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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 September 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

Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12B-2 of the Exchange Act)

Yes o     No x

The number of shares of the Registrants Common Stock outstanding as of
November 12, 2003 was approximately 35,596,195.





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TABLE OF CONTENTS



|                                      |                                                                                                |                                                             |  |  |  |  |  | 
|------------------------------------- | ---------------------------------------------------------------------------------------------- | ----------------------------------------------------------- |  |  |  |  |  | 
|Part I                               
|                                      | Item 1. Financial Statements                                                                  
|                                      |                                                                                                | 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                                                                     
|SIGNATURES                           
|Ex-31.1 Section 302 CEO Certification
|Ex-31.2 Section 302 CFO Certification
|Ex-32.1 Section 906 CEO Certification
|Ex-32.2 Section 906 CFO Certification



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##### Table of Contents



TABLE OF CONTENTS

|           |                                                                                               |                                                                                                         |    |    |   | 
|---------- | --------------------------------------------------------------------------------------------- | ------------------------------------------------------------------------------------------------------- | -- | -- | - | 
|PART I     |                                                                                               |                                                                                                         |    |   
|           | Item 1. Financial Statements                                                                  |                                                                                                         |    |    |  
|           |                                                                                               | Consolidated Balance Sheets at September 30, 2003 and December 31, 2002                                 |    |    | 3 | 
|           |                                                                                               | Consolidated Statements of Operations for the three and nine months ended September 30, 2003 and 2002   |    |    | 4 | 
|           |                                                                                               | Consolidated Statement of Changes in Stockholders Deficit for the nine months ended September 30, 2003 |    |    | 5 | 
|           |                                                                                               | Consolidated Statements of Cash Flows for the nine months ended September 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 |                                                                                                         |    | 17 |  
|           | Item 3. Quantitative and Qualitative Disclosures about Market Risk                            |                                                                                                         |    | 34 |  
|           | Item 4. Controls and Procedures                                                               |                                                                                                         |    | 35 |  
|PART II    |                                                                                               |                                                                                                         |    |   
|           | Item 1. Legal Proceedings                                                                     |                                                                                                         |    | 35 |  
|           | Item 6.
Exhibits and Reports on Form 8-K                                                      |                                                                                                         |    | 36 |  
|Signatures |                                                                                               |                                                                                                         | 41 |   

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Z-Tel Technologies, Inc. and Subsidiaries




Consolidated Balance Sheets


(In thousands, except share data)
(Unaudited)


|                                                                                                                                                                                                               |                                                                                                                                             |                             |                                                                                                 |          |               |        |              |          |         |         | 
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------- | --------------------------- | ----------------------------------------------------------------------------------------------- | -------- | ------------- | ------ | ------------ | -------- | ------- | ------- | 
|                                                                                                                                                                                                               |                                                                                                                                             |                             |                                                                                                 |          | September 30, |        | December 31,
|                                                                                                                                                                                                               |                                                                                                                                             |                             |                                                                                                 |          | 2003          |        | 2002        
|                                                                                                                                                                                                               |                                                                                                                                             |                             |                                                                                                 |          |               |        |             
|Assets                                                                                                                                                                                                         |                                                                                                                                             |                             |                                                                                                 |          |               |        |              |         
|Current assets:                                                                                                                                                                                                |                                                                                                                                             |                             |                                                                                                 |          |               |        |              |         
|                                                                                                                                                                                                               | Cash and cash equivalents                                                                                                                   |                             | $                                                                                               | 14,544   |               |        | $            | 16,037   |        
|                                                                                                                                                                                                               | Accounts receivable, net of allowance for doubtful
accounts of $16,765 and $17,401                                                          |                             |                                                                                                 | 25,183   |               |        |              | 26,749   |        
|                                                                                                                                                                                                               | Prepaid expenses and other current assets                                                                                                   |                             |                                                                                                 | 5,071    |               |        |              | 5,741    |        
|                                                                                                                                                                                                               |                                                                                                                                             |                             |                                                                                                 |          |               |        |              |         
|                                                                                                                                                                                                               |                                                                                                                                             | Total current assets        |                                                                                                 |          | 44,798        |        |              |          | 48,527  |        
|Property and equipment, net                                                                                                                                                                                    |                                                                                                                                             |                             | 40,769                                                                                          |          |               |        | 48,320       |         
|Intangible assets, net                                                                                                                                                                                         |                                                                                                                                             |                             | 2,744                                                                                           |          |               |        | 4,116        |         
|Other assets                                                                                                                                                                                                   |                                                                                                                                             |                             | 4,940                                                                                           |          |               |        | 5,748        |         
|                                                                                                                                                                                                               |                                                                                                                                             |                             |                                                                                                 |          |               |        |              |         
|                                                                                                                                                                                                               |                                                                                                                                             |                             | Total assets                                                                                    |          | $             | 93,251 |              |          | $       | 106,711 | 
|                                                                                                                                                                                                               |                                                                                                                                             |                             |                                                                                                 |          |               |        |              |         
|Liabilities, Mandatorily Redeemable Convertible Preferred
Stock and Stockholders Deficit                                                                                                                      |                                                                                                                                             |                             |                                                                                                 |          |               |        |              |         
|Current liabilities:                                                                                                                                                                                           |                                                                                                                                             |                             |                                                                                                 |          |               |        |              |         
|                                                                                                                                                                                                               | Accounts payable and accrued liabilities                                                                                                    |                             | $                                                                                               | 53,682   |               |        | $            | 51,771   |        
|                                                                                                                                                                                                               | Deferred revenue                                                                                                                            |                             |                                                                                                 | 14,710   |               |        |              | 10,172   |        
|                                                                                                                                                                                                               | Current portion of long-term debt
and capital lease obligations                                                                             |                             |                                                                                                 | 6,553    |               |        |              | 5,964    |        
|                                                                                                                                                                                                               |                                                                                                                                             |                             |                                                                                                 |          |               |        |              |         
|                                                                                                                                                                                                               |                                                                                                                                             | Total current liabilities   |                                                                                                 |          | 74,945        |        |              |          | 67,907  |        
|Long-term deferred revenue                                                                                                                                                                                     |                                                                                                                                             |                             | 481                                                                                             |          |               |        | 6,277        |         
|Long-term debt and capital lease obligations                                                                                                                                                                   |                                                                                                                                             |                             | 562                                                                                             |          |               |        | 4,180        |         
|                                                                                                                                                                                                               |                                                                                                                                             |                             |                                                                                                 |          |               |        |              |         
|                                                                                                                                                                                                               |                                                                                                                                             |                             | Total liabilities                                                                               |          |               | 75,988 |              |          |         | 78,364  | 
|                                                                                                                                                                                                               |                                                                                                                                             |                             |                                                                                                 |          |               |        |              |         
|Mandatorily redeemable convertible preferred stock, $.01 par value;
50,000,000 shares authorized; 8,855,089 issued; 8,738,422 and 8,855,089
outstanding (aggregate liquidation value of $153,980 and $145,503) |                                                                                                                                             |                             | 138,559                                                                                         |          |               |        | 127,631      |         
|                                                                                                                                                                                                               |                                                                                                                                             |                             |                                                                                                 |          |               |        |              |         
|Commitments and contingencies (Note 6)                                                                                                                                                                         |                                                                                                                                             |                             |                                                                                                 |          |               |        |              |         
|Stockholders deficit:                                                                                                                                                                                         |                                                                                                                                             |                             |                                                                                                 |          |               |        |              |         
|                                                                                                                                                                                                               | Common stock, $.01 par value; 150,000,000
shares authorized; 35,837,412 and 35,609,803 shares issued;
35,495,862 and 35,268,253 outstanding |                             |                                                                                                 | 358      |               |        |              | 356      |        
|                                                                                                                                                                                                               | Notes receivable from stockholders                                                                                                          |                             |                                                                                                 | (1,121   | )             |        |              | (1,589   | )      
|                                                                                                                                                                                                               | Additional paid-in capital                                                                                                                  |                             |                                                                                                 | 194,274  |               |        |              | 205,090  |        
|                                                                                                                                                                                                               | Accumulated deficit                                                                                                                         |                             |                                                                                                 | (314,419 | )             |        |              | (302,753 | )      
|                                                                                                                                                                                                               | Treasury stock, 341,550 shares at cost                                                                                                      |                             |                                                                                                 | (388     | )             |        |              | (388     | )      
|                                                                                                                                                                                                               |                                                                                                                                             |                             |                                                                                                 |          |               |        |              |         
|                                                                                                                                                                                                               |                                                                                                                                             | Total stockholders deficit |                                                                                                 |          | (121,296      | )      |              |          | (99,284 | )      
|                                                                                                                                                                                                               |                                                                                                                                             |                             |                                                                                                 |          |               |        |              |         
|                                                                                                                                                                                                               |                                                                                                                                             |                             | Total liabilities, mandatorily redeemable convertible preferred
stock and stockholders deficit |          | $             | 93,251 |              |          | $       | 106,711 | 
|                                                                                                                                                                                                               |                                                                                                                                             |                             |                                                                                                 |          |               |        |              |         

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

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Z-Tel Technologies, Inc. and Subsidiaries




