |       | Change        |       | Percentage of Revenues
|                                          |                               |                                                                                 |       |                          |       | Favorable |       | Favorable     |       |                       
|                                          |                               |                                                                                 |       | 2003                     |       | 2002      |       | (Unfavorable) |       | (Unfavorable)          |      | 2003  |      | 2002
|                                          |                               |                                                                                 |       |                          |       |           |       |               |       |                        |      |       |      |     
|                                          |                               |                                                                                 |       | (In Millions)           
|Results of Operations:                    |                               |                                                                                 |       |                          |       |           |       |               |       |                        |      |       |      |      |      |       |       |    |       |      |       |    |       |     
|Revenues                                  |                               | $                                                                               | 130.1 |                          |       | $         | 119.5 |               |       | $                      | 10.6 |       |      |      | 8.9  | %     |       |    | 100.0 | %    |       |    | 100.0 | %   
|                                          |                               |                                                                                 |       |                          |       |           |       |               |       |                        |      |       |      |      |      |       |       |    |       |      |       |    |       |     
|Operating expenses:                       |                               |                                                                                 |       |                          |       |           |       |               |       |                        |      |       |      |      |      |       |       |    |       |      |       |    |       |     
|                                          | Network operations            |                                                                                 |       | 57.0                     |       |           |       | 46.1          |       |                        |      | (10.9 | )    |      |      | (23.6 | )%    |    |       | 43.8 | %     |    |       | 38.6 | %    
|                                          | Sales and marketing           |                                                                                 |       | 11.1                     |       |           |       | 7.0           |       |                        |      | (4.1  | )    |      |      | (58.6 | )%    |    |       | 8.5  | %     |    |       | 5.9  | %    
|                                          | General and administrative    |                                                                                 |       | 58.8                     |       |           |       | 60.6          |       |                        |      | 1.8   |      |      |      | 3.0   | %     |    |       | 45.2 | %     |    |       | 50.7 | %    
|                                          | Asset impairment charge       |                                                                                 |       |                         |       |           |       | 1.1           |       |                        |      | 1.1   |      |      |      | 100.0 | %     |    |       |     | %     |    |       | 0.9  | %    
|                                          | Wholesale development costs   |                                                                                 |       |                         |       |           |       | 1.0           |       |                        |      | 1.0   |      |      |      | 100.0 | %     |    |       |     | %     |    |       | 0.8  | %    
|                                          | Restructuring expense         |                                                                                 |       |                         |       |           |       | 1.9           |       |                        |      | 1.9   |      |      |      | 100.0 | %     |    |       |     | %     |    |       | 1.6  | %    
|                                          | Depreciation and amortization |                                                                                 |       | 12.0                     |       |           |       | 11.6          |       |                        |      | (0.4  | )    |      |      | (3.4  | )%    |    |       | 9.2  | %     |    |       | 9.7  | %    
|                                          |                               |                                                                                 |       |                          |       |           |       |               |       |                        |      |       |      |      |      |       |       |    |       |      |       |    |       |     
|                                          |                               | Total operating expenses                                                        |       |                          | 138.9 |           |       |               | 129.3 |                        |      |       | (9.6 | )    |      |       | (7.4  | )% |       |      | 106.7 | %  |       |      | 108.2 | % 
|                                          |                               |                                                                                 |       |                          |       |           |       |               |       |                        |      |       |      |      |      |       |       |    |       |      |       |    |       |     
|                                          |                               | Operating loss                                                                  |       |                          | (8.8  | )         |       |               | (9.8  | )                      |      |       | 1.0  |      |      |       | 10.2  | %  |       |      | (6.7  | )% |       |      | (8.2  | )%
|                                          |                               |                                                                                 |       |                          |       |           |       |               |       |                        |      |       |      |      |      |       |       |    |       |      |       |    |       |     
|Nonoperating income (expense):            |                               |                                                                                 |       |                          |       |           |       |               |       |                        |      |       |      |      |      |       |       |    |       |      |       |    |       |     
|                                          | Interest and other income     |                                                                                 |       | 1.1                      |       |           |       | 1.5           |       |                        |      | (0.4  | )    |      |      | (26.7 | )%    |    |       | 0.8  | %     |    |       | 1.3  | %    
|                                          | Interest and other expense    |                                                                                 |       | (1.4                     | )     |           |       | (2.0          | )     |                        |      | 0.6   |      |      |      | 30.0  | %     |    |       | (1.0 | )%    |    |       | (1.7 | )%   
|                                          |                               |                                                                                 |       |                          |       |           |       |               |       |                        |      |       |      |      |      |       |       |    |       |      |       |    |       |     
|                                          |                               | Total nonoperating expense                                                      |       |                          | (0.3  | )         |       |               | (0.5  | )                      |      |       | 0.2  |      |      |       | (40.0 | )% |       |      | (0.2  | )% |       |      | (0.4  | )%
|                                          |                               |                                                                                 |       |                          |       |           |       |               |       |                        |      |       |      |      |      |       |       |    |       |      |       |    |       |     
|                                          |                               | Net loss                                                                        |       |                          | (9.1  | )         |       |               | (10.3 | )                      |      |       | 1.2  |      |      |       | 11.7  | %  |       |      | (6.9  | )% |       |      | (8.6  | )%
|                                          |                               | Less mandatorily redeemable convertible
preferred stock dividends and accretion |       |                          | (8.9  | )         |       |               | (7.8  | )                      |      |       | (1.1 | )    |      |       | (14.1 | )% |       |      | (6.8  | )% |       |      | (6.5  | )%
|                                          |                               | Less deemed dividend related to beneficial
conversion feature                   |       |                          | (0.1  | )         |       |               | (0.1  | )                      |      |       |     |      |      |       |      | %  |       |      | (0.1  | )% |       |      | (0.1  | )%
|                                          |                               |                                                                                 |       |                          |       |           |       |               |       |                        |      |       |      |      |      |       |       |    |       |      |       |    |       |     
|                                          |                               | Net loss attributable to common stockholders                                    |       | $                        | (18.1 | )         |       | $             | (18.2 | )                      |      | $     | 0.1  |      |      |       | 0.5   | %  |       |      | (13.8 | )% |       |      | (15.2 | )%
|                                          |                               |                                                                                 |       |                          |       |           |       |               |       |                        |      |       |      |      |      |       |       |    |       |      |       |    |       |     
|EBITDA                                    |                               | $                                                                               | 3.2   |                          |       | $         | 1.8   |               |       | $                      | 1.4  |       |      |      | 77.8 | %     |       |    | 2.5   | %    |       |    | 1.5   | %   
|                                          |                               |                                                                                 |       |                          |       |           |       |               |       |                        |      |       |      |      |      |       |       |    |       |      |       |    |       |     
|Cash
Flow Data:                           |                               |                                                                                 |       |                          |       |           |       |               |       |                        |      |       |      |      |      |       |       |    |       |      |       |    |       |     
|Net cash provided by operating activities |                               | $                                                                               | 6.1   |                          |       | $         | 4.8   |               |       | $                      | 1.3  |       |      |      | 27.1 | %     |       |    | *     |      |       |    | *     |     
|Net cash used in investing activities     |                               |                                                                                 | (5.7  | )                        |       |           | (11.8 | )             |       |                        | 6.1  |       |      |      | 51.7 | %     |       |    | *     |      |       |    | *     |     
|Net cash used in financing activities     |                               |                                                                                 | (2.2  | )                        |       |           | (2.8  | )             |       |                        | 0.6  |       |      |      | 21.4 | %     |       |    | *     |      |       |    | *     |     
|                                          |                               |                                                                                 |       |                          |       |           |       |               |       |                        |      |       |      |      |      |       |       |    |       |      |       |    |       |     
|Net decrease in cash and cash equivalents |                               | $                                                                               | (1.8  | )                        |       | $         | (9.8  | )             |       | $                      | 8.0  |       |      |      | 81.6 | %     |       |    | *     |      |       |    | *     |     
|                                          |                               |                                                                                 |       |                          |       |           |       |               |       |                        |      |       |      |      |      |       |       |    |       |      |       |    |       |     



---

|* |  | Not meaningful
|- |  | --------------

Revenues.Revenues increased by $7.7 million to $69.9 million for the
three months ended June 30, 2003, compared to $62.2 million the prior year. The
increase was primarily attributable to our wholesale services segment, which
increased by $9.2 million and contributed revenues of $15.9 million for the
three months ended June 30, 2003 compared to $6.7 million for the same period
in the prior year.

Revenues increased by $10.6 million to $130.1 million for the six months
ended June 30, 2003, compared to $119.5 million the prior year. The increase
was primarily attributable to our wholesale services segment, which increased
by $22.2 million and contributed revenues of $28.9 million for the six months
ended June 30, 2003 compared to 6.7 million for the same period in the prior
year.

16



---



##### Table of Contents



The increase in revenue was
primarily a result of increases of $9.2 and
$22.2 million in our wholesale services revenue for the three and six months
ended June 30, 2003, respectively. This net increase was
primarily a result of increase
revenues from our new contract with Sprint, signed in February 2003, and was
offset by the decreases in MCIs wholesale service revenues compared to the
prior year periods. The revenue from our Z-LineHOME and Z-LineBUSINESS
(Z-Line) lines increased by $0.6 and decreased by $9.7 million for the three and six
months ended June 30, 2003, respectively, compared to the prior year.
Additionally, the decrease in Touch 1 (1+) long distance lines in service, as a
result of attrition, contributed a decrease of $2.1 and $1.9 million for the
three and six months ended June 30, 2003, respectively, compared to the prior
year.