Consolidated Statements of Operations


(In thousands, except share and per share data)
(Unaudited)


|                                           |                                                                            |                                                                                 |            |                    |        |                   |            |        |        |      |            |        |         |   |            |        |         |  
|------------------------------------------ | -------------------------------------------------------------------------- | ------------------------------------------------------------------------------- | ---------- | ------------------ | ------ | ----------------- | ---------- | ------ | ------ | ---- | ---------- | ------ | ------- | - | ---------- | ------ | ------- | -
|                                           |                                                                            |                                                                                 |            | Three months ended |        | Nine months ended
|                                           |                                                                            |                                                                                 |            | September 30,      |        | September 30,    
|                                           |                                                                            |                                                                                 |            |                    |        |                  
|                                           |                                                                            |                                                                                 |            | 2003               |        | 2002              |            | 2003   |        | 2002
|                                           |                                                                            |                                                                                 |            |                    |        |                   |            |        |        |     
|Revenues                                   |                                                                            | $                                                                               | 81,454     |                    |        | $                 | 58,715     |        |        | $    | 211,605    |        |         | $ | 178,208    |       
|                                           |                                                                            |                                                                                 |            |                    |        |                   |            |        |        |      |            |        |         |   |            |       
|Operating expenses:                        |                                                                            |                                                                                 |            |                    |        |                   |            |        |        |      |            |        |         |   |            |       
|                                           | Network operations, exclusive of depreciation and
amortization shown below |                                                                                 |            | 38,476             |        |                   |            | 23,799 |        |      |            | 95,504 |         |   |            | 69,863 |        
|                                           | Sales and marketing                                                        |                                                                                 |            | 3,589              |        |                   |            | 2,211  |        |      |            | 14,700 |         |   |            | 8,166  |        
|                                           | General and administrative                                                 |                                                                                 |            | 35,621             |        |                   |            | 31,663 |        |      |            | 94,471 |         |   |            | 93,382 |        
|                                           | Asset impairment charge                                                    |                                                                                 |            |                   |        |                   |            |       |        |      |            |       |         |   |            | 1,129  |        
|                                           | Wholesale development costs                                                |                                                                                 |            |                   |        |                   |            |       |        |      |            |       |         |   |            | 1,018  |        
|                                           | Restructuring charge                                                       |                                                                                 |            |                   |        |                   |            |       |        |      |            |       |         |   |            | 1,861  |        
|                                           | Depreciation and amortization                                              |                                                                                 |            | 5,837              |        |                   |            | 6,169  |        |      |            | 17,866 |         |   |            | 17,751 |        
|                                           |                                                                            |                                                                                 |            |                    |        |                   |            |        |        |      |            |        |         |   |            |       
|                                           |                                                                            | Total operating expenses                                                        |            |                    | 83,523 |                   |            |        | 63,842 |      |            |        | 222,541 |   |            |        | 193,170 |  
|                                           |                                                                            |                                                                                 |            |                    |        |                   |            |        |        |      |            |        |         |   |            |       
|                                           |                                                                            | Operating loss                                                                  |            |                    | (2,069 | )                 |            |        | (5,127 | )    |            |        | (10,936 | ) |            |        | (14,962 | )
|                                           |                                                                            |                                                                                 |            |                    |        |                   |            |        |        |      |            |        |         |   |            |       
|Nonoperating income (expense):             |                                                                            |                                                                                 |            |                    |        |                   |            |        |        |      |            |        |         |   |            |       
|                                           | Interest and other income                                                  |                                                                                 |            | 494                |        |                   |            | 1,179  |        |      |            | 1,658  |         |   |            | 2,663  |        
|                                           | Interest and other expense                                                 |                                                                                 |            | (978               | )      |                   |            | (1,014 | )      |      |            | (2,388 | )       |   |            | (3,011 | )      
|                                           |                                                                            |                                                                                 |            |                    |        |                   |            |        |        |      |            |        |         |   |            |       
|                                           |                                                                            | Total nonoperating income (expense)                                             |            |                    | (484   | )                 |            |        | 165    |      |            |        | (730    | ) |            |        | (348    | )
|                                           |                                                                            |                                                                                 |            |                    |        |                   |            |        |        |      |            |        |         |   |            |       
|                                           |                                                                            | Net loss                                                                        |            |                    | (2,553 | )                 |            |        | (4,962 | )    |            |        | (11,666 | ) |            |        | (15,310 | )
|                                           |                                                                            | Less mandatorily redeemable convertible
preferred stock dividends and accretion |            |                    | (3,707 | )                 |            |        | (3,969 | )    |            |        | (12,611 | ) |            |        | (11,761 | )
|                                           |                                                                            | Less deemed dividend related to beneficial
conversion feature                   |            |                    | (46    | )                 |            |        | (47    | )    |            |        | (138    | ) |            |        | (139    | )
|                                           |                                                                            |                                                                                 |            |                    |        |                   |            |        |        |      |            |        |         |   |            |       
|                                           |                                                                            | Net loss attributable to common stockholders                                    |            | $                  | (6,306 | )                 |            | $      | (8,978 | )    |            | $      | (24,415 | ) |            | $      | (27,210 | )
|                                           |                                                                            |                                                                                 |            |                    |        |                   |            |        |        |      |            |        |         |   |            |       
|Weighted average common shares outstanding |                                                                            |                                                                                 | 35,368,759 |                    |        |                   | 35,191,836 |        |        |      | 35,340,089 |        |         |   | 34,861,229 |       
|                                           |                                                                            |                                                                                 |            |                    |        |                   |            |        |        |      |            |        |         |   |            |       
|Basic and diluted net loss per share       |                                                                            | $                                                                               | (0.18      | )                  |        | $                 | (0.26      | )      |        | $    | (0.69      | )      |         | $ | (0.78      | )     
|                                           |                                                                            |                                                                                 |            |                    |        |                   |            |        |        |      |            |        |         |   |            |       

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

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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                                                  |  |  | 92,870       |  |                  |   | 1            |  |             |   |          |   |               |   | 61      |   |       |   |          |   |  |   |      |   |  |   | 62       |  
|Exercise of warrants                                                       |  |  | 25,714       |  |                  |   |             |  |             |   |          |   |               |   |         |   |       |   |          |   |  |   |      |   |  |   |         |  
|Accelerated vesting of stock options                                       |  |  |              |  |                  |   |              |  |             |   |          |   |               |   | 123     |   |       |   |          |   |  |   |      |   |  |   | 123      |  
|Conversion of mandatorily
redeemable convertible preferred stock to common |  |  | 109,025      |  |                  |   | 1            |  |             |   |          |   |               |   | 942     |   |       |   |          |   |  |   |      |   |  |   | 943      |  
|Repayment of notes receivable                                              |  |  |              |  |                  |   |              |  |             |   | 468      |   |               |   |         |   |       |   |          |   |  |   |      |   |  |   | 468      |  
|Mandatorily redeemable convertible preferred
stock dividends and accretion |  |  |              |  |                  |   |              |  |             |   |          |   |               |   | (11,942 | ) |       |   |          |   |  |   |      |   |  |   | (11,942  | )
|Net loss                                                                   |  |  |              |  |                  |   |              |  |             |   |          |   |               |   |         |   |       |   | (11,666  | ) |  |   |      |   |  |   | (11,666  | )
|                                                                           |  |  |              |  |                  |   |              |  |             |   |          |   |               |   |         |   |       |   |          |   |  |   |      |   |  |   |          |  
|Balance, September 30, 2003                                                |  |  | 35,495,862   |  |                  | $ | 358          |  |             | $ | (1,121   | ) |               | $ | 194,274 |   |       | $ | (314,419 | ) |  | $ | (388 | ) |  | $ | (121,296 | )
|                                                                           |  |  |              |  |                  |   |              |  |             |   |          |   |               |   |         |   |       |   |          |   |  |   |      |   |  |   |          |  

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

5



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##### Table of Contents



Z-Tel Technologies, Inc. and Subsidiaries




Consolidated Statements of Cash Flows


(In thousands)
(Unaudited)


|                                                                            |                                                                    |                                                      |                                           |        |                   |        |         |         |         |         |  
|--------------------------------------------------------------------------- | ------------------------------------------------------------------ | ---------------------------------------------------- | ----------------------------------------- | ------ | ----------------- | ------ | ------- | ------- | ------- | ------- | -
|                                                                            |                                                                    |                                                      |                                           |        | Nine months ended
|                                                                            |                                                                    |                                                      |                                           |        | September 30,    
|                                                                            |                                                                    |                                                      |                                           |        |                  
|                                                                            |                                                                    |                                                      |                                           |        | 2003              |        | 2002   
|                                                                            |                                                                    |                                                      |                                           |        |                   |        |        
|Cash flows from operating activities:                                       |                                                                    |                                                      |                                           |        |                   |        |         |        
|Net loss                                                                    |                                                                    | $                                                    | (11,666                                   | )      |                   | $      | (15,310 | )      
|                                                                            |                                                                    |                                                      |                                           |        |                   |        |         |        
|Adjustments to reconcile net loss to net cash used in
operating activities: |                                                                    |                                                      |                                           |        |                   |        |         |        
|                                                                            | Depreciation and amortization                                      |                                                      |                                           | 17,866 |                   |        |         | 17,751  |        
|                                                                            | Provision for bad debts                                            |                                                      |                                           | 12,009 |                   |        |         | 17,929  |        
|                                                                            | Asset impairment charge                                            |                                                      |                                           |       |                   |        |         | 1,129   |        
|                                                                            | Loss on disposal of equipment                                      |                                                      |                                           | 44     |                   |        |         |        |        
|                                                                            | Expense charged for granting of stock options                      |                                                      |                                           | 123    |                   |        |         | 184     |        
|                                                                            | Change in operating assets and liabilities:                        |                                                      |                                           |        |                   |        |         |         |        
|                                                                            |                                                                    | Increase in accounts receivable                      |                                           |        | (10,443           | )      |         |         | (17,425 | )      
|                                                                            |                                                                    | (Increase) decrease in prepaid expenses              |                                           |        | 670               |        |         |         | (765    | )      
|                                                                            |                                                                    | Decrease in other assets                             |                                           |        | 781               |        |         |         | 343     |        
|                                                                            |                                                                    | Increase in accounts payable and accrued liabilities |                                           |        | 1,912             |        |         |         | 9,257   |        
|                                                                            |                                                                    | Decrease in deferred revenue                         |                                           |        | (1,258            | )      |         |         | (127    | )      
|                                                                            |                                                                    |                                                      |                                           |        |                   |        |         |        
|                                                                            |                                                                    |                                                      | Total adjustments                         |        |                   | 21,704 |         |         |         | 28,276  |  
|                                                                            |                                                                    |                                                      |                                           |        |                   |        |         |        
|                                                                            |                                                                    |                                                      | Net cash provided by operating activities |        |                   | 10,038 |         |         |         | 12,966  |  
|                                                                            |                                                                    |                                                      |                                           |        |                   |        |         |        
|Cash flows from investing activities:                                       |                                                                    |                                                      |                                           |        |                   |        |         |        
|                                                                            | Purchases of property and equipment                                |                                                      |                                           | (7,731 | )                 |        |         | (13,706 | )      
|                                                                            | Principal repayments received on notes receivable                  |                                                      |                                           | 27     |                   |        |         | 590     |        
|                                                                            | Issuance of note receivable                                        |                                                      |                                           |       |                   |        |         | (997    | )      
|                                                                            |                                                                    |                                                      |                                           |        |                   |        |         |        
|                                                                            |                                                                    |                                                      | Net cash used in investing activities     |        |                   | (7,704 | )       |         |         | (14,113 | )
|                                                                            |                                                                    |                                                      |                                           |        |                   |        |         |        
|Cash flows from financing activities:                                       |                                                                    |                                                      |                                           |        |                   |        |         |        
|                                                                            | Payments on long-term debt and capital lease obligations           |                                                      |                                           | (4,285 | )                 |        |         | (4,283  | )      
|                                                                            | Payment of preferred stock dividends                               |                                                      |                                           | (72    | )                 |        |         |        |        
|                                                                            | Principal repayments received on notes receivable issued for stock |                                                      |                                           | 468    |                   |        |         |        |        
|                                                                            | Proceeds from exercise of stock options and warrants               |                                                      |                                           | 62     |                   |        |         | 2       |        
|                                                                            |                                                                    |                                                      |                                           |        |                   |        |         |        
|                                                                            |                                                                    |                                                      | Net cash used in financing activities     |        |                   | (3,827 | )       |         |         | (4,281  | )
|                                                                            |                                                                    |                                                      |                                           |        |                   |        |         |        
|Net decrease in cash and cash equivalents                                   |                                                                    |                                                      | (1,493                                    | )      |                   |        | (5,428  | )      
|Cash and cash equivalents, beginning of period                              |                                                                    |                                                      | 16,037                                    |        |                   |        | 18,892  |        
|                                                                            |                                                                    |                                                      |                                           |        |                   |        |         |        
|Cash and cash equivalents, end of period                                    |                                                                    | $                                                    | 14,544                                    |        |                   | $      | 13,464  |        
|                                                                            |                                                                    |                                                      |                                           |        |                   |        |         |        

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

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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 our services on both a retail and
wholesale basis.

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 can
engage a single telephone company instead of several local phone companies for
their communication needs. The majority of our Z-Line customers are
concentrated 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 service 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 privately labeled 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 nine months ended
September 30, 2003 are not necessarily indicative of the results that may be
expected for the year ending December 31, 2003.

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RECLASSIFICATION

Certain amounts in the consolidated statements of operations for the three
and nine months ended September 30, 2002 have been reclassified to conform to
the presentation for the three and nine months ended September 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.
EITF No. 00-21 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. EITF No. 00-21 also
supersedes certain guidance set forth in Staff Accounting Bulletin No. 101
(SAB 101), 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, on a prospective basis. This adoption did not have a
material impact on our consolidated financial statements.

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. We reviewed this new pronouncement and concluded
that none of the mandatorily redeemable convertible preferred stock recorded in
the mezzanine section of our balance sheet is within the scope of SFAS No. 150.
This conclusion is based on the facts that no unconditional
obligation requiring the redemption of the securities exists because they are
convertible into common at the option of the holder and the conversion option
is substantial. We recognize that the FASB is in the process of possibly
promulgating additional rules in the future related to securities similar to
the ones that we have in the mezzanine section, but are unable to determine
what any future rules impact might have on our consolidated financial
statements.

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. We adopted SFAS 149 in the third quarter of
2003. This adoption did not have any impact on our consolidated financial
statements.

3. WHOLESALE SERVICES

In February 2003, we executed an agreement providing for the resale of our
local wireline telecommunications services and provision of ancillary services
with Sprint Communications Company L.P. (Sprint). Under this agreement, we
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 underlying expenses that are incorporated into our
pricing in connection with 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 being recorded in the appropriate

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operating expense line. As a result of this accounting treatment, increases or
decreases in pricing or volume that impact direct costs that are incurred in
connection with this agreement 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, of which we have returned $0.8 million to
Sprint as a bill credit during the third quarter of 2003 for the achievement of
reaching certain line-count thresholds. As of September 30, 2003, there was
$0.2 million of the stimulus payment remaining which is recorded in short-term
deferred revenue. We expect this amount to be returned to Sprint via bill
credits in the fourth quarter of 2003.

As of September 30, 2003, under our contract with Sprint, we had
approximately $5.8 million of deferred revenue, of which $0.4 million is
recorded as long-term deferred revenue.

On August 7, 2003, we amended our contract with MCI to terminate the
contract on December 31, 2003. On August 15, 2003, MCI provided us with notice
that they were terminating the contract effective October 15, 2003. As a
result of these events we accelerated the recognition of deferred revenue to
the termination date of October 15, 2003. Prior to the early
termination, we were recognizing
the deferred revenue ratably over the life of the agreement with a termination
date of December 31, 2005. During the third quarter of 2003, we recognized an
additional $3.7 million of revenue as a result of the termination notice from
MCI. As of September 30, 2003, we had $1.6 million of short-term deferred
revenue attributable to MCI.

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. From March 2002 until the middle of September
2003, we sold our receivables at a discount rate of 19%. As of the end of
September 2003, we were selling our receivables at a discount rate of 16%. This
rate is negotiable and may change according to our actual collection
experience. The collection percentage for receivables sold to RFC has been
approximately 93% 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 $94.9 and $108.5 million of receivables to RFC, for
net proceeds of approximately $77.0 and $85.6 million, during the nine months
ended September 30, 2003 and 2002, respectively. A net receivable servicing
asset of approximately $12.9 million is included in our accounts receivable
balance at September 30, 2003. We recorded costs, included in interest and
other expenses, related to the agreement of approximately $0.3 million for both
the three months ended September 30, 2003 and 2002, and $0.7 and $1.0 million
for the nine months ended September 30, 2003 and 2002, respectively. Included
in accounts payable and accrued liabilities are advances for unbilled
receivables in the amount of $5.2 million at September 30, 2003. We are
responsible for the continued servicing of the receivables sold, under any
circumstance.

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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.
We do not have any intangible assets that are not being amortized to a zero
balance.

|                                           |  |                    |       |              |  |                |       |  |  |   |       | 
|------------------------------------------ |  | ------------------ | ----- | ------------ |  | -------------- | ----- |  |  | - | ----- | 
|                                           |  | September 30, 2003
|                                           |  |                   
|                                           |  | Carrying           |       | Accumulated  |  | Net Intangible
|                                           |  | Amount             |       | Amortization |  | Assets        
|                                           |  |                    |       |              |  |               
|Intangible assets subject to amortization: |  |                    |       |              |  |                |       |  |  |   |       | 
|Customer related intangible assets         |  | $                  | 6,860 |              |  | $              | 4,116 |  |  | $ | 2,744 | 

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

|                                                                |      |   |       |       | 
|--------------------------------------------------------------- | ---- | - | ----- | ----- | 
|Aggregate amortization expense:                                 |      |   |       |      
|For the nine months ended September 30, 2003                    |      | $ | 1,372 |      
|Expected amortization expense for the remainder of 2003         |      | $ | 457   |      
|Expected amortization expense for the years ending December 31, |      |   |       |      
|                                                                | 2004 |   | $     | 1,829 | 
|                                                                | 2005 |   | $     | 458   | 

We did not record any asset impairment charge during the three or nine
months ended September 30, 2003.

6. 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, as we generally only pay or record as
expense amounts that in our judgment represent a liability to us. At September
30, 2003, we had total disputes of approximately $21.7 million, of which
approximately $3.0 million have been recorded as an expense in our statement of
operations.

We received a billing for $2.3 million from Verizon relating to the
back-billing of dispatch charges believed to relate to the period from August
2000 to February 2002 and from March 2003 to September 2003. This amount is
not included in the totals in the above paragraph and we do not know if this is
the entire amount they will bill us. We have disputed these charges. We
expect that if any of these charges are valid, a potion of these charges may be
subject to being billed to our wholesale services customers for services that
we provided under our contracts with them. We have not received any detail
related to these charges from Verizon and therefore, are unable to determine
their validity.

In October 2003, we received correspondence from WilTel Communications,
Inc. (WilTel), stating that they believe we are not
fulfilling our minutes-of-use commitment under our network agreement for long distance services signed
with them on February 22, 2003. They have alleged that we owe them $3.1
million for our cumulative minutes-of-use commitment shortfall as of September
30, 2003. We have disputed this amount, which is included in the $21.7 of
total disputes discussed in the first paragraph of this footnote, and believe
that these charges are without merit and that WilTel was the cause for any
shortfall in minutes-of-use, as they failed to provide the service under the
agreement. Additionally, WilTel provided no notice of the alleged shortfalls
as required under

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the contract. Finally, we believe that WilTel has over billed us for transport
charges and owes us a credit for certain charges we incurred in order to
utilize WilTels network as agreed to in our contract. We are continuing to
work with this carrier to resolve this issue and do not expect a material
adverse impact on our financial statements.

For the customers of our wholesale clients provisioned using our company
code, we are the ILECs customer of record for billing. If one of our wholesale
customers would default on amounts owed to us, become insolvent, or file
bankruptcy, it is very likely that state utility regulators would require us to
continue providing services to the end users of our wholesale client for at
least a 90-day period. We attempt to mitigate this risk by requiring our
wholesale customers to pay certain charges in advance to us.