The following table, in millions, provides a summary of our revenues:

|                                    |  |                            |      |                          |  |      |      |      |  |   |       |  |  |   |       | 
|----------------------------------- |  | -------------------------- | ---- | ------------------------ |  | ---- | ---- | ---- |  | - | ----- |  |  | - | ----- | 
|                                    |  | For the three months ended |      | For the six months ended
|                                    |  | June 30,                   |      | June 30,                
|                                    |  |                            |      |                         
|Type of Revenues                    |  | 2003                       |      | 2002                     |  | 2003 |      | 2002
|                                    |  |                            |      |                          |  |      |      |     
|Z-Line                              |  | $                          | 51.4 |                          |  | $    | 50.8 |      |  | $ | 95.6  |  |  | $ | 105.3 | 
|Touch 1 (1+) Long Distance Services |  |                            | 2.6  |                          |  |      | 4.7  |      |  |   | 5.6   |  |  |   | 7.5   | 
|Wholesale Services                  |  |                            | 15.9 |                          |  |      | 6.7  |      |  |   | 28.9  |  |  |   | 6.7   | 
|                                    |  |                            |      |                          |  |      |      |      |  |   |       |  |  |   |       | 
|Total                               |  | $                          | 69.9 |                          |  | $    | 62.2 |      |  | $ | 130.1 |  |  | $ | 119.5 | 
|                                    |  |                            |      |                          |  |      |      |      |  |   |       |  |  |   |       | 

Our Z-Line accounts made up 73.5% of our total revenues for both the three
and six months ended June 30, 2003, compared to 81.7% and 88.1% for the same
periods in the prior year. These offerings are currently available in 47
states. We expect Z-Line revenue to continue to increase as a percentage of
total retail revenues, relative to our Touch 1 (1+) Long Distance Services, but
decrease as an overall percentage of total revenues because we expect growth in
our wholesale service business.

Network Operations.Our network operations expense primarily consists of
fixed and variable transmission expenses for interconnection agreements with
ILECs, service level agreements with IXCs, and transmission services based on
tariffed arrangements.

Network operations expense increased by $12.9 million to $30.9 million for
the three months ended June 30, 2003, compared to $18.0 million the prior year.

Network operations expense increased by $10.9 million to $57.0 million for
the six months ended June 30, 2003, compared to $46.1 million the prior year.

Our network operations expense as a percentage of revenues, increased to
44.2% and 43.8% for the three and six months ended June 30, 2003, respectively,
compared to 28.9% and 38.6% in the prior year. Included in the prior year is a
$9.0 million retroactive rate reduction for access rates. Excluding that for
the three and six months ended June 30, 2002, the network costs, as a
percentage of revenues was 43.4% and 46.1%, respectively. The increase in
network operation expenses is primarily the result of having an overall higher
average number of subscribers in service for the three and six months ended
June 30, 2003 compared to the prior year. We recorded a reduction to network
operations expense for certain retroactive rate reductions and billing errors
in the amounts of $1.3 million and $2.5 million for the three and six months
ended June 30, 2003.

Sales and Marketing.Our sales and marketing expense primarily consists
of brand awareness advertising, independent sales contractors one-time bounty
and residual commissions, direct mail and salaries and benefit expenses paid to
employees engaged in sales and marketing activities.

Sales and marketing expense increased $4.1 million to $6.6 million for the
three months ended June 30, 2003, compared to $2.5 million the prior year.

Sales and marketing expense increased $4.1 million to $11.1 million for
the six months ended June 30, 2003, compared to $7.0 million the prior year.

The increase in sales and marketing expense are directly attributable to
increased advertising and the payment of one-time and recurring commissions to
independent sales contractors. Advertising and independent sales contractors
were primarily responsible for the approximately 60,000 net lines added for the
six months ended June 2003. This increase was offset by savings realized in
2003 from the closing of our telemarketing centers in the second quarter of
2002. We have continued our primary focus toward retail line growth and
invested in a multi-faceted marketing campaign in Atlanta, Georgia,
Indianapolis, Indiana and Nashville, Tennessee that

17



---



##### Table of Contents



combined radio, billboard, and television advertising to launch our new
service offering, Personal Voice Assistant (PVA) during the second quarter of
2003. In addition to our marketing campaign, we also contracted with several
independent sales contractors during the latter half of 2002 that largely
contributed to our retail line growth for the first quarter of 2003. We are
also expanding our sales and marketing efforts to growth of our Z-LineBUSINESS
services. Until recently we have focused our sales and marketing efforts on
residential customers only.

We expect to continue our sales and marketing efforts to maintain
acceptable acquisition costs per subscriber. We expect to slow our advertising
levels, limit our independent sales contractors sales force growth, market new
services and continue to seek partnering opportunities throughout 2003. We have
further shifted our marketing focus to be centered on our PVA offering. We
believe that this approach will allow us to reduce our acquisition costs by
partnering with organizations that can provide us with strong distribution
economics, like our recent contract with Sportsline.com. We are also planning
on leveraging PVA to not only improve communications but to be leveraged as a
distribution and delivery strategy that involves ourselves and current
customers providing PVA to others as a free trial. We believe that this
coupled with our new PVA community address and recruiting of member-based
organization will provide increased retail customers at a lower acquisition
cost than we are currently experiencing. Additionally, we will be introducing
new bundle and pricing points in an effort to expand the marketability of our
offerings to consumers. We will continue to build the overall awareness of our
Z brand, and explore alliances and ventures with other companies. We expect
sales and marketing expense to decrease for the remainder of 2003, over that
experienced during the first half of 2003. We are expecting to invest in sales
and marketing at a level necessary to maintain our current retail line count
and slowly grow our business lines.

General and Administrative.General and administrative expense primarily
consists of employee salaries and benefits, temporary services, bad debt
expense, billing and collection costs, occupancy costs, and provisioning costs.

General and administrative expense increased $0.5 million to $31.9 million
for the three months ended June 30, 2003, compared to $31.4 million the prior
year. General and administrative expense improved by 4.9% to 45.6% of revenues
for the three months ended June 30, 2003 compared to 50.5% the prior year.

General and administrative expense decreased $1.8 million to $58.8 million
for the six months ended June 30, 2003, compared to $60.6 million the prior
year. General and administrative expense improved by 5.5% to 45.2% of revenues
for the six months ended June 30, 2003 compared to 50.7% the prior year.

The increase in our general and administrative expenses for the three
months ended June 30, 2003 was primarily a result of the growth in wholesale
lines from our agreement with Sprint and the increase in our retail lines in
service.

The overall reduction in general and administrative expense for the six
months ended June 30, 2003 was a result of our ability to leverage more of our
fixed costs across a larger revenue base while also improving our incremental
costs, which resulting in the reduced general and administrative expense as a
percentage of revenue. We anticipate general and administrative expenditures
will continue to increase in the future to support our expanding service
offerings, our expected increase in wholesale lines and to a lesser degree our
expected increase in business lines during the latter half of 2003. We will
continue to evaluate our operations for efficiencies and our employee staffing
requirements as they relate to increased efficiencies or needs to expand or
outsource. We expect to continue reductions to our general and administrative
expense as a percentage of revenues in 2003. This reduction is necessary for
our achievement of profitability and the continued generation of positive cash
flow.

Asset Impairment Charge.Asset impairment charges were $1.1 million for
the three and six months ended June 30, 2002. In April 2002, we announced a
restructuring plan that included a reduction in force and the closure of the
North Dakota call centers resulting in an asset impairment charge totaling $1.1
million for property, plant, and equipment sold in conjunction with the
settlement of the leases in these locations.

Wholesale development costs.Wholesale development costs were $1.0 million
for the six months ended June 30, 2002. We incurred these costs, related to the
initiation of our wholesale services offerings, during the first quarter of
2002.

Restructuring Expense.Restructuring expenses were $1.9 million for the
three and six months ended June 30, 2002. In April 2002, we approved and
implemented a restructuring to enhance our future cash flows and operating
earnings. The restructuring included a reduction of force coupled with the
closure of our North Dakota call centers and our New York sales office. In
accordance with Emerging Issues Task Force (EITF) 94-3, Liability
Recognition for Certain Employee Termination Benefits and Other costs to Exit
an Activity, the restructuring costs were recognized as liabilities at the
time management committed us to the plan. Management determined that these
costs provided no future economic benefit to us.

18



---



##### Table of Contents



The restructuring charge includes termination benefits and lease
abandonment costs. In addition, we agreed to a settlement to exit the two
leases for our call centers in North Dakota as of July 1, 2002. All
termination benefits and settlements to exit our lease in North Dakota were
paid as of December 31, 2002. We have recorded a lease abandonment charge
representing the future lease cash payments for our New York office as a
liability and continue to make payments through August 2005. As of June 30,
2003 we had an accrual of $0.5 million remaining for this restructuring charge.

Depreciation and Amortization.Depreciation and amortization expense was
$6.0 million for the three months ended June 30, 2003 and the prior year.

Depreciation and amortization expense increased $0.4 million to $12.0
million for the six months ended June 30, 2003, compared to $11.6 million the
prior year.

The slight increase in depreciation and amortization expense for the six
months ended June 30, 2003 is primarily a result of increased capital
expenditures during the last two years. We anticipate a flat to slightly
increased depreciation and amortization expense during 2003 depending on our
requirements to purchase additional computer equipment, switching equipment,
furniture and leasehold improvements as a result of our retail line growth, the
line growth of our wholesale services clients and the introduction of new
services.

Interest and Other Income.Interest and other income decreased $0.1
million to $0.2 million for the three months ended June 30, 2003, compared to
$0.3 million the prior year.

Interest and other income decreased $0.4 million to $1.1 million for the
six months ended June 30, 2003, compared to $1.5 million the prior year.

Interest and other income consists of interest charged to our Z-Line
customers for not paying their bills on-time and income from interest earned
from our cash balance. The decrease for 2003 was primarily due to our having
fewer average customers in service during the first quarter of 2003 compared to
the prior year and our improved subscriber management activities.

Interest and Other Expense.Interest and other expense decreased $0.7
million to $0.7 million for the three months ended June 30, 2003, compared to
$1.4 million the prior year.

Interest and other expense decreased $0.6 million to $1.4 million for the
six months ended June 30, 2003, compared to $2.0 million the prior year.

Our interest expense is a result of late fees for vendor payments, charges
related to our RFC Capital Corporation (RFC) accounts receivable agreement,
capital leases and our debt obligations. The overall decrease in interest
expense is a result of increased liquidity that allowed us to make more
timely payments of our network costs while simultaneously reducing our reliance
on our RFC accounts receivable agreement. We also have less outstanding term
debt obligations, which has contributed to lower interest payments. We
anticipate that interest expense will decrease in the near future as we
continue to reduce our debt obligations and improve our cash flow
from operating activities. This
decrease may be offset to the extent that we are able to borrow money to
support growth through new funding sources and to finance any significant
capital expenditures necessary to grow our business during 2003. We expect the
continued utilization of our RFC accounts receivable agreement during 2003.

Income Tax Benefit.No provision for federal or state income taxes has
been recorded due to the full valuation allowance recorded against the deferred
tax asset for the three and six months ended June 30, 2003 and 2002.

Net Loss.Our net loss increased by $6.2 million to a loss of $6.0 million
for the three months ended June 30, 2003, compared to net income of $0.2
million the prior year.

Our net loss improved $1.2 million to a loss of $9.1 million for the six
months ended June 30, 2003, compared to a net loss of $10.3 million the prior
year.

Net Loss Attributable to Common Stockholders.Our net loss attributable to
common stockholders increased $6.9 million to a loss of $10.7 million for the
three months ended June 30, 2003, compared to a loss of $3.8 million the prior
year.

19



---



##### Table of Contents



Our net
loss attributable to common stockholders decreased $0.1 million to
a loss of $18.1 million for the six months ended June 30, 2003, compared to a
loss $18.2 million the prior year.

This decrease was primarily discussed above, however, the decrease was
offset by an increase of $1.1 million for the accumulation of dividends and
accretion of the preferred stock in 2003.

EBITDA.Many securities analysts use the measure of earnings before
deducting interest, income taxes, depreciation and amortization, also commonly
referred to as EBITDA, as a way of evaluating financial performance. EBITDA
is not a measure under GAAP, is not meant to be a replacement for GAAP and
should not be considered an alternative to net income as a measure of
performance. We have included EBITDA data because it is a measure commonly used
in the telecommunications industry and is presented to assist in understanding
our operating results. Our EBITDA decreased by $6.9 million to $0.4 million for
the three months ended June 30, 2003, compared to $7.3 million the prior year.
Our EBITDA increased by $1.4 million to $3.2 million for the six months ended
June 30, 2003 compared to $1.8 million the prior year. We expect to improve
our positive EBITDA quarter over quarter during the remainder of 2003. The
continued generation of positive EBITDA is expected to be driven by increases
in subscriber lines, the realization of operating efficiencies, and the
contribution of existing and new wholesale services and possibly the other
introduction of other new service offerings.

The table below, in thousands, reconciles EBITDA to net loss:

|                              |  |                            |        |                          |  |      |       |      |  |   |        |   |  |   |         |  
|----------------------------- |  | -------------------------- | ------ | ------------------------ |  | ---- | ----- | ---- |  | - | ------ | - |  | - | ------- | -
|                              |  | For the three months ended |        | For the six months ended
|                              |  | June 30,                   |        | June 30,                
|                              |  |                            |        |                         
|                              |  | 2003                       |        | 2002                     |  | 2003 |       | 2002
|                              |  |                            |        |                          |  |      |       |     
|Net income (loss)             |  | $                          | (6,008 | )                        |  | $    | 259   |      |  | $ | (9,113 | ) |  | $ | (10,348 | )
|Nonoperating income           |  |                            | 421    |                          |  |      | 1,079 |      |  |   | 246    |   |  |   | 531     |  
|Depreciation and amortization |  |                            | 6,002  |                          |  |      | 6,003 |      |  |   | 12,029 |   |  |   | 11,582  |  
|                              |  |                            |        |                          |  |      |       |      |  |   |        |   |  |   |         |  
|EBITDA                        |  | $                          | 415    |                          |  | $    | 7,341 |      |  | $ | 3,162  |   |  | $ | 1,765   |  
|                              |  |                            |        |                          |  |      |       |      |  |   |        |   |  |   |         |  

RESULTS OF OPERATIONS BY SEGMENT

Management evaluates the performance of each
segment based on operating
income excluding depreciation and amortization and adjustments for special items. Special items are
transactions or events that are included in our reported consolidated results
but are excluded from segment results due to their nonrecurring or
nonoperational nature. We have detailed these special items in
footnote 13  Segment Reporting and any other excluded items to reconcile to net loss as reported in our consolidated
statement of operations. In addition, when changes in our business affect the
comparability of current versus historical results, we will adjust historical
operating information to reflect the current business structure.

The following tables present, in millions, our reportable segments. These
tables will facilitate our discussion of our results by segment. It is
important to understand that we only record direct expenses in our wholesale
services segment, therefore, all employee benefits, occupancy, insurance, and
other indirect or overhead related expenses are reflected in the retail
services segment. We are in the process of reviewing and possibly adopting a
methodology for internal reporting purposes that would allocate these indirect
and overhead related expenses to the respective units or possibly separating
these expenses from our future segment analysis.

20



---



##### Table of Contents



|                    |                            |                          |      |                                  |      |                                  |      |              |      |          |      |           |      |              |      |      |      |   |     |     |     |   |      |      |      | 
|------------------- | -------------------------- | ------------------------ | ---- | -------------------------------- | ---- | -------------------------------- | ---- | ------------ | ---- | -------- | ---- | --------- | ---- | ------------ | ---- | ---- | ---- | - | --- | --- | --- | - | ---- | ---- | ---- | 
|                    |                            |                          |      | Three Months Ended June 30, 2003 |      | Three Months Ended June 30, 2002
|                    |                            |                          |      |                                  |      |                                 
|                    |                            |                          |      | Retail                           |      | Wholesale                        |      | Consolidated |      | Retail   |      | Wholesale |      | Consolidated
|                    |                            |                          |      | Services                         |      | Services                         |      | Results      |      | Services |      | Services  |      | Results     
|                    |                            |                          |      |                                  |      |                                  |      |              |      |          |      |           |      |             
|Revenues            |                            | $                        | 54.0 |                                  |      | $                                | 15.9 |              |      | $        | 69.9 |           |      | $            | 55.5 |      |      | $ | 6.7 |     |     | $ | 62.2 |     
|                    |                            |                          |      |                                  |      |                                  |      |              |      |          |      |           |      |              |      |      |      |   |     |     |     |   |      |     
|Operating expenses: |                            |                          |      |                                  |      |                                  |      |              |      |          |      |           |      |              |      |      |      |   |     |     |     |   |      |     
|                    | Network operations         |                          |      | 23.6                             |      |                                  |      | 7.3          |      |          |      | 30.9      |      |              |      | 25.7 |      |   |     | 1.3 |     |   |      | 27.0 |     
|                    | Sales and marketing        |                          |      | 6.6                              |      |                                  |      |             |      |          |      | 6.6       |      |              |      | 2.5  |      |   |     |    |     |   |      | 2.5  |     
|                    | General and administrative |                          |      | 26.6                             |      |                                  |      | 5.3          |      |          |      | 31.9      |      |              |      | 28.4 |      |   |     | 3.0 |     |   |      | 31.4 |     
|                    |                            |                          |      |                                  |      |                                  |      |              |      |          |      |           |      |              |      |      |      |   |     |     |     |   |      |     
|                    |                            | Total operating expenses |      |                                  | 56.8 |                                  |      |              | 12.6 |          |      |           | 69.4 |              |      |      | 56.6 |   |     |     | 4.3 |   |      |      | 60.9 | 
|                    |                            |                          |      |                                  |      |                                  |      |              |      |          |      |           |      |              |      |      |      |   |     |     |     |   |      |     
|                    |                            | Segment results          |      | $                                | (2.8 | )                                |      | $            | 3.3  |          |      | $         | 0.5  |              |      | $    | (1.1 | ) |     | $   | 2.4 |   |      | $    | 1.3  | 
|                    |                            |                          |      |                                  |      |                                  |      |              |      |          |      |           |      |              |      |      |      |   |     |     |     |   |      |     

|                    |                            |                          |       |                                |       |                                |      |              |      |          |       |              |       |              |       |      |       |   |     |     |     |   |       |      |       |  
|------------------- | -------------------------- | ------------------------ | ----- | ------------------------------ | ----- | ------------------------------ | ---- | ------------ | ---- | -------- | ----- | ------------ | ----- | ------------ | ----- | ---- | ----- | - | --- | --- | --- | - | ----- | ---- | ----- | -
|                    |                            |                          |       | Six Months Ended June 30, 2003 |       | Six Months Ended June 30, 2002
|                    |                            |                          |       |                                |       |                               
|                    |                            |                          |       | Retail                         |       | Wholesale                      |      | Consolidated |      | Retail   |       | Wholesale    |       | Consolidated
|                    |                            |                          |       | Services                       |       | Services                       |      | Results      |      | Services |       | Services (1) |       | Results     
|                    |                            |                          |       |                                |       |                                |      |              |      |          |       |              |       |             
|Revenues            |                            | $                        | 101.2 |                                |       | $                              | 28.9 |              |      | $        | 130.1 |              |       | $            | 112.8 |      |       | $ | 6.7 |     |     | $ | 119.5 |     
|                    |                            |                          |       |                                |       |                                |      |              |      |          |       |              |       |              |       |      |       |   |     |     |     |   |       |     
|Operating expenses: |                            |                          |       |                                |       |                                |      |              |      |          |       |              |       |              |       |      |       |   |     |     |     |   |       |     
|                    | Network operations         |                          |       | 45.6                           |       |                                |      | 11.4         |      |          |       | 57.0         |       |              |       | 53.4 |       |   |     | 1.7 |     |   |       | 55.1 |      
|                    | Sales and marketing        |                          |       | 11.1                           |       |                                |      |             |      |          |       | 11.1         |       |              |       | 7.0  |       |   |     |    |     |   |       | 7.0  |      
|                    | General and administrative |                          |       | 51.7                           |       |                                |      | 7.1          |      |          |       | 58.8         |       |              |       | 56.5 |       |   |     | 4.1 |     |   |       | 60.6 |      
|                    |                            |                          |       |                                |       |                                |      |              |      |          |       |              |       |              |       |      |       |   |     |     |     |   |       |     
|                    |                            | Total operating expenses |       |                                | 108.4 |                                |      |              | 18.5 |          |       |              | 126.9 |              |       |      | 116.9 |   |     |     | 5.8 |   |       |      | 122.7 |  
|                    |                            |                          |       |                                |       |                                |      |              |      |          |       |              |       |              |       |      |       |   |     |     |     |   |       |     
|                    |                            | Segment results          |       | $                              | (7.2  | )                              |      | $            | 10.4 |          |       | $            | 3.2   |              |       | $    | (4.1  | ) |     | $   | 0.9 |   |       | $    | (3.2  | )
|                    |                            |                          |       |                                |       |                                |      |              |      |          |       |              |       |              |       |      |       |   |     |     |     |   |       |     



---

|(1) |  | We began our wholesale services business in April of 2002. Therefore,
there was not a wholesale services line of business in the first quarter of
2002.
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------