7. 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 No. 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.

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                     |  |             |     |            |  |             |     |       |  |   | (147 | ) |  |   | (147   | )
|                              |  |             |      |            |  |             |      |       |  |   |      |   |  |   |        |  
|Balance at September 30, 2003 |  | $           |     |            |  | $           |     |       |  | $ | 404  |   |  | $ | 404    |  
|                              |  |             |      |            |  |             |      |       |  |   |      |   |  |   |        |  

8. STOCK-BASED COMPENSATION

In connection with employee stock options, SFAS No. 123, Accounting for
Stock-Based Compensation, requires entities to recognize as an expense, over
the vesting period, the fair value of stock 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 option valuation model to calculate
the value of the option on the measurement date.

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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 |       | Nine months ended
|                                                                                                            |             |   | September 30,      |       | September 30,    
|                                                                                                            |             |   |                    |       |                  
|                                                                                                            |             |   | 2003               |       | 2002              |   | 2003    |       | 2002
|                                                                                                            |             |   |                    |       |                   |   |         |       |     
|Net loss attributable to common stockholders, as
reported                                                   |             | $ | (6,306             | )     |                   | $ | (8,978  | )     |      | $ | (24,415 | )     |   | $ | (27,210 | )    
|Add: Stock based compensation included in net loss                                                          |             |   | 123                |       |                   |   | 17      |       |      |   | 123     |       |   |   | 184     |      
|Deduct: Total stock based employee compensation
determined under the fair value based method for all
awards |             |   | (785               | )     |                   |   | (3,744  | )     |      |   | (5,181  | )     |   |   | (11,188 | )    
|                                                                                                            |             |   |                    |       |                   |   |         |       |      |   |         |       |   |   |         |      
|Net loss attributable to common stockholders, pro
forma                                                     |             | $ | (6,968             | )     |                   | $ | (12,705 | )     |      | $ | (29,473 | )     |   | $ | (38,214 | )    
|                                                                                                            |             |   |                    |       |                   |   |         |       |      |   |         |       |   |   |         |      
|                                                                                                            | As reported |   | $                  | (0.18 | )                 |   | $       | (0.26 | )    |   | $       | (0.69 | ) |   | $       | (0.78 | )
|                                                                                                            |             |   |                    |       |                   |   |         |       |      |   |         |       |   |   |         |      
|                                                                                                            | Pro forma   |   |                    | (0.20 | )                 |   |         | (0.36 | )    |   |         | (0.83 | ) |   |         | (1.10 | )
|                                                                                                            |             |   |                    |       |                   |   |         |       |      |   |         |       |   |   |         |      

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 |      | Nine months ended
|                             |  | September 30,      |      | September 30,    
|                             |  |                    |      |                  
|                             |  | 2003               |      | 2002              |  | 2003    |      | 2002   
|                             |  |                    |      |                   |  |         |      |        
|Discount Rate                |  |                    | 3.5  | %                 |  |         | 4.6  | %       |  |  | 3.1  | % |  |  | 4.6  | %
|Volatility                   |  |                    | 96.1 | %                 |  |         | 92.6 | %       |  |  | 96.4 | % |  |  | 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.

9. 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.

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Net loss per share is calculated as follows:

|                                      |                                                                                 |                                              |   |                    |        |                   |   |            |        |      |   |            |         |   |   |            |         |  
|------------------------------------- | ------------------------------------------------------------------------------- | -------------------------------------------- | - | ------------------ | ------ | ----------------- | - | ---------- | ------ | ---- | - | ---------- | ------- | - | - | ---------- | ------- | -
|                                      |                                                                                 |                                              |   | Three months ended |        | Nine months ended
|                                      |                                                                                 |                                              |   | September 30,      |        | September 30,    
|                                      |                                                                                 |                                              |   |                    |        |                  
|                                      |                                                                                 |                                              |   | 2003               |        | 2002              |   | 2003       |        | 2002
|                                      |                                                                                 |                                              |   |                    |        |                   |   |            |        |     
|Basic and diluted
net loss per share: |                                                                                 |                                              |   |                    |        |                   |   |            |        |      |   |            |         |   |   |           
|                                      | Net loss                                                                        |                                              | $ | (2,553             | )      |                   | $ | (4,962     | )      |      | $ | (11,666    | )       |   | $ | (15,310    | )      
|                                      | Less mandatorily redeemable
convertible preferred stock
dividends and accretion |                                              |   | (3,707             | )      |                   |   | (3,969     | )      |      |   | (12,611    | )       |   |   | (11,761    | )      
|                                      | Less deemed dividend related to
beneficial conversion feature                   |                                              |   | (46                | )      |                   |   | (47        | )      |      |   | (138       | )       |   |   | (139       | )      
|                                      |                                                                                 |                                              |   |                    |        |                   |   |            |        |      |   |            |         |   |   |           
|                                      |                                                                                 | Net loss attributable to
common stockholders |   | $                  | (6,306 | )                 |   | $          | (8,978 | )    |   | $          | (24,415 | ) |   | $          | (27,210 | )
|                                      |                                                                                 |                                              |   |                    |        |                   |   |            |        |      |   |            |         |   |   |           
|                                      | Weighted average common shares outstanding                                      |                                              |   | 35,368,759         |        |                   |   | 35,191,836 |        |      |   | 35,340,089 |         |   |   | 34,861,229 |        
|                                      |                                                                                 |                                              |   |                    |        |                   |   |            |        |      |   |            |         |   |   |           
|                                      | Basic and diluted net loss per share                                            |                                              | $ | (0.18              | )      |                   | $ | (0.26      | )      |      | $ | (0.69      | )       |   | $ | (0.78      | )      
|                                      |                                                                                 |                                              |   |                    |        |                   |   |            |        |      |   |            |         |   |   |           

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:

|                                                                      |                                                               |  |               |            | 
|--------------------------------------------------------------------- | ------------------------------------------------------------- |  | ------------- | ---------- | 
|                                                                      |                                                               |  | September 30,
|                                                                      |                                                               |  | 2003         
|                                                                      |                                                               |  |              
|Unexercised stock options                                             |                                                               |  | 13,803,391    |           
|Unexercised warrants                                                  |                                                               |  | 10,580,985    |           
|Mandatorily redeemable preferred
stock convertible into common shares |                                                               |  | 30,454,848    |           
|                                                                      |                                                               |  |               |           
|                                                                      | Total potentially dilutive
shares of common stock equivalents |  |               | 54,839,224 | 
|                                                                      |                                                               |  |               |           

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

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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. We do not anticipate that this
litigation will have an adverse material impact on us.

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 are vigorously opposing the allegations.
We cannot predict the outcome of this litigation with any certainty.

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.

On October 9, 2003, we filed a lawsuit against SBC Communications, Inc.
and several of its subsidiaries (collectively, SBC) in federal court in
Texas, where both SBC and we do business. The lawsuit alleges SBCs violation
of the federal antitrust laws, the Racketeering Influenced Corrupt
Organizations Act (RICO), the Lanham Act, and other federal and state laws.
The complaint seeks damages and an injunction against SBC. We cannot
predict the outcome of this litigation with any certainty.

On October 2, 2003, the Federal Communications Commissions decision in
FCC CC Docket No. 01-338 (referred to as the Triennial Review) became
effective. That decision establishes a new framework for identifying and
ordering unbundled network element access to incumbent local telephone company
networks. In particular, the Federal Communications Commission (FCC) made a
national finding that companies like us were entitled to unbundled access to
the constituent components of the Unbundled Network Element Platform (UNE-P)
to serve analog customers (what the FCC calls the mass market). The FCCs
regulatory framework does not require access to many unbundled network elements
that had been previously ordered, particularly elements that

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would be utilized by entrants to provide broadband services, such as digital
subscriber line (DSL). The FCCs Triennial Review framework provides for
state commission review of many of these network elements (including loops,
transport, and switching) in 9-month proceedings, which have begun in many of
the states in which we operate, as well as continuing review. We expect that
state commissions will in the coming months engage in a detailed and
fact-intensive review of the availability of UNE-P for the services we
currently provide. The results of these state commission proceedings are
uncertain at this time and the results will certainly impact our business. In
particular, any state commission action that restricts the availability of
UNE-P or any of its constituent network elements could have a material adverse
impact on our business. In addition, several parties, including us, have filed
appeals of the FCCs Triennial Review Order, which have been consolidated in
United States Telecom Assn. v. FCC, Nos. 00-0012, 03-1310 and consolidated
cases, now pending before the D.C. Circuit. We intend to appeal the FCCs
standard for identifying unbundled network elements, the ostensible preemptive
nature of the Order, and the FCCs failure to recognize fully that section 271
obligates Bell operating companies that have obtained authorization to provide
interLATA services have an obligation to provide unbundled loops, switching,
transport and signaling, regardless of section 251 requirements. Verizon, SBC,
Qwest and USTA have filed for a stay of the FCCs rules related to UNE-P and
other elements and have also requested that the D.C. Circuit issue an immediate
writ of mandamus reversing the Triennial Review Order on these points. The
impact of any such stay or grant of mandamus is uncertain at this time, but any
such action that results in the vacating of any unbundling rules could have an
immediate and adverse impact upon our business. BellSouth and other parties
have filed petitions before the FCC for reconsideration of the Triennial Review
Order on section 271 grounds and broadband unbundling rules; granting of any of
those petitions in whole or in part similarly could impact our business.

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 ongoing 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.

11. 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, which are 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.

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

We evaluate the performance of each operating segment 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

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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 segment or possibly separating these expenses from
the reported segments.

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

|                              |  |                                       |        |                                       |  |              |        |          |  |          |        |              |  |   |        |   |  |   |        |  |  |   |        | 
|----------------------------- |  | ------------------------------------- | ------ | ------------------------------------- |  | ------------ | ------ | -------- |  | -------- | ------ | ------------ |  | - | ------ | - |  | - | ------ |  |  | - | ------ | 
|                              |  | Three months ended September 30, 2003 |        | Three months ended September 30, 2002
|                              |  |                                       |        |                                      
|                              |  | Retail                                |        | Wholesale                             |  |              |        |          |  | Retail   |        | Wholesale    |  |   |        |  
|                              |  | Services                              |        | Services                              |  | Consolidated |        | Services |  | Services |        | Consolidated
|                              |  |                                       |        |                                       |  |              |        |          |  |          |        |             
|Revenues                      |  | $                                     | 52,793 |                                       |  | $            | 28,661 |          |  | $        | 81,454 |              |  | $ | 46,688 |   |  | $ | 12,027 |  |  | $ | 58,715 | 
|Segment results               |  | $                                     | (5,139 | )                                     |  | $            | 8,907  |          |  | $        | 3,768  |              |  | $ | (3,294 | ) |  | $ | 4,336  |  |  | $ | 1,042  | 
|Depreciation and amortization |  | $                                     | 5,207  |                                       |  | $            | 630    |          |  | $        | 5,837  |              |  | $ | 5,596  |   |  | $ | 573    |  |  | $ | 6,169  | 
|Capital expenditures          |  | $                                     | 1,685  |                                       |  | $            | 263    |          |  | $        | 1,948  |              |  | $ | 1,609  |   |  | $ | 328    |  |  | $ | 1,937  | 

|                              |  |                                      |         |                                      |  |              |        |          |  |          |         |              |  |   |         |   |  |   |        |  |  |   |         |  
|----------------------------- |  | ------------------------------------ | ------- | ------------------------------------ |  | ------------ | ------ | -------- |  | -------- | ------- | ------------ |  | - | ------- | - |  | - | ------ |  |  | - | ------- | -
|                              |  | Nine months ended September 30, 2003 |         | Nine months ended September 30, 2002
|                              |  |                                      |         |                                     
|                              |  | Retail                               |         | Wholesale                            |  |              |        |          |  | Retail   |         | Wholesale    |  |   |         |  
|                              |  | Services                             |         | Services                             |  | Consolidated |        | Services |  | Services |         | Consolidated
|                              |  |                                      |         |                                      |  |              |        |          |  |          |         |             
|Revenues                      |  | $                                    | 154,080 |                                      |  | $            | 57,525 |          |  | $        | 211,605 |              |  | $ | 159,527 |   |  | $ | 18,681 |  |  | $ | 178,208 |  
|Segment results               |  | $                                    | (12,235 | )                                    |  | $            | 19,165 |          |  | $        | 6,930   |              |  | $ | (7,310  | ) |  | $ | 5,189  |  |  | $ | (2,121  | )
|Depreciation and amortization |  | $                                    | 16,004  |                                      |  | $            | 1,862  |          |  | $        | 17,866  |              |  | $ | 16,840  |   |  | $ | 911    |  |  | $ | 17,751  |  
|Capital expenditures          |  | $                                    | 7,265   |                                      |  | $            | 466    |          |  | $        | 7,731   |              |  | $ | 5,799   |   |  | $ | 7,907  |  |  | $ | 13,706  |  
|Identifiable assets           |  | $                                    | 80,931  |                                      |  | $            | 12,320 |          |  | $        | 93,251  |              |  | $ | 96,376  |   |  | $ | 10,335 |  |  | $ | 106,711 |  

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 |        | Nine months ended
|                                              |                                              |  |                    |        |                  
|                                              |                                              |  | September 30,      |        | September 30,     |  | September 30, |        | September 30,
|                                              |                                              |  | 2003               |        | 2002              |  | 2003          |        | 2002         
|                                              |                                              |  |                    |        |                   |  |               |        |              
|Reconciliation of segment results to net loss |                                              |  |                    |        |                   |  |               |        |               |  |   |         |   |  |   |        
|                                              | Consolidated
segment operating income (loss) |  | $                  | 3,768  |                   |  | $             | 1,042  |               |  | $ | 6,930   |   |  | $ | (2,121  | )
|                                              | Retroactive reduction to network access rate |  |                    |       |                   |  |               |       |               |  |   |        |   |  |   | 8,981   |  
|                                              | Asset impairment charge                      |  |                    |       |                   |  |               |       |               |  |   |        |   |  |   | (1,129  | )
|                                              | Wholesale development costs                  |  |                    |       |                   |  |               |       |               |  |   |        |   |  |   | (1,081  | )
|                                              | Restructuring charge                         |  |                    |       |                   |  |               |       |               |  |   |        |   |  |   | (1,861  | )
|                                              | Depreciation and amortization                |  |                    | (5,837 | )                 |  |               | (6,169 | )             |  |   | (17,866 | ) |  |   | (17,751 | )
|                                              | Interest and other income                    |  |                    | 494    |                   |  |               | 1,179  |               |  |   | 1,658   |   |  |   | 2,663   |  
|                                              | Interest and other expense                   |  |                    | (978   | )                 |  |               | (1,014 | )             |  |   | (2,388  | ) |  |   | (3,011  | )
|                                              |                                              |  |                    |        |                   |  |               |        |               |  |   |         |   |  |   |        
|                                              | Net loss                                     |  | $                  | (2,553 | )                 |  | $             | (4,962 | )             |  | $ | (11,666 | ) |  | $ | (15,310 | )
|                                              |                                              |  |                    |        |                   |  |               |        |               |  |   |         |   |  |   |        

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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. You can identify forward-looking statements by
the fact that they do not relate strictly to historical or current facts. The
words believe, anticipate, intend, expect, estimate, project and
similar expressions are intended to identify forward-looking statements. Our
actual results may differ materially from those projected in the
forward-looking statements as a result of various 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 others during the
first quarter of 2002. This service enables other companies
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 nine months ended September 30,
2003 compared to the same periods 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.

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|                                          |                               |                                                                                 |      |                            |      |           |      |               |      |                        |      |       |       |      |       |       |        |    |       |      |       |    |       |      |       |   
|----------------------------------------- | ----------------------------- | ------------------------------------------------------------------------------- | ---- | -------------------------- | ---- | --------- | ---- | ------------- | ---- | ---------------------- | ---- | ----- | ----- | ---- | ----- | ----- | ------ | -- | ----- | ---- | ----- | -- | ----- | ---- | ----- | --
|                                          |                               |                                                                                 |      | For the three months ended |      | Amount    |      | Percentage    |      |                        |      |       |       |      |       |      
|                                          |                               |                                                                                 |      | September 30,              |      | Change    |      | Change        |      | Percentage of Revenues
|                                          |                               |                                                                                 |      |                            |      | Favorable |      | Favorable     |      |                       
|                                          |                               |                                                                                 |      | 2003                       |      | 2002      |      | (Unfavorable) |      | (Unfavorable)          |      | 2003  |       | 2002
|                                          |                               |                                                                                 |      |                            |      |           |      |               |      |                        |      |       |       |     
|                                          |                               |                                                                                 |      | (In Millions)              |      |           |      |               |      |                        |      |       |       |      |       |      
|Results of Operations:                    |                               |                                                                                 |      |                            |      |           |      |               |      |                        |      |       |       |      |       |       |        |    |       |      |       |    |       |     
|Revenues                                  |                               | $                                                                               | 81.5 |                            |      | $         | 58.7 |               |      | $                      | 22.8 |       |       |      | 38.8  | %     |        |    | 100.0 | %    |       |    | 100.0 | %   
|                                          |                               |                                                                                 |      |                            |      |           |      |               |      |                        |      |       |       |      |       |       |        |    |       |      |       |    |       |     
|Operating expenses:                       |                               |                                                                                 |      |                            |      |           |      |               |      |                        |      |       |       |      |       |       |        |    |       |      |       |    |       |     
|                                          | Network operations            |                                                                                 |      | 38.5                       |      |           |      | 23.8          |      |                        |      | (14.7 | )     |      |       | (61.8 | )%     |    |       | 47.3 | %     |    |       | 40.6 | %    
|                                          | Sales and marketing           |                                                                                 |      | 3.6                        |      |           |      | 2.2           |      |                        |      | (1.4  | )     |      |       | (63.6 | )%     |    |       | 4.4  | %     |    |       | 3.7  | %    
|                                          | General and administrative    |                                                                                 |      | 35.6                       |      |           |      | 31.7          |      |                        |      | (3.9  | )     |      |       | (12.3 | )%     |    |       | 43.7 | %     |    |       | 54.0 | %    
|                                          | Depreciation and amortization |                                                                                 |      | 5.8                        |      |           |      | 6.2           |      |                        |      | 0.4   |       |      |       | 6.5   | %      |    |       | 7.1  | %     |    |       | 10.6 | %    
|                                          |                               |                                                                                 |      |                            |      |           |      |               |      |                        |      |       |       |      |       |       |        |    |       |      |       |    |       |     
|                                          |                               | Total operating expenses                                                        |      |                            | 83.5 |           |      |               | 63.9 |                        |      |       | (19.6 | )    |       |       | (30.7  | )% |       |      | 102.5 | %  |       |      | 108.9 | % 
|                                          |                               |                                                                                 |      |                            |      |           |      |               |      |                        |      |       |       |      |       |       |        |    |       |      |       |    |       |     
|                                          |                               | Operating loss                                                                  |      |                            | (2.0 | )         |      |               | (5.2 | )                      |      |       | 3.2   |      |       |       | 61.5   | %  |       |      | (2.5  | )% |       |      | (8.9  | )%
|                                          |                               |                                                                                 |      |                            |      |           |      |               |      |                        |      |       |       |      |       |       |        |    |       |      |       |    |       |     
|Nonoperating income (expense):            |                               |                                                                                 |      |                            |      |           |      |               |      |                        |      |       |       |      |       |       |        |    |       |      |       |    |       |     
|                                          | Interest and other income     |                                                                                 |      | 0.5                        |      |           |      | 1.2           |      |                        |      | (0.7  | )     |      |       | (58.3 | )%     |    |       | 0.6  | %     |    |       | 2.0  | %    
|                                          | Interest and other expense    |                                                                                 |      | (1.0                       | )    |           |      | (1.0          | )    |                        |      |      |       |      |       |      | %      |    |       | (1.2 | )%    |    |       | (1.7 | )%   
|                                          |                               |                                                                                 |      |                            |      |           |      |               |      |                        |      |       |       |      |       |       |        |    |       |      |       |    |       |     
|                                          |                               | Total nonoperating income (expense)                                             |      |                            | (0.5 | )         |      |               | 0.2  |                        |      |       | (0.7  | )    |       |       | (350.0 | )% |       |      | (0.6  | )% |       |      | 0.3   | % 
|                                          |                               |                                                                                 |      |                            |      |           |      |               |      |                        |      |       |       |      |       |       |        |    |       |      |       |    |       |     
|                                          |                               | Net loss                                                                        |      |                            | (2.5 | )         |      |               | (5.0 | )                      |      |       | 2.5   |      |       |       | 50.0   | %  |       |      | (3.1  | )% |       |      | (8.5  | )%
|                                          |                               | Less mandatorily redeemable convertible
preferred stock dividends and accretion |      |                            | (3.7 | )         |      |               | (3.9 | )                      |      |       | 0.2   |      |       |       | 5.1    | %  |       |      | (4.5  | )% |       |      | (6.6  | )%
|                                          |                               | Less deemed dividend related to beneficial
conversion feature                   |      |                            | (0.1 | )         |      |               | (0.1 | )                      |      |       |      |      |       |       |       | %  |       |      | (0.1  | )% |       |      | (0.2  | )%
|                                          |                               |                                                                                 |      |                            |      |           |      |               |      |                        |      |       |       |      |       |       |        |    |       |      |       |    |       |     
|                                          |                               | Net loss attributable to common stockholders                                    |      | $                          | (6.3 | )         |      | $             | (9.0 | )                      |      | $     | 2.7   |      |       |       | 30.0   | %  |       |      | (7.7  | )% |       |      | (15.3 | )%
|                                          |                               |                                                                                 |      |                            |      |           |      |               |      |                        |      |       |       |      |       |       |        |    |       |      |       |    |       |     
|Cash Flow Data:                           |                               |                                                                                 |      |                            |      |           |      |               |      |                        |      |       |       |      |       |       |        |    |       |      |       |    |       |     
|Net cash provided by operating activities |                               | $                                                                               | 3.9  |                            |      | $         | 7.8  |               |      | $                      | (3.9 | )     |       |      | (50.0 | )%    |        |    | *     |      |       |    | *     |     
|Net cash used in investing activities     |                               |                                                                                 | (1.9 | )                          |      |           | (1.9 | )             |      |                        |     |       |       |      |      | %     |        |    | *     |      |       |    | *     |     
|Net cash used in financing activities     |                               |                                                                                 | (1.6 | )                          |      |           | (1.5 | )             |      |                        | (0.1 | )     |       |      | (6.7  | )%    |        |    | *     |      |       |    | *     |     
|                                          |                               |                                                                                 |      |                            |      |           |      |               |      |                        |      |       |       |      |       |       |        |    |       |      |       |    |       |     
|Net increase in cash and cash equivalents |                               | $                                                                               | 0.4  |                            |      | $         | 4.4  |               |      | $                      | (4.0 | )     |       |      | (90.9 | )%    |        |    | *     |      |       |    | *     |     
|                                          |                               |                                                                                 |      |                            |      |           |      |               |      |                        |      |       |       |      |       |       |        |    |       |      |       |    |       |     