21



---



##### Table of Contents



Retail Services Segment

The following table, in millions, provides our retail services segment for
the periods presented.

|                    |                            |                          |      |                            |      |           |      |               |      |                        |      |      |      |      |      |        |        |    |       |      |       |    |       |      |       |   
|------------------- | -------------------------- | ------------------------ | ---- | -------------------------- | ---- | --------- | ---- | ------------- | ---- | ---------------------- | ---- | ---- | ---- | ---- | ---- | ------ | ------ | -- | ----- | ---- | ----- | -- | ----- | ---- | ----- | --
|                    |                            |                          |      | Retail Services Segment   
|                    |                            |                          |      |                           
|                    |                            |                          |      | For the three months ended |      | Amount    |      | Percentage    |      |                        |      |      |      |      |      |       
|                    |                            |                          |      | June 30,                   |      | Change    |      | Change        |      | Percentage of Revenues
|                    |                            |                          |      |                            |      | Favorable |      | Favorable     |      |                       
|                    |                            |                          |      | 2003                       |      | 2002      |      | (Unfavorable) |      | (Unfavorable)          |      | 2003 |      | 2002
|                    |                            |                          |      |                            |      |           |      |               |      |                        |      |      |      |     
|Revenues            |                            | $                        | 54.0 |                            |      | $         | 55.5 |               |      | $                      | (1.5 | )    |      |      | (2.7 | )%     |        |    | 100.0 | %    |       |    | 100.0 | %   
|                    |                            |                          |      |                            |      |           |      |               |      |                        |      |      |      |      |      |        |        |    |       |      |       |    |       |     
|Operating expenses: |                            |                          |      |                            |      |           |      |               |      |                        |      |      |      |      |      |        |        |    |       |      |       |    |       |     
|                    | Network operations         |                          |      | 23.6                       |      |           |      | 25.7          |      |                        |      | 2.1  |      |      |      | 8.2    | %      |    |       | 43.7 | %     |    |       | 46.3 | %    
|                    | Sales and marketing        |                          |      | 6.6                        |      |           |      | 2.5           |      |                        |      | (4.1 | )    |      |      | (164.0 | )%     |    |       | 12.2 | %     |    |       | 4.5  | %    
|                    | General and administrative |                          |      | 26.6                       |      |           |      | 28.4          |      |                        |      | 1.8  |      |      |      | 6.3    | %      |    |       | 49.3 | %     |    |       | 51.2 | %    
|                    |                            |                          |      |                            |      |           |      |               |      |                        |      |      |      |      |      |        |        |    |       |      |       |    |       |     
|                    |                            | Total operating expenses |      |                            | 56.8 |           |      |               | 56.6 |                        |      |      | (0.2 | )    |      |        | (0.4   | )% |       |      | 105.2 | %  |       |      | 102.0 | % 
|                    |                            |                          |      |                            |      |           |      |               |      |                        |      |      |      |      |      |        |        |    |       |      |       |    |       |     
|                    |                            | Segment results          |      | $                          | (2.8 | )         |      | $             | (1.1 | )                      |      | $    | (1.7 | )    |      |        | (154.5 | )% |       |      | (5.2  | )% |       |      | (2.0  | )%
|                    |                            |                          |      |                            |      |           |      |               |      |                        |      |      |      |      |      |        |        |    |       |      |       |    |       |     

|                    |                            |                          |       |                          |       |           |       |               |       |                        |       |      |      |      |       |       |       |    |       |      |       |    |       |      |       |   
|------------------- | -------------------------- | ------------------------ | ----- | ------------------------ | ----- | --------- | ----- | ------------- | ----- | ---------------------- | ----- | ---- | ---- | ---- | ----- | ----- | ----- | -- | ----- | ---- | ----- | -- | ----- | ---- | ----- | --
|                    |                            |                          |       | For the six months ended |       | Amount    |       | Percentage    |       |                        |       |      |      |      |       |      
|                    |                            |                          |       | June 30,                 |       | Change    |       | Change        |       | Percentage of Revenues
|                    |                            |                          |       |                          |       | Favorable |       | Favorable     |       |                       
|                    |                            |                          |       | 2003                     |       | 2002      |       | (Unfavorable) |       | (Unfavorable)          |       | 2003 |      | 2002
|                    |                            |                          |       |                          |       |           |       |               |       |                        |       |      |      |     
|Revenues            |                            | $                        | 101.2 |                          |       | $         | 112.8 |               |       | $                      | (11.6 | )    |      |      | (10.3 | )%    |       |    | 100.0 | %    |       |    | 100.0 | %   
|                    |                            |                          |       |                          |       |           |       |               |       |                        |       |      |      |      |       |       |       |    |       |      |       |    |       |     
|Operating expenses: |                            |                          |       |                          |       |           |       |               |       |                        |       |      |      |      |       |       |       |    |       |      |       |    |       |     
|                    | Network operations         |                          |       | 45.6                     |       |           |       | 53.4          |       |                        |       | 7.8  |      |      |       | 14.6  | %     |    |       | 45.0 | %     |    |       | 47.3 | %    
|                    | Sales and marketing        |                          |       | 11.1                     |       |           |       | 7.0           |       |                        |       | (4.1 | )    |      |       | (58.6 | )%    |    |       | 11.0 | %     |    |       | 6.2  | %    
|                    | General and administrative |                          |       | 51.7                     |       |           |       | 56.5          |       |                        |       | 4.8  |      |      |       | 8.5   | %     |    |       | 51.1 | %     |    |       | 50.1 | %    
|                    |                            |                          |       |                          |       |           |       |               |       |                        |       |      |      |      |       |       |       |    |       |      |       |    |       |     
|                    |                            | Total operating expenses |       |                          | 108.4 |           |       |               | 116.9 |                        |       |      | 8.5  |      |       |       | 7.3   | %  |       |      | 107.1 | %  |       |      | 103.6 | % 
|                    |                            |                          |       |                          |       |           |       |               |       |                        |       |      |      |      |       |       |       |    |       |      |       |    |       |     
|                    |                            | Segment results          |       | $                        | (7.2  | )         |       | $             | (4.1  | )                      |       | $    | (3.1 | )    |       |       | (75.6 | )% |       |      | (7.1  | )% |       |      | (3.6  | )%
|                    |                            |                          |       |                          |       |           |       |               |       |                        |       |      |      |      |       |       |       |    |       |      |       |    |       |     

Revenues.Revenues decreased by $1.5 million to $54.0 million for the
three months ended June 30, 2003, compared to $55.5 million the prior year.

Revenues decreased by $11.6 million to $101.2 million for the six months
ended June 30, 2003, compared to $112.8 million the prior year.

The decrease in revenue for the three months is primarily attributable to
a drop in Touch 1 revenues by $2.1 million to $2.6 million for the three months
ended June 30, 2003, compared to $4.7 million the prior year. This decrease is
slightly offset by the increase in Z-Line revenue. The average monthly revenue
per line was $67 per line for the both the three months ended June 30, 2003 and
2002. The average lines in service were 255,000 and 253,000 for the three
months ended June 30, 2003 and 2002, respectively.

The decrease in revenue for the six months is primarily a result of a
decrease in both the average lines in service and the average revenue per line
in service. Average lines in service decreased 14,000 lines to 236,000 average
Z-Lines in service for the six months ended June 30, 2003 compared 250,000
lines the prior year. Our average monthly revenue per line decreased by $2 per
line to $68 per line for the six months ended June 30, 2003 compared to $70 per
line the prior year. The decrease in Touch 1 (1+) long distance lines in
service contributed an additional decrease of $1.9 million for the six months
ended June 30, 2003, compared to the prior year periods.

22



---



##### Table of Contents



Although both periods presented show an overall decrease to revenue
compared to the prior year there was a significant difference in the movement
of our lines. Our lines increased a total of 60,000 and 39,000 compared to
lines decreasing a total of 39,000 and
65,000 for the three and six months ended June 30, 2003 and
2002, respectively. The decrease in 2002 was the
result of focusing our efforts on establishing and growing our wholesale
services business, launched in 2002, and improving our internal processes
rather than growing lines for most of 2002. We changed our primary focus to
increasing our line growth for our retail services in the fourth quarter of
2002 and continued that growth through the second quarter of 2003. We are
decreasing our sales and marketing activity for the second half of the year and
expect an increase to our current average Z-Lines in service, but to a lesser
degree than experienced during the first six months of 2003. We expect retail
service revenues to continue to grow at a slower rate than our wholesale
services revenues, resulting in retail services being a smaller percentage of
total consolidated revenues during 2003 compared to 2002, but that retail
revenue will still represent the majority of total consolidated revenues during
2003.

Network Operations.Network operations expense decreased by $2.1 million
to $23.6 million for the three months ended June 30, 2003, compared to $25.7
million the prior year. Our gross margin percentage increased by 2.6% to 56.3%
for the three months ended June 30, 2003, compared to 53.7% in the prior year.

Network operations expense decreased by $7.8 million to $45.6 million for
the six months ended June 30, 2003, compared to $53.4 million the prior year.
Our gross margin percentage increased by 2.2% to 54.9% for the six months ended
June 30, 2003, compared to 52.7% in the prior year.

Our network operations expense as a percentage of revenues decreased
primarily as a result of decreases in the unbundled network element platform
rates we pay to lease lines from the ILECs in the states in which we are
operating and more specifically due to the rate reduction in New York, our
largest market. Other reductions resulted from improvements we have made to
internal operations and processes that minimize our network operations costs.

Sales and Marketing.Sales and marketing expense increased $4.1 million to
$6.6 million for the three months ended June 30, 2003, compared to $2.5 million
the prior year.

Sales and marketing expense increased $4.1 million to $11.1 million for
the six months ended June 30, 2003, compared to $7.0 million the prior year.

The increase in sales and marketing for both the three and six months
ended June 30, 2003 compared to the prior year was a result of our change in
focus during the first half of 2003 to grow our retail lines. Our increased investments in
advertising and the productivity of our independent sales contractors has
driven the growth of our retail residential lines. We have also invested to grow our retail business offering. These investments have resulted
in an increase of 60,000 lines for the six months ended June 30, 2003 and
39,000 lines for the three months ended the same period. We intend to decrease
our overall marketing activity for the remainder of 2003 compared to our
activity through June 30, 2003 in an effort to increase and improve our overall
financial results and cash flow.

General and Administrative.General and administrative expense decreased
$1.8 million to $26.6 million for the three months ended June 30, 2003,
compared to $28.4 million the prior year. As a percentage of revenues general
and administrative expense decreased by 1.9% to 49.3% of revenues in 2003
compared to 51.2% in the prior year.

General and administrative expense decreased $4.8 million to $51.7 million
for the six months ended June 30, 2003, compared to $56.5 million the prior
year. As a percentage of revenues, general and administrative expense increased
by 1.0% to 51.1% of revenues in 2003 compared to 50.1% in the prior year.

The decrease in general and administrative expense was primarily
attributed to the $3.4 million increase and $8.2 million decrease in bad debt
expense, the $2.6 million and $2.9 million decrease in tax accruals and $1.7
million and $2.5 million increase in performance credits received from the
ILECS, which reduce our general and administrative expense, and $2.4 million
and $3.9 million decrease in head-count related expenses for the three and six
months ended June 30, 2003, respectively, compared to the prior year periods.
Additionally, for the six months ended June 30, 2003 compared to the prior
year, our contract development work decreased by $1.7 million. The remaining
changes are spread between several other general and administrative expenses
including but not limited to provisioning and insurance expense.

23



---



##### Table of Contents



With our focus on limited line growth for the remainder of 2003, we expect
general and administrative expense to decrease as a percentage of revenues as
the result of leveraging certain elements of our fixed cost structure, although
we expect an increase in total expenses as we incur more charges for
incremental costs such as billing, collection, and headcount related expenses
during 2003. Included in the retail services general and administrative expense
is all employee benefits, occupancy, insurance, and other indirect or
overhead-related expenses, including wholesale service related costs as only
direct costs are recorded in our wholesale services segment. We are in the
process of reviewing and possibly adopting a methodology for internal reporting
purposes that would allocate these indirect and overhead related expenses to
the respective segments or possibly separating these expenses from each
segment. We expect that our retail services business will grow at a slower rate
than our wholesale services during the remainder of 2003 and therefore
represents a smaller percentage of consolidated general and administrative
expense during 2003.

Wholesale Services Segment

The following table, in millions, provides our wholesale services segment
for 2003 compared to 2002 to facilitate our discussion of results for our
wholesale services segment:

|                    |                            |                          |      |                            |      |           |     |               |     |                        |     |      |      |      |       |        |        |    |       |      |      |   |       |      |      |  
|------------------- | -------------------------- | ------------------------ | ---- | -------------------------- | ---- | --------- | --- | ------------- | --- | ---------------------- | --- | ---- | ---- | ---- | ----- | ------ | ------ | -- | ----- | ---- | ---- | - | ----- | ---- | ---- | -
|                    |                            |                          |      | Wholesale Services Segment
|                    |                            |                          |      |                           
|                    |                            |                          |      | For the three months ended |      | Amount    |     | Percentage    |     |                        |     |      |      |      |       |       
|                    |                            |                          |      | June 30,                   |      | Change    |     | Change        |     | Percentage of Revenues
|                    |                            |                          |      |                            |      | Favorable |     | Favorable     |     |                       
|                    |                            |                          |      | 2003                       |      | 2002      |     | (Unfavorable) |     | (Unfavorable)          |     | 2003 |      | 2002
|                    |                            |                          |      |                            |      |           |     |               |     |                        |     |      |      |     
|Revenues            |                            | $                        | 15.9 |                            |      | $         | 6.7 |               |     | $                      | 9.2 |      |      |      | 137.3 | %      |        |    | 100.0 | %    |      |   | 100.0 | %   
|                    |                            |                          |      |                            |      |           |     |               |     |                        |     |      |      |      |       |        |        |    |       |      |      |   |       |     
|Operating expenses: |                            |                          |      |                            |      |           |     |               |     |                        |     |      |      |      |       |        |        |    |       |      |      |   |       |     
|                    | Network operations         |                          |      | 7.3                        |      |           |     | 1.3           |     |                        |     | (6.0 | )    |      |       | (461.5 | )%     |    |       | 45.9 | %    |   |       | 19.4 | %   
|                    | General and administrative |                          |      | 5.3                        |      |           |     | 3.0           |     |                        |     | (2.3 | )    |      |       | (76.7  | )%     |    |       | 33.3 | %    |   |       | 44.8 | %   
|                    |                            |                          |      |                            |      |           |     |               |     |                        |     |      |      |      |       |        |        |    |       |      |      |   |       |     
|                    |                            | Total operating expenses |      |                            | 12.6 |           |     |               | 4.3 |                        |     |      | (8.3 | )    |       |        | (193.0 | )% |       |      | 79.2 | % |       |      | 64.2 | %
|                    |                            |                          |      |                            |      |           |     |               |     |                        |     |      |      |      |       |        |        |    |       |      |      |   |       |     
|                    |                            | Segment results          |      | $                          | 3.3  |           |     | $             | 2.4 |                        |     | $    | 0.9  |      |       |        | 37.5   | %  |       |      | 20.8 | % |       |      | 35.8 | %
|                    |                            |                          |      |                            |      |           |     |               |     |                        |     |      |      |      |       |        |        |    |       |      |      |   |       |     

|                    |                            |                          |      |                          |      |           |     |               |     |                        |      |      |       |      |       |        |         |    |       |      |      |   |       |      |      |  
|------------------- | -------------------------- | ------------------------ | ---- | ------------------------ | ---- | --------- | --- | ------------- | --- | ---------------------- | ---- | ---- | ----- | ---- | ----- | ------ | ------- | -- | ----- | ---- | ---- | - | ----- | ---- | ---- | -
|                    |                            |                          |      | For the six months ended |      | Amount    |     | Percentage    |     |                        |      |      |       |      |       |       
|                    |                            |                          |      | June 30,                 |      | Change    |     | Change        |     | Percentage of Revenues
|                    |                            |                          |      |                          |      | Favorable |     | Favorable     |     |                       
|                    |                            |                          |      | 2003                     |      | 2002 (1)  |     | (Unfavorable) |     | (Unfavorable)          |      | 2003 |       | 2002
|                    |                            |                          |      |                          |      |           |     |               |     |                        |      |      |       |     
|Revenues            |                            | $                        | 28.9 |                          |      | $         | 6.7 |               |     | $                      | 22.2 |      |       |      | 331.3 | %      |         |    | 100.0 | %    |      |   | 100.0 | %   
|                    |                            |                          |      |                          |      |           |     |               |     |                        |      |      |       |      |       |        |         |    |       |      |      |   |       |     
|Operating expenses: |                            |                          |      |                          |      |           |     |               |     |                        |      |      |       |      |       |        |         |    |       |      |      |   |       |     
|                    | Network operations         |                          |      | 11.4                     |      |           |     | 1.7           |     |                        |      | (9.7 | )     |      |       | (570.6 | )%      |    |       | 39.4 | %    |   |       | 25.4 | %   
|                    | General and administrative |                          |      | 7.1                      |      |           |     | 4.1           |     |                        |      | (3.0 | )     |      |       | (73.2  | )%      |    |       | 24.6 | %    |   |       | 61.2 | %   
|                    |                            |                          |      |                          |      |           |     |               |     |                        |      |      |       |      |       |        |         |    |       |      |      |   |       |     
|                    |                            | Total operating expenses |      |                          | 18.5 |           |     |               | 5.8 |                        |      |      | (12.7 | )    |       |        | (219.0  | )% |       |      | 64.0 | % |       |      | 86.6 | %
|                    |                            |                          |      |                          |      |           |     |               |     |                        |      |      |       |      |       |        |         |    |       |      |      |   |       |     
|                    |                            | Segment results          |      | $                        | 10.4 |           |     | $             | 0.9 |                        |      | $    | 9.5   |      |       |        | 1,055.6 | %  |       |      | 36.0 | % |       |      | 13.4 | %
|                    |                            |                          |      |                          |      |           |     |               |     |                        |      |      |       |      |       |        |         |    |       |      |      |   |       |     

(1)  We began our wholesale services business in April of 2002. Therefore,
there was not a wholesale services line of business in the first quarter of
2002.

Revenues.Revenues increased by $9.2 million to $15.9 million for the
three months ended June 30, 2003, compared to $6.7 million the prior year.

24



---



##### Table of Contents



Revenues increased by $22.2 million to $28.9 million for the six months
ended June 30, 2003, compared to $6.7 million the prior year.

We signed our wholesale services agreement with Sprint in February of
2003. Sprint contributed $10.6 million and $12.2 million of revenue for the
three and six months ended June 30, 2003, respectively. These increases to
revenue were offset by the decreases in MCIs wholesale service agreement,
contributing decreases to revenue of $1.5 million and $9.6 million for the
three and six months ended June 30, 2003 compared to the prior year periods,
respectively. As of August 7, 2003, we amended our wholesale
services agreement with MCI to terminate the agreement on
December 31, 2003. As a result of this amendment we will begin
to recognize all remaining unrecognized revenue that totaled
$5.6 million as of June 30, 2003. This increase in revenue
while MCI is decreasing its activity with us is a result of the
recognition of revenue required over the life of the contract as
required under GAAP for certain payments of cash received at the
inception of the contract. As a result of this treatment our revenues
will increase, however, there will be no increase to our cash for
this revenue as it was already paid in prior periods.
In addition, our business development group is actively pursuing other
potential wholesale partners and working to develop new wholesale services. We
expect wholesale services to continue to grow and continue to be a larger
percentage of overall revenues for the remainder of 2003 and compared to the
prior year.

Network Operations.Network operations expense increased by $6.0 million
to $7.3 million for the three months ended June 30, 2003, compared to $1.3
million the prior year.

Network operations expense increased by $9.7 million to $11.4 million for
the six months ended June 30, 2003, compared to $1.7 million the prior year.

The increase in network operations is the result of increased wholesale
lines in service for both the three and six months ended June 30, 2003 compared
to the prior year. We expect this expense to vary depending on each individual
wholesale contract. We incur these expenses in leasing unbundled network
elements from the ILECs. We use these elements in providing our telephone
exchange services to our wholesale customers. Certain wholesale customers may
not utilize this service or may use this service for only a limited period of
time under the contract. Therefore, it is difficult to anticipate the change to
this expense during 2003. Since our wholesale pricing incorporates these
expenses under our wholesale service agreements an increase or decrease in
these costs has no impact on our EBITDA and net income.