*     Not meaningful

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|                                          |                               |                                                                                 |       |                           |       |           |       |               |       |                        |      |       |       |      |       |       |        |    |       |      |       |    |       |      |       |   
|----------------------------------------- | ----------------------------- | ------------------------------------------------------------------------------- | ----- | ------------------------- | ----- | --------- | ----- | ------------- | ----- | ---------------------- | ---- | ----- | ----- | ---- | ----- | ----- | ------ | -- | ----- | ---- | ----- | -- | ----- | ---- | ----- | --
|                                          |                               |                                                                                 |       | For the nine months ended |       | Amount    |       | Percentage    |       |                        |      |       |       |      |       |      
|                                          |                               |                                                                                 |       | September 30,             |       | Change    |       | Change        |       | Percentage of Revenues
|                                          |                               |                                                                                 |       |                           |       | Favorable |       | Favorable     |       |                       
|                                          |                               |                                                                                 |       | 2003                      |       | 2002      |       | (Unfavorable) |       | (Unfavorable)          |      | 2003  |       | 2002
|                                          |                               |                                                                                 |       |                           |       |           |       |               |       |                        |      |       |       |     
|                                          |                               |                                                                                 |       | (In Millions)             |       |           |       |               |       |                        |      |       |       |      |       |      
|Results of Operations:                    |                               |                                                                                 |       |                           |       |           |       |               |       |                        |      |       |       |      |       |       |        |    |       |      |       |    |       |     
|Revenues                                  |                               | $                                                                               | 211.6 |                           |       | $         | 178.2 |               |       | $                      | 33.4 |       |       |      | 18.7  | %     |        |    | 100.0 | %    |       |    | 100.0 | %   
|                                          |                               |                                                                                 |       |                           |       |           |       |               |       |                        |      |       |       |      |       |       |        |    |       |      |       |    |       |     
|Operating expenses:                       |                               |                                                                                 |       |                           |       |           |       |               |       |                        |      |       |       |      |       |       |        |    |       |      |       |    |       |     
|                                          | Network operations            |                                                                                 |       | 95.5                      |       |           |       | 69.9          |       |                        |      | (25.6 | )     |      |       | (36.6 | )%     |    |       | 45.1 | %     |    |       | 39.2 | %    
|                                          | Sales and marketing           |                                                                                 |       | 14.7                      |       |           |       | 8.2           |       |                        |      | (6.5  | )     |      |       | (79.3 | )%     |    |       | 6.9  | %     |    |       | 4.6  | %    
|                                          | General and administrative    |                                                                                 |       | 94.5                      |       |           |       | 93.3          |       |                        |      | (1.2  | )     |      |       | (1.3  | )%     |    |       | 44.6 | %     |    |       | 52.3 | %    
|                                          | Asset impairment charge       |                                                                                 |       |                          |       |           |       | 1.1           |       |                        |      | 1.1   |       |      |       | 100.0 | %      |    |       |     | %     |    |       | 0.6  | %    
|                                          | Wholesale development costs   |                                                                                 |       |                          |       |           |       | 1.0           |       |                        |      | 1.0   |       |      |       | 100.0 | %      |    |       |     | %     |    |       | 0.6  | %    
|                                          | Restructuring expense         |                                                                                 |       |                          |       |           |       | 1.9           |       |                        |      | 1.9   |       |      |       | 100.0 | %      |    |       |     | %     |    |       | 1.1  | %    
|                                          | Depreciation and amortization |                                                                                 |       | 17.9                      |       |           |       | 17.8          |       |                        |      | (0.1  | )     |      |       | (0.6  | )%     |    |       | 8.5  | %     |    |       | 10.0 | %    
|                                          |                               |                                                                                 |       |                           |       |           |       |               |       |                        |      |       |       |      |       |       |        |    |       |      |       |    |       |     
|                                          |                               | Total operating expenses                                                        |       |                           | 222.6 |           |       |               | 193.2 |                        |      |       | (29.4 | )    |       |       | (15.2  | )% |       |      | 105.1 | %  |       |      | 108.4 | % 
|                                          |                               |                                                                                 |       |                           |       |           |       |               |       |                        |      |       |       |      |       |       |        |    |       |      |       |    |       |     
|                                          |                               | Operating loss                                                                  |       |                           | (11.0 | )         |       |               | (15.0 | )                      |      |       | 4.0   |      |       |       | 26.7   | %  |       |      | (5.1  | )% |       |      | (8.4  | )%
|                                          |                               |                                                                                 |       |                           |       |           |       |               |       |                        |      |       |       |      |       |       |        |    |       |      |       |    |       |     
|Nonoperating income (expense):            |                               |                                                                                 |       |                           |       |           |       |               |       |                        |      |       |       |      |       |       |        |    |       |      |       |    |       |     
|                                          | Interest and other income     |                                                                                 |       | 1.7                       |       |           |       | 2.7           |       |                        |      | (1.0  | )     |      |       | (37.0 | )%     |    |       | 0.8  | %     |    |       | 1.5  | %    
|                                          | Interest and other expense    |                                                                                 |       | (2.4                      | )     |           |       | (3.0          | )     |                        |      | 0.6   |       |      |       | 20.0  | %      |    |       | (1.1 | )%    |    |       | (1.7 | )%   
|                                          |                               |                                                                                 |       |                           |       |           |       |               |       |                        |      |       |       |      |       |       |        |    |       |      |       |    |       |     
|                                          |                               | Total nonoperating expense                                                      |       |                           | (0.7  | )         |       |               | (0.3  | )                      |      |       | (0.4  | )    |       |       | (133.3 | )% |       |      | (0.3  | )% |       |      | (0.2  | )%
|                                          |                               |                                                                                 |       |                           |       |           |       |               |       |                        |      |       |       |      |       |       |        |    |       |      |       |    |       |     
|                                          |                               | Net loss                                                                        |       |                           | (11.7 | )         |       |               | (15.3 | )                      |      |       | 3.6   |      |       |       | 23.5   | %  |       |      | (5.4  | )% |       |      | (8.6  | )%
|                                          |                               | Less mandatorily redeemable convertible
preferred stock dividends and accretion |       |                           | (12.6 | )         |       |               | (11.8 | )                      |      |       | (0.8  | )    |       |       | (6.8   | )% |       |      | (6.0  | )% |       |      | (6.6  | )%
|                                          |                               | Less deemed dividend related to beneficial
conversion feature                   |       |                           | (0.1  | )         |       |               | (0.1  | )                      |      |       |      |      |       |       |       | %  |       |      | (0.1  | )% |       |      | (0.1  | )%
|                                          |                               |                                                                                 |       |                           |       |           |       |               |       |                        |      |       |       |      |       |       |        |    |       |      |       |    |       |     
|                                          |                               | Net loss attributable to common stockholders                                    |       | $                         | (24.4 | )         |       | $             | (27.2 | )                      |      | $     | 2.8   |      |       |       | 10.3   | %  |       |      | (11.5 | )% |       |      | (15.3 | )%
|                                          |                               |                                                                                 |       |                           |       |           |       |               |       |                        |      |       |       |      |       |       |        |    |       |      |       |    |       |     
|Cash Flow Data:                           |                               |                                                                                 |       |                           |       |           |       |               |       |                        |      |       |       |      |       |       |        |    |       |      |       |    |       |     
|Net cash provided by operating activities |                               | $                                                                               | 10.0  |                           |       | $         | 13.0  |               |       | $                      | (3.0 | )     |       |      | (23.1 | )%    |        |    | *     |      |       |    | *     |     
|Net cash used in investing activities     |                               |                                                                                 | (7.7  | )                         |       |           | (14.1 | )             |       |                        | 6.4  |       |       |      | 45.4  | %     |        |    | *     |      |       |    | *     |     
|Net cash used in financing activities     |                               |                                                                                 | (3.8  | )                         |       |           | (4.3  | )             |       |                        | 0.5  |       |       |      | 11.6  | %     |        |    | *     |      |       |    | *     |     
|                                          |                               |                                                                                 |       |                           |       |           |       |               |       |                        |      |       |       |      |       |       |        |    |       |      |       |    |       |     
|Net decrease in cash and cash equivalents |                               | $                                                                               | (1.5  | )                         |       | $         | (5.4  | )             |       | $                      | 3.9  |       |       |      | 72.2  | %     |        |    | *     |      |       |    | *     |     
|                                          |                               |                                                                                 |       |                           |       |           |       |               |       |                        |      |       |       |      |       |       |        |    |       |      |       |    |       |     