General and Administrative.General and administrative expense increased
$2.3 million to $5.3 million for the three months ended June 30, 2003, compared
to $3.0 million the prior year.

General and administrative expense increased $3.0 million to $7.1 million
for the six months ended June 30, 2003, compared to $4.1 million the prior
year.

The significant components of this expense mirror our consolidated
expenses, however, we only isolated as wholesale expense those expenses that
are directly associated with our wholesale services activity.
Therefore, we have not allocated any indirect or overhead expenses such as
employee benefits, occupancy, insurance or other similar expenses to the
wholesale services segment. These expenses are all currently included in the
retail services segment. The increase in general and administrative expenses
is a result of increased wholesale lines in service and providing additional
services during 2003 that were not provided in 2002.

We expect general and administrative expense to increase in total dollars
and as a percentage of our consolidated expenses. We began to increase
headcount during the first quarter of 2003 to address the expected increase in
wholesale services and also have outsourced certain functions that were
previously handled internally. The outsourcing of services allows us to
effectively manage the anticipated growth of our wholesale services in an
effort to limit our cost exposure. We have not recorded any bad debt expense
for wholesale services and have not had any writeoffs of receivables. We will
continue to monitor our wholesale services and determine the appropriate bad
debt methodology based on each individual wholesale contract but do not expect
any changes as our current agreements provide us to receive pre-payments of a
substantial portion of our payments from our wholesale customers.

25



---



##### Table of Contents



LIQUIDITY AND CAPITAL RESOURCES

The competitive local telecommunications service business is traditionally
considered to be a capital intensive business owing to the significant
investments required in building fiber optic communication networks and the
colocation of switching and transmission equipment in incumbent local exchange
carriers central offices. Although we will continue to make capital
expenditures, we do not expect that the growth of our business will require the
levels of capital investment in fiber optics and switches that existed in
historical telecommunications facilities-based models. Instead, we will devote
significant amounts of our capital resources to continued operations, software
development, new service offerings and marketing efforts that we have designed
to achieve penetration of our target markets.

We have incurred accumulated losses since our inception as a result of
developing our business, research and development, building and maintaining
network infrastructure and technology, sales and promotion of our services, and
administrative expenditures. As of June 30, 2003, we had an accumulated deficit
of $311.9 million and $14.2 million in cash and cash equivalents. We have
funded our expenditures primarily through operating revenues, private
securities offerings, a sale-leaseback credit facility, sales of accounts
receivable and an initial public offering that raised net proceeds of $109.1
million. We intend to continue building our organization in anticipation of
future growth and believe that our operating expenditures will also continue to
increase.

Our net
cash provided by operating activities improved by $1.3 million to
$6.1 million for the six months ended June 30, 2003 compared to $4.8 million
the prior year. This improvement resulted from our overall improvement to net
loss and the increase in our wholesale business that has resulted in increased
pre-payments of services increasing our deferred revenue.

Included in our net cash provided by operating activities was the sale of
$51.5 million and $74.5 million of receivables, for net proceeds of $41.7
million and $58.0 million, for the six months ended June 30, 2003 and 2002,
respectively. A net receivable servicing asset of $10.3 is included in accounts
receivable and $1.0 million of advances on unbilled receivables are included in
accounts payable and accrued liabilities as of June 30, 2003. The costs
relating to the RFC receivable financing agreement of $0.4 and $0.7 million are
included in interest and other expense for six months ended June 30, 2003 and
2002, respectively.

Our net cash used in investing activities improved by $6.1 million to $5.7
million for the six months ended June 30, 2003 compared to $11.8 million the
prior year. Nearly all the improvement was attributable to the purchasing of
less property and equipment during 2003. We expect to maintain similar levels
of purchases of property and equipment, but may invest in additional resources
if additional cash is available as a result of our improved operating
activities, or if we secure another significant wholesale services customer.

Our net cash used in financing activities improved by $0.6 million to $2.2
million for the six months ended June 30, 2003 compared to $2.8 million the
prior year. This improvement is primarily a result of receiving the repayment
of $0.5 million from an executive who is also a member of the board of
directors in fulfillment of a note payable for the issuance of common stock. We
expect to maintain a low amount of long-term debt, although if appropriate terms
became available to obtain a more traditional loan we would likely replace our
existing accounts receivable agreement. Most of our existing debt has a fixed
interest rate that is payable in monthly installments.

In January 2002, we entered into an agreement with a company that provided
us with software to automate the processing, auditing, dispute tracking,
management reporting and various other functions with respect to our ILEC and
long-distance network costs. In addition to the set-up and implementation fees,
under this agreement, we have committed to minimum cash payments of $0.6
million for 2003. In accordance with the contract we make monthly payments
based on a schedule that correlates to net monthly carrier invoice volume. We
made payments under this agreement totaling $0.4 million for the six months
ended June 30, 2003 and 2002.

On August 6, 2002, we filed a complaint against Southwestern Bell
Telephone Company (SWBT) before the Public Utility Commission of Texas
(PUCT), requesting that the PUCT enjoin SWBT from disconnecting our access to
customers in Texas on the basis of a billing dispute between the parties. The
billing dispute centered on whether we owed SWBT certain amounts for
alternatively billed service.  On August 23, 2002, the PUCT issued, in part, the injunctive relief
requested by us, making clear that service not be interrupted. On April 17,
2003, we entered into a settlement agreement with SWBT. The terms of the
settlement are confidential. We do not expect the settlement to have a
material effect on our financial condition or the results of our operations.

26



---



##### Table of Contents



We currently have agreements with two long-distance carriers to provide
transmission and termination services for all of our long distance traffic.
These agreements generally provide for the resale of long distance services on
a per-minute basis and contain minimum volume commitments. Although we have not
fulfilled all of our volume commitments as outlined in one of these contracts
for technical reasons, the carrier has not imposed any penalties as provided
under the agreement. We are continuing to work with this carrier and believe
that we are quickly ramping to meet the minimum volume commitments during 2003
and do not expect any financial penalty to be applied by the carrier during the
course of the agreement.

In
February 2003, we executed an agreement allowing the resale of our local
wireline telecommunications services and provision of ancillary services with
Sprint Communications Company L.P. (Sprint). Under this agreement, we will
provide Sprint access to our web-integrated, enhanced communications platform
and operational support systems. This contract includes various per minute, per
line, and other charges that are being recorded as revenue as earned. We are
the primary obligor for expenses under the agreement and therefore, are
recording revenues using a gross presentation, consistent with the method used
for our wholesale services agreement with MCI. This method results in all per
line, per minute and certain direct costs being recorded as revenues and the
corresponding expenses recorded in the appropriate operating expense line. As a
result of this treatment, increases or decreases in pricing or volume that
include direct costs would have no impact on net income as the amount is
recorded in an equivalent amount in both revenue and expense. Our wholesale
services agreement with Sprint is non-exclusive in nature.

We are deferring $1.0 million of revenues for pre-contract payments by
recognizing this amount ratably over the life of the agreement. Additionally,
we received a $1.0 million payment that could potentially be returned to Sprint
as a bill credit, over several months, as a stimulus for the achievement of
reaching certain line-count thresholds. The stimulus payment would be recorded
as revenue only if Sprint does not achieve the required line thresholds upon
termination of the contract. As of June 30, 2003, we have recorded the $1.0
million stimulus payment as long-term deferred revenue.

On November 1, 2002 we significantly amended the terms or our agreement
with MCI. This amendment was made as a result of MCIs bankruptcy filing on
July 21, 2002. The significant financial changes contained in the amendment are
the elimination of the $50 million limited-term technology license fee,
increases to various fees calculated on a per minute and per line basis,
certain additional fees for services provided, elimination of exclusivity
clauses, a reduction to the monthly minimum payments and forgiveness of certain
amounts to be repaid to MCI.

As of June 30, 2003, under our contract with MCI, we had recorded $9.6
million in deferred revenue, of which $4.3 million is long-term deferred
revenue. A portion of these deferred revenues is being recognized over the
term of the agreement and may be recognized earlier if the agreement is
terminated before it stated termination date.

In March 2003, our Board of Directors authorized the repurchase of up to
one million shares of our common stock over the next twelve months. We have not
purchased any stock under this plan.

On March 11, 2003, we executed an agreement to outsource a portion of
inbound order processing and customer service with Sykes Enterprises, Inc.
(Sykes). We entered this agreement primarily to lower our risk and increase
our capacity to manage the growth of our wholesale customers while also
providing us with the flexibility to outsource services for our retail services
growth. Under this agreement we are subject to minimum guaranteed monthly
payments of $50,000. The initial term of this contract is two years.

On August 7, 2003, we amended our agreement with MCI to terminate the
agreement on December 31, 2003. This will result in the acceleration of
recognition of approximately $5.6 million, as of June 30, 2003, of unrecognized
revenue that was being deferred through December 31, 2004 to be recognized
ratably from the amendment date through December 31, 2003.

Our short-term liquidity relies heavily upon our accounts receivable
agreement, cash provided from operations, cash management strategies, and if
needed, our ability to reduce certain discretionary capital and marketing
expenses costs and growth of our retail and wholesale services. We have
generated cash flow from operating activities for seven consecutive quarters
and positive cash flow for the prior three quarters, however, we had an overall
negative cash flow for the three and six months ended June 30, 2003 primarily
as a result of our investment in sales and marketing and other growth related
expenses. We expect this trend to change for the second half of 2003 because
as we slow our growth we expect to improve our cash from operations while our
expected cash for equipment should stay consistent to slightly increase and our
debt payments should be flat resulting in an overall increase to cash. We are
aware of the risks, discussed throughout this document, of not achieving our
goals and the potential impact thereof on our liquidity and the various factors
and circumstances that could cause us to alter from this approach.

27



---



##### Table of Contents



Our ongoing capital requirements will depend on several factors, including
market acceptance of our services, the amount of resources we devote to
investments in our networks, facilities, build-out of additional enterprise
management centers, services development and brand promotions, the resources we
devote to sales and marketing of our services, and other factors. We will
continue to provide our back-office services and the technology that we have
developed to other companies seeking the capability of offering residential and
small business telecommunication services. As growth and opportunities arise,
we expect to make strategic investments in technology and our network
architecture and enter potential strategic alliances or partnerships with other
entities.

We will make investments in sales and marketing to build our overall Z
brand, build strategic partnerships, and develop new service offerings in an
attempt to attract new customers. We will focus on what we expect to be
attractive distribution channels that are expected to achieve cost effective
acquisition costs per subscriber.




ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We do not enter into financial instruments for trading or speculative
purposes and do not currently utilize derivative financial instruments. Our
operations are conducted primarily in the United States and as such are not
subject to material foreign currency exchange rate risk.

The fair value of our investment portfolio or related income would not be
significantly impacted by either a 100 basis point increase or decrease in
interest rates due mainly to the short-term nature of the major portion of our
investment portfolio.

We have no material future earnings or cash flow exposures from changes in
interest rates on our long-term debt obligations, as substantially all of our
long-term debt obligations are fixed rate obligations.




ITEM 4. CONTROLS AND PROCEDURES

EVALUATION OF CONTROLS AND PROCEDURES

We maintain disclosure controls and procedures, which we have designed to
ensure that material information related to us, including our consolidated
subsidiaries, is made known to our disclosure committee on a regular basis. In
response to recent legislation and proposed regulations, we reviewed our
internal control structure and our disclosure controls and procedures. We also
established a disclosure committee, which consists of certain members of our
management.

As of
the end of the most recent period covered under this report, management carried out
an evaluation, under the supervision of our Chief Executive Officer, D. Gregory
Smith, and Chief Financial Officer, Horace J. Davis, III, of the effectiveness
of the design and operation of the our disclosure controls and procedures.
Based upon that evaluation, Mr. Smith and Mr. Davis concluded that our
disclosure controls and procedures are effective in causing material
information to be recorded, processed, summarized, and reported by our
management on a timely basis and to ensure that the quality and timeliness of
our public disclosures complies with its SEC disclosure obligations.

CHANGES IN CONTROLS AND PROCEDURES

There were no significant changes in our internal controls or in other
factors that could significantly affect these internal controls after the date
of our most recent evaluation.




PART II




ITEM 1. LEGAL PROCEEDINGS

Master File Number 21 MC 92; In re Initial Public Offering Securities
Litigation., in the United States District Court for the Southern District of
New York (filed June 7, 2001)

During June and July 2001, three separate class action lawsuits were filed
against us, certain of our current and former directors and officers (the
D&Os) and firms engaged in the underwriting (the Underwriters) of our
initial public offering of stock (the IPO). The lawsuits, along with
approximately 310 other similar lawsuits filed against other issuers arising
out of initial public offering allocations, have been assigned to a Judge in
the United States District Court for the Southern District of New York for

28



---



##### Table of Contents



pretrial coordination. The lawsuits against us have been consolidated into
a single action. A consolidated amended complaint was filed on April 20, 2002.
A Second Corrected Amended Complaint (the Amended Complaint), which is the
operative complaint, was filed on July 12, 2002.

The Amended Complaint is based on the allegations that our registration
statement on Form S-1, filed with the Securities and Exchange Commission
(SEC) in connection with the IPO, contained untrue statements of material
fact and omitted to state facts necessary to make the statements made not
misleading by failing to disclose that the underwriters allegedly had received
additional, excessive and undisclosed commissions from, and allegedly had entered into
unlawful tie-in and other arrangements with, certain customers to whom they
allocated shares in the IPO. The plaintiffs in the Amended Complaint assert
claims against us and the D&Os pursuant to Section 11 of the Securities Act of
1933 and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5
promulgated by the SEC thereunder. The plaintiffs in the Amended Complaint
assert claims against the D&Os pursuant to Sections 11 and 15 of the Securities
Act of 1933 and Sections 10(b) and 20(a) of the Securities Exchange Act of 1934
and Rule 10b-5 promulgated by the SEC thereunder. The plaintiffs seek an
undisclosed amount of damages, as well as pre-judgment and post-judgment
interest, costs and expenses, including attorneys fees, experts fees and
other costs and disbursements. Initial discovery has begun. We believe we are
entitled to indemnification from our Underwriters.

A memorandum of understanding has been reached by lawyers for the
plaintiffs, the issuers and insurers of the issuers. The memorandum sets forth
the terms of a proposed settlement, the principal components of which are (i) a
release of all claims against the issuers and their officers and directors,
(ii) the assignment by the issuers to the plaintiffs of certain claims the
issuers may have against the Underwriters and (iii) an undertaking by the
insurers to ensure the plaintiffs receive not less than $1 billion in
connection with claims against the Underwriters. Our board of directors has
approved the memorandum of understanding. To be binding, the settlement must
be approved by substantially all the issuers and thereafter submitted to and
approved by the court. The settlement will not be binding upon any plaintiffs
electing to opt-out of the settlement.

PUC Docket No. 26417 Before the Public Utility Commission of Texas. Z-Tel
Communications, Inc. Complaint for Post-Interconnection Agreement Dispute
Resolution, Request for Expedited Ruling, And Request for Interim Ruling
Against Southwestern Bell Telephone Company.

On August 6, 2002, we filed a complaint against Southwestern Bell
Telephone Company (SWBT) before the Public Utility Commission of Texas
(PUCT), requesting that the PUCT enjoin SWBT from disconnecting our access to
customers in Texas on the basis of a billing dispute between the parties. The
billing dispute centered on whether we owed SWBT certain amounts for
alternatively billed service.  On August 23, 2002, the PUCT issued, in part, the injunctive relief
requested by us, making clear that service not be interrupted. On April 17,
2003, we entered into a settlement agreement with SWBT. The terms of the
settlement are confidential.




ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

At the Annual Meeting of Shareholders held on May 29, 2003, the following
proposal was adopted by the margins indicated:

1.     To elect the following individuals to the Board of Directors to hold office until their successors are elected and qualified:

|                   |  |                  |            |          |  |  |         | 
|------------------ |  | ---------------- | ---------- | -------- |  |  | ------- | 
|                   |  | Number of Shares
|                   |  |                 
|Nominee            |  | For              |            | Withheld
|D. Gregory Smith   |  |                  | 35,169,018 |          |  |  | 160,979 | 
|Jeffrey A. Bowden  |  |                  | 35,169,018 |          |  |  | 160,979 | 
|Lawrence C. Tucker |  |                  | 35,169,053 |          |  |  | 160,944 | 

29



---



##### Table of Contents









ITEM 5. OTHER INFORMATION.

N. Dumas Garrett, our senior vice president-business development and corporate
secretary, has resigned from those offices effective August 1, 2003 and August
2, 2003, respectively. Mr. Garrett is leaving us for personal reasons.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a)  The following exhibits are filed as part of this report:

|        |  |                                                                                                                                                                                                                                                                                                              
|------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|EXHIBIT |  |                                                                                                                                                                                                                                                                                                              
|NUMBER  |  | DESCRIPTION                                                                                                                                                                                                                                                                                                  
|        |  |                                                                                                                                                                                                                                                                                                              
|3.1     |  | Amended and Restated Certificate of Incorporation of Z-Tel, as
amended. Incorporated by reference to the correspondingly numbered exhibit to
our Quarterly Report on Form 10-Q for the quarter ended June 30, 2001, filed on
August 13, 2001.                                                                
|        |  |                                                                                                                                                                                                                                                                                                              
|3.2     |  | Amended and Restated Bylaws of Z-Tel. Incorporated by reference
to the correspondingly numbered exhibit to our Registration Statement on Form
S-1 (File No. 333-89063), originally filed October 14, 1999, as amended
and as effective December 14, 1999.                                                    
|        |  |                                                                                                                                                                                                                                                                                                              
|4.1     |  | Form of Common Stock Certificate. Incorporated by reference to
the correspondingly numbered exhibit to our Registration Statement on Form S-1
(File No. 333-89063), originally filed October 14, 1999, as amended and
as effective December 14, 1999.                                                        
|        |  |                                                                                                                                                                                                                                                                                                              
|4.2     |  | See Exhibits 3.1 and 3.2 of this Form for provisions of the
Amended and Restated Certificate of Incorporation, as amended, and our Bylaws
defining rights of security holders.                                                                                                                               
|        |  |                                                                                                                                                                                                                                                                                                              
|4.3     |  | Stock Purchase Agreement, dated July 6, 2000, by and between us
and the various purchasers of our Series D Convertible Preferred Stock.
Incorporated by reference to the correspondingly numbered exhibit to our
Quarterly Report on Form 10-Q for the quarter ended June 30, 2000, filed on
August 14, 2000.
|        |  |                                                                                                                                                                                                                                                                                                              
|4.4     |  | Certificate of Designations, Preferences and Relative Rights,
Qualifications, Limitations and Restrictions relating to our Series D
Convertible Preferred Stock, as amended March 13, 2003. Incorporated by
reference to Exhibit 4.4 to our Quarterly Report on Form 10-Q for the quarterly
period           

30



---



##### Table of Contents



|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|EXHIBIT |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|NUMBER  |  | DESCRIPTION                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|        |  | ended June 30, 2000, filed on August 14, 2000, and (the amendment) to
Exhibit 4.20 of our Quarterly Report on Form 10-Q for the quarter ended March
31, 2003, filed on May 15, 2003.                                                                                                                                                                                                                                                                                                                                                     
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|4.5     |  | From of Registration Rights Agreement by and between us and each
of the purchasers of our Series D Convertible Preferred Stock. Incorporated by
reference to the correspondingly numbered exhibits to our Quarterly Report on
Form 10-Q for the quarter ended June 30, 2000, filed on August 14, 2000.                                                                                                                                                                                                                                   
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|4.6     |  | Form of Warrant for the purchase of shares of our common stock by
each of the purchasers of our Series D Convertible Preferred Stock.
Incorporated by reference to the correspondingly numbered exhibits to our
Quarterly Report on Form 10-Q for the quarter ended June 30, 2000, filed on
August 14, 2000.                                                                                                                                                                                                                             
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|4.7     |  | Stock and Warrant Purchase Agreement, dated October 19, 2000, by
and among us and The 1818 Fund III, L.P. Incorporated by reference to the
correspondingly numbered exhibit to our Quarterly Report on Form 10-Q for the
quarter ended September 30, 2000, filed on November 14, 2000.                                                                                                                                                                                                                                                   
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|4.8     |  | Amended and Restated Certificate of Designation of 8% Convertible
Preferred Stock, Series E, Setting Forth the Powers, Preferences, Rights,
Qualifications, Limitations and Restrictions of Such Series of Preferred Stock,
as amended March 13, 2003. Incorporated by reference to Exhibit 4.8 to our
Quarterly Report on Form 10-Q for the quarter ended June 30, 2001, filed on
August 13, 2001, and (the amendment) to Exhibit 4.21 of our Quarterly Report on
Form 10-Q for the quarter ended March 31, 2003, filed on May 15, 2003.
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|4.9     |  | Registration Rights Agreement between and among us and The 1818
Fund III, L.P. Incorporated by reference to the correspondingly numbered
exhibit to our Quarterly Report on Form 10-Q for the quarter ended September
30, 2000, filed on November 14, 2000.                                                                                                                                                                                                                                                                              
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|4.10    |  | Warrant issued to The 1818 Fund III, L.P. for the purchase of
shares of our common stock. Incorporated by reference to the correspondingly
numbered exhibit to our Quarterly Report on Form 10-Q for the quarter ended
September 30, 2000, filed on November 14, 2000.                                                                                                                                                                                                                                                                   
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|4.11    |  | Certificate of Designation of Series F Junior Participating
Preferred Stock. Incorporated by reference to the correspondingly numbered
exhibit to our Annual Report on Form 10-K for the year ended December 31, 2000,
filed on March 30, 2001.                                                                                                                                                                                                                                                                                          