*     Not meaningful

Revenues.Revenues increased by $22.8 million to $81.5 million for the
three months ended September 30, 2003, compared to $58.7 million the prior year
period.

Revenues increased by $33.4 million to $211.6 million for the nine months
ended September 30, 2003, compared to $178.2 million the prior year period.

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

|                          |  |                            |      |                           |  |      |      |      |  |   |       |  |  |   |       | 
|------------------------- |  | -------------------------- | ---- | ------------------------- |  | ---- | ---- | ---- |  | - | ----- |  |  | - | ----- | 
|                          |  | For the three months ended |      | For the nine months ended
|                          |  | September 30,              |      | September 30,            
|                          |  |                            |      |                          
|Type of Revenues          |  | 2003                       |      | 2002                      |  | 2003 |      | 2002
|                          |  |                            |      |                           |  |      |      |     
|Bundled
Service UNE-P     |  | $                          | 50.4 |                           |  | $    | 42.5 |      |  | $ | 146.1 |  |  | $ | 147.8 | 
|1+ Long Distance Services |  |                            | 2.4  |                           |  |      | 4.2  |      |  |   | 8.0   |  |  |   | 11.7  | 
|Wholesale Services        |  |                            | 28.7 |                           |  |      | 12.0 |      |  |   | 57.5  |  |  |   | 18.7  | 
|                          |  |                            |      |                           |  |      |      |      |  |   |       |  |  |   |       | 
|Total                     |  | $                          | 81.5 |                           |  | $    | 58.7 |      |  | $ | 211.6 |  |  | $ | 178.2 | 
|                          |  |                            |      |                           |  |      |      |      |  |   |       |  |  |   |       | 

The increase in revenue was primarily a result of increases of $16.7 and
$38.8 million in our wholesale services revenue for the three and nine months
ended September 30, 2003, respectively. These increases were primarily a result
of increased revenues from our new contract with Sprint, signed in February
2003, and were partially 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 (Bundled Service UNE-P) lines
increased by $7.9 million and decreased by $1.7
million for the three and nine months ended September 30, 2003, respectively,
compared to the prior year periods. Additionally, the decrease in 1+ long
distance (1+) lines in service, as a result of expected attrition in lines,
contributed a decrease of $1.8 and $3.7 million for the three and nine months
ended September 30, 2003, respectively, compared to the prior year periods.

Our
Bundled Service UNE-P accounts made up 61.8% and 69.1% of our total revenues for the
three and nine months ended September 30, 2003, respectively, compared to 72.4%
and 82.9% for the same periods in the prior year. These service offerings are
currently available in 47 states. We expect Bundled Service UNE-P revenue to continue to
increase as a percentage of retail revenues, relative to our 1+, but decrease
as an overall percentage of total revenues because we expect continued growth
in our wholesale service business.

Network Operations.Our network operations expense primarily consists of
fixed and variable transmission and unbundled network element platform expenses
for interconnection with ILECs and transport and transmission services with
IXCs.

Network operations expense increased by $14.7 million to $38.5 million for
the three months ended September 30, 2003, compared to $23.8 million the prior
year period.

Network operations expense increased by $25.6 million to $95.5 million for
the nine months ended September 30, 2003, compared to $69.9 million the prior
year period.

Our network operations expense as a percentage of revenues, increased to
47.3% and 45.1% for the three and nine months ended September 30, 2003,
respectively, compared to 40.6% and 39.2% in the prior year periods. Included
in the prior year is a $9.0 million retroactive rate reduction for access rates
that occurred in the second quarter of 2002. Excluding that for the nine months
ended September 30, 2002, the network costs, as a percentage of
revenues, was
44.3%. The increase in network operation expenses is primarily the result of an
increase in our wholesale business, resulting in increases of $7.5 and $17.4
million for the three and nine months ended September 30, 2003, while our retail
business network operations expense decreased $1.8 and $0.8 million for the
same periods. We recorded a reduction to network operations expense for certain
retroactive rate reductions and billing errors in the amounts of $2.5 million
for the nine months ended September 30, 2003, $1.2 during the first quarter and
$1.3 million recorded in the second quarter of 2003. Additionally, during the
third quarter of 2003 we settled various disputes with Ameritech resulting in a
reduction to network operations expense in the amount of $0.9 million.

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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 $1.4 million to $3.6 million for the
three months ended September 30, 2003, compared to $2.2 million the prior year
period.

Sales and marketing expense increased $6.5 million to $14.7 million for
the nine months ended September 30, 2003, compared to $8.2 million the prior
year period.

The increase in sales and marketing expense is directly attributable to
increased payments of one-time and recurring commissions to independent sales
contractors, which increased by $1.8 and $6.9 million for the three and nine
months ended September 30, 2003 compared to the prior year periods.

We slowed our advertising levels and limited our independent sales
contractor sales force during the third quarter of 2003, a significant change
from the first two quarters of 2003, which saw an increase of sales and
marketing efforts. During the third quarter of 2003, we
changed the focus of our overall sales and marketing efforts toward
Z-LineBUSINESS services, primarily through the addition of an in-house sales
team dedicated to the effort and the recruitment of independent master sales
contractors. This focus has provided us with the ability to leverage our
national footprint by consolidating billing and providing local and
long distance services to multi-location businesses while further diversifying
our product offerings beyond residential and wholesale. Our business services
have provided lower acquisition cost and we believe that the limited amount of
sales and marketing dollars and resources were best spent focused on business
rather than residential customer acquisition during the third quarter of 2003.
During this time, we also changed our Z-LineHOME strategy to leverage the value
of product differentiation through the use of the Personal Voice
Assistant(TM)
(PVA).

In the
coming quarters, our use of PVA as the sales strategy focus and
product differentiator for our residential
offering will become more apparent. We believe that this approach will allow us
to reduce our acquisition costs by creating opportunities to partner with organizations that can
provide us with strong distribution economics. We are also planning on
leveraging PVA not only to improve communications but as a distribution and
delivery strategy that involves ourselves and current customers providing PVA
to others as a free trial via e-mail. Customers and independent sales
contractors will be able to provide PVA as an introduction to our service
offerings via on-line sign-up and communications. We believe this new
approach, coupled with our new PVA community and recruiting of member-based
organizations, will provide increased retail customers at a lower acquisition
cost than we have experienced through the independent contractor acquisition
process. Additionally, we have introduced new bundle and pricing points in an
effort to expand the marketability of our offerings to consumers including
variations of our PVA on a stand-alone basis. During the fourth quarter of
2003, we expect to introduce the sale of PVA in electronic stores. 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
stay relatively flat during the fourth quarter of 2003 compared to the third
quarter, and we will continue to manage sales and marketing expense as a
discretionary item to assist with managing our overall cash position. We are
expecting to invest in sales and marketing at a level necessary to maintain our
current retail line count and continue to grow the number of our
business lines steadily.

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 cost.
Provisioning is the process of establishing us as the end-users primary
carrier.

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General and administrative expense increased $3.9 million to $35.6 million
for the three months ended September 30, 2003, compared to $31.7 million the
prior year period. General and administrative expense improved by 10.3% to
43.7% of revenues for the three months ended September 30, 2003 compared to
54.0% the prior year period.

General and administrative expense increased $1.2 million to $94.5 million
for the nine months ended September 30, 2003, compared to $93.3 million the
prior year period. General and administrative expense improved by 7.7% to 44.6%
of revenues for the nine months ended September 30, 2003 compared to 52.3% the
prior year period.

The increase in our general and administrative expenses for the three
months ended September 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 compared to the prior year period.

The overall increase in general and administrative expense for the nine
months ended September 30, 2003 was a result of an increase of $7.5 million
associated with the growth of our wholesale services and was off set by
improved incremental costs and reductions to bad debt, resulting in a reduction
of retail general and administrative expense of $6.3 million compared to the
prior year period.