31



---



##### Table of Contents



|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|EXHIBIT |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|NUMBER  |  | DESCRIPTION                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|4.12    |  | Rights Agreement dated as of February 19, 2001 between us and
American Stock Transfer Trust Company, as Rights Agent. Incorporated by
reference to the correspondingly numbered exhibit to our Annual Report on Form
10-K for the year ended December 31, 2000, filed on March 30, 2001. The
agreement was amended July 2, 2001 to reflect the issuance of the Series G
Preferred Stock.                                                                    
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|4.13    |  | Stock and Warrant Purchase Agreement, dated as of July 2, 2001,
by and between us, D. Gregory Smith, and others. Incorporated by reference to
Exhibit 1 to Amendment No. 1 of the Schedule 13D filed July 12, 2001 with
respect to our common stock by, among other persons, The 1818 Fund III, L.P.                                                                                                                                                        
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|4.14    |  | Warrant for the Purchase of Shares of Common Stock of Z-Tel,
dated as of July 2, 2001. Incorporated by reference to Exhibit 2 to Amendment
No. 1 of the Schedule 13D filed July 12, 2001 with respect to our common stock
by, among other persons, The 1818 Fund III, L.P.                                                                                                                                                                                  
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|4.15    |  | Certificate of Designation for the Series G Preferred Stock.
Incorporated by reference to Exhibit 3 to Amendment No. 1 of the Schedule 13D
filed July 12, 2001 with respect to our common stock by, among other persons,
The 1818 Fund III, L.P.                                                                                                                                                                                                            
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|4.16    |  | Backup Purchase Agreement, dated as of July 2, 2001, by and among
Z-Tel Communications, Inc., a Delaware corporation and our wholly owned
subsidiary, Touch 1 Communications, Inc., an Alabama corporation and our wholly
owned subsidiary, D. Gregory Smith and others. Incorporated by reference to
Exhibit 4 to Amendment No. 1 of the Schedule 13D filed July 12, 2001 with
respect to our common stock by, among other persons, The 1818 Fund III, L.P.
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|4.17    |  | Additional Investor Registration Rights Agreement, dated as of
July 2, 2001, between Z-Tel, D. Gregory Smith and others. Incorporated by
reference to Exhibit 5 to the Schedule 13D filed July 24, 2001 with respect to
our common stock by, among other persons, D. Gregory Smith.                                                                                                                                                                         
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|4.18    |  | Voting Agreement, dated as of June 29, 2001, between us and
certain of our stockholders. Incorporated by reference to Exhibit 5 to
Amendment No. 1 of the Schedule 13D filed July 12, 2001 with respect to our
common stock by, among other persons, The 1818 Fund III, L.P.                                                                                                                                                                                
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|4.19    |  | Employee Stock Restriction Agreement, dated September 1, 1998, by
and between us and D. Gregory Smith. Incorporated by reference to Exhibit 7 to
the Schedule 13D filed July 24, 2001 with respect to our common stock by, among
other persons, D. Gregory Smith.                                                                                                                                                                                           

32



---



##### Table of Contents



|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|EXHIBIT |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|NUMBER  |  | DESCRIPTION                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|10.2.1  |  | 1998 Equity Participation Plan. Incorporated by reference to
the correspondingly numbered exhibit to our Registration Statement on Form S-1
(File No. 333-89063), originally filed October 14, 1999, as amended and as
effective December 14, 1999.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|10.2.2  |  | 2000 Equity Participation Plan. Incorporated by reference to
Appendix B to our Preliminary Proxy Statement filed on April 14, 2000, with the
following amendment effective May 31, 2001:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|        |  | Section 2.1(a) of the Plan is hereby amended in its entirety to read as
follows:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|        |  | The shares of stock subject to Options, awards of Restricted
Stock, Performance Awards, Dividend Equivalents, awards of
Deferred Stock, Stock Payments or Stock Appreciation Rights
shall be Common Stock, initially shares of the Companys
Common Stock, par value $0.01 per share. The aggregate number
of such shares which may be issued upon exercise of such
options or rights or upon any such awards under the Plan shall
be Four Million Five Hundred Thousand (4,500,000) plus an
annual increase to be added on the first day of the Companys
fiscal year beginning in 2001 equal to the lesser of (i) Three
Million (3,000,000) shares of the Companys Common Stock, (ii)
6% of the outstanding shares on such date, or (iii) a lesser
amount determined by the Board. The shares of Common Stock
issuable upon exercise of such options or rights or upon any
such awards may be either previously authorized but unissued
shares or treasury shares.
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|10.3    |  | Employment Agreement of D. Gregory Smith, dated July 30, 2002.
Incorporated by reference to the correspondingly numbered exhibit to our
Quarterly Report on Form 10-Q for the quarter ended September 30, 2002, filed
on November 14, 2002.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|10.4    |  | Receivables Sales Agreement dated as of July 27, 2000 by and
between Z-Tel Communications, Inc., as seller and subservicer, Touch 1
Communications, Inc., as seller and subservicer, and RFC Capital Corporation,
as purchaser. Incorporated by reference to the correspondingly numbered
exhibit to our Quarterly Report on Form 10-Q for the quarter ended June 30,
2000, filed on August 14, 2000, with an amendment extending the agreement until
July 27, 2004.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|10.5    |  | Form of Indemnification Agreement for our executive officers and
directors. Incorporated by reference to the correspondingly numbered exhibit
to our Annual Report on Form 10-K for the year ended December 31, 2000, filed
on March 30, 2001.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       

33



---



##### Table of Contents



|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|EXHIBIT |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|NUMBER  |  | DESCRIPTION                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|10.6    |  | Employment Agreement of Ned Dumas Garrett, dated August 14, 2002.
Incorporated by reference to the correspondingly numbered exhibit to our
Quarterly Report on Form 10-Q for the quarter ended September 30, 2002, filed
on November 14, 2002.                                                                                                                                                                                                                      
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|10.7    |  | Employment Agreement of J. Bryan Bunting, dated August 14, 2002.
Incorporated by reference to the correspondingly numbered exhibit to our
Quarterly Report on Form 10-Q for the quarter ended September 30, 2002, filed
on November 14, 2002.                                                                                                                                                                                                                       
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|10.8    |  | Employment Agreement of Charles W. McDonough, dated August 14,
2002. Incorporated by reference to the correspondingly numbered exhibit to our
Quarterly Report on Form 10-Q for the quarter ended September 30, 2002, filed
on November 14, 2002.                                                                                                                                                                                                                   
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|10.9    |  | Employment Agreement of Robert A. Curtis, dated July 30, 2002.
Incorporated by reference to the correspondingly numbered exhibit to our
Quarterly Report on Form 10-Q for the quarter ended September 30, 2002, filed
on November 14, 2002.                                                                                                                                                                                                                         
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|10.11   |  | Promissory Note, dated September 10, 1999, from Touch 1
Communications, Inc. and William F. Corman (First Revocable Trust).
Incorporated by reference to the correspondingly numbered exhibits to our
Annual Report on Form 10-K for the year ended December 31, 2000, filed
on March 30, 2001.                                                                                                                                                                     
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|10.12   |  | Promissory Note, dated September 10, 1999, from Touch 1
Communications, Inc. and James F. Corman. Incorporated by reference to the
correspondingly numbered exhibits to our Annual Report on
Form 10-K for the
year ended December 31, 2000, filed on March 30, 2001.                                                                                                                                                                                               
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|10.13   |  | Agreement for Wholesale Telephone Exchange Services, Z-Node
Services, Ancillary Services and Technology License, dated March 20, 2002,
between Z-Tel Communications, Inc. and MCI WORLDCOM Communications, Inc.
Incorporated by reference to the correspondingly numbered exhibit to our
Quarterly Report on Form 10-Q for the quarter ended March 31, filed on May 15,
2002. The agreement was amended August 7, 2003 to terminate the agreement
December 31, 2003.
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|31.1    |  | Certification of the Chief Executive Officer                                                                                                                                                                                                                                                                                                                                                                                                                        

34



---



##### Table of Contents



|        |  |                                                                              
|------- |  | -----------------------------------------------------------------------------
|EXHIBIT |  |                                                                              
|NUMBER  |  | DESCRIPTION                                                                  
|        |  |                                                                              
|31.2    |  | Certification of the Chief Financial Officer                                 
|        |  |                                                                              
|32.1    |  | Written Statement of the Chief Executive Officer Pursuant to 18
U.S.C.ss.1350
|        |  |                                                                              
|32.2    |  | Written Statement of the Chief Financial Officer Pursuant to 18
U.S.C.ss.1350

(b)  Reports on Form 8-K

On May 8 and May 13, 2003, respectively, we filed Forms 8-K in connection
with our earnings release and the subsequent earnings conference call.

35



---



##### Table of Contents






SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) 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, as of
the 14th
day of August 2003.

| |     |  |                                                                                                                                          
| | --- |  | -----------------------------------------------------------------------------------------------------------------------------------------
| |     |  | Z-TEL TECHNOLOGIES, INC
(Registrant)                                                                                                     
|
| |     | 
|
| | By: |  | /s/ HORACE J. DAVIS IIISenior Vice-President  Chief Financial Officer
(Authorized officer of Registrant and principal financial officer)

36