Overall general and administrative expense as a percentage of revenue
decreased for both the three and nine months ended September 30, 2003 compared
to the prior year periods. The reduction of general and administrative expense
as a percentage of revenue was the result of our ability to leverage our fixed
costs across our growing wholesale and business offerings while reducing
incremental costs by improving the overall quality of our residential customer
base and lower cost-per-line to maintain a business line in comparison to a
residential line. We anticipate general and administrative expenditures will
continue to increase in the future to support our expanding service offerings,
our expected increase in wholesale and business lines. 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 and recognize that this reduction is necessary for our
achievement of profitability and the generation of positive cash flow.

Asset Impairment Charge.Asset impairment charges were $1.1 million for
the nine months ended September 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 nine months ended September 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
nine months ended September 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.

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

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abandonment charge representing the future lease cash payments for our New York
office as a liability and these payments are scheduled to continue monthly
through August 2005. As of September 30, 2003 we had an accrual recorded in the
amount of $0.4 million remaining for this restructuring charge.

Depreciation and Amortization.Depreciation and amortization expense
decreased by $0.4 million to $5.8 million for the three months ended September
30, 2003, compared to $6.2 million the prior year period.

Depreciation and amortization expense increased $0.1 million to $17.9
million for the nine months ended September 30, 2003, compared to $17.8 million
the prior year period.

The relatively small changes in depreciation and amortization expense for
the three and nine months ended September 30, 2003 are primarily a result of
fixed asset purchases remaining relatively flat during 2003. We anticipate a
flat to slightly increased depreciation and amortization expense for the
remainder of 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 $0.7
million to $0.5 million for the three months ended September 30, 2003, compared
to $1.2 million the prior year period.

Interest and other income decreased $1.0 million to $1.7 million for the
nine months ended September 30, 2003, compared to $2.7 million the prior year
period.

Interest
and other income consists of interest charged to our Bundled Service UNE-P
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 compared to the prior year periods and our
improved subscriber management activities.

Interest and Other Expense.Interest and other expense was $1.0 million
for both the three months ended September 30, 2003 and 2002.

Interest and other expense decreased $0.6 million to $2.4 million for the
nine months ended September 30, 2003, compared to $3.0 million the prior year
period.

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 for the nine
months in interest and other expense is a result of our overall increased liquidity in
2003 compared to the prior year period that allowed us to make more timely
payments of our operating expenses while simultaneously reducing our reliance
on our RFC accounts receivable agreement during the year. 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
in the future. We expect the continued utilization of our RFC accounts receivable
agreement, at least through July 2004, the current maturity date of the
existing agreement.

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 nine months ended September 30, 2003 and 2002.

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Net Loss.Our net loss improved by $2.5 million to a loss of $2.5 million
for the three months ended September 30, 2003, compared to net loss of $5.0
million the prior year period.

Our net loss improved $3.6 million to a loss of $11.7 million for the nine
months ended September 30, 2003, compared to a net loss of $15.3 million the
prior year period.

Net Loss Attributable to Common Stockholders.Our net loss attributable to
common stockholders improved $2.7 million to a loss of $6.3 million for the
three months ended September 30, 2003, compared to a loss of $9.0 million the
prior year period.

Our net loss attributable to common stockholders improved $2.8 million to
a loss of $24.4 million for the nine months ended September 30, 2003, compared
to a loss $27.2 million the prior year period.

This
primary reasons for this decrease are discussed above, however, the
change in the accumulation of dividends and accretion of the preferred stock
further improved our net loss attributable to common stockholders by $0.2
million for the three months ended September 30, 2003 and an offset the
improvement by $0.8 million for the nine months ended September 30, 2003.

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. 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.

|                    |                            |                          |      |                                       |      |                                       |      |              |      |          |      |           |      |              |      |      |      |   |      |     |     |   |      |      |      | 
|------------------- | -------------------------- | ------------------------ | ---- | ------------------------------------- | ---- | ------------------------------------- | ---- | ------------ | ---- | -------- | ---- | --------- | ---- | ------------ | ---- | ---- | ---- | - | ---- | --- | --- | - | ---- | ---- | ---- | 
|                    |                            |                          |      | Three months ended September 30, 2003 |      | Three months ended September 30, 2002
|                    |                            |                          |      |                                       |      |                                      
|                    |                            |                          |      | Retail                                |      | Wholesale                             |      | Consolidated |      | Retail   |      | Wholesale |      | Consolidated
|                    |                            |                          |      | Services                              |      | Services                              |      | Results      |      | Services |      | Services  |      | Results     
|                    |                            |                          |      |                                       |      |                                       |      |              |      |          |      |           |      |             
|Revenues            |                            | $                        | 52.8 |                                       |      | $                                     | 28.7 |              |      | $        | 81.5 |           |      | $            | 46.7 |      |      | $ | 12.0 |     |     | $ | 58.7 |     
|                    |                            |                          |      |                                       |      |                                       |      |              |      |          |      |           |      |              |      |      |      |   |      |     |     |   |      |     
|Operating expenses: |                            |                          |      |                                       |      |                                       |      |              |      |          |      |           |      |              |      |      |      |   |      |     |     |   |      |     
|                    | Network operations         |                          |      | 26.1                                  |      |                                       |      | 12.4         |      |          |      | 38.5      |      |              |      | 18.9 |      |   |      | 4.9 |     |   |      | 23.8 |     
|                    | Sales and marketing        |                          |      | 3.6                                   |      |                                       |      |             |      |          |      | 3.6       |      |              |      | 2.2  |      |   |      |    |     |   |      | 2.2  |     
|                    | General and administrative |                          |      | 28.2                                  |      |                                       |      | 7.4          |      |          |      | 35.6      |      |              |      | 28.9 |      |   |      | 2.8 |     |   |      | 31.7 |     
|                    |                            |                          |      |                                       |      |                                       |      |              |      |          |      |           |      |              |      |      |      |   |      |     |     |   |      |     
|                    |                            | Total operating expenses |      |                                       | 57.9 |                                       |      |              | 19.8 |          |      |           | 77.7 |              |      |      | 50.0 |   |      |     | 7.7 |   |      |      | 57.7 | 
|                    |                            |                          |      |                                       |      |                                       |      |              |      |          |      |           |      |              |      |      |      |   |      |     |     |   |      |     
|                    |                            | Segment results          |      | $                                     | (5.1 | )                                     |      | $            | 8.9  |          |      | $         | 3.8  |              |      | $    | (3.3 | ) |      | $   | 4.3 |   |      | $    | 1.0  | 
|                    |                            |                          |      |                                       |      |                                       |      |              |      |          |      |           |      |              |      |      |      |   |      |     |     |   |      |     

24



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|                    |                            |                          |       |                                      |       |                                      |      |              |      |          |       |              |       |              |       |      |       |   |      |     |      |   |       |      |       |  
|------------------- | -------------------------- | ------------------------ | ----- | ------------------------------------ | ----- | ------------------------------------ | ---- | ------------ | ---- | -------- | ----- | ------------ | ----- | ------------ | ----- | ---- | ----- | - | ---- | --- | ---- | - | ----- | ---- | ----- | -
|                    |                            |                          |       | Nine months ended September 30, 2003 |       | Nine months ended September 30, 2002
|                    |                            |                          |       |                                      |       |                                     
|                    |                            |                          |       | Retail                               |       | Wholesale                            |      | Consolidated |      | Retail   |       | Wholesale    |       | Consolidated
|                    |                            |                          |       | Services                             |       | Services                             |      | Results      |      | Services |       | Services (1) |       | Results     
|                    |                            |                          |       |                                      |       |                                      |      |              |      |          |       |              |       |             
|Revenues            |                            | $                        | 154.1 |                                      |       | $                                    | 57.5 |              |      | $        | 211.6 |              |       | $            | 159.5 |      |       | $ | 18.7 |     |      | $ | 178.2 |     
|                    |                            |                          |       |                                      |       |                                      |      |              |      |          |       |              |       |              |       |      |       |   |      |     |      |   |       |     
|Operating expenses: |                            |                          |       |                                      |       |                                      |      |              |      |          |       |              |       |              |       |      |       |   |      |     |      |   |       |     
|                    | Network operations         |                          |       | 71.6                                 |       |                                      |      | 23.9         |      |          |       | 95.5         |       |              |       | 72.4 |       |   |      | 6.5 |      |   |       | 78.9 |      
|                    | Sales and marketing        |                          |       | 14.7                                 |       |                                      |      |             |      |          |       | 14.7         |       |              |       | 8.1  |       |   |      |    |      |   |       | 8.1  |      
|                    | General and administrative |                          |       | 80.0                                 |       |                                      |      | 14.4         |      |          |       | 94.4         |       |              |       | 86.3 |       |   |      | 7.0 |      |   |       | 93.3 |      
|                    |                            |                          |       |                                      |       |                                      |      |              |      |          |       |              |       |              |       |      |       |   |      |     |      |   |       |     
|                    |                            | Total operating expenses |       |                                      | 166.3 |                                      |      |              | 38.3 |          |       |              | 204.6 |              |       |      | 166.8 |   |      |     | 13.5 |   |       |      | 180.3 |  
|                    |                            |                          |       |                                      |       |                                      |      |              |      |          |       |              |       |              |       |      |       |   |      |     |      |   |       |     
|                    |                            | Segment results          |       | $                                    | (12.2 | )                                    |      | $            | 19.2 |          |       | $            | 7.0   |              |       | $    | (7.3  | ) |      | $   | 5.2  |   |       | $    | (2.1  | )
|                    |                            |                          |       |                                      |       |                                      |      |              |      |          |       |              |       |              |       |      |       |   |      |     |      |   |       |     



|(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.
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------

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    |      |                        |     |      |      |      |      |      
|                    |                            |                          |      | September 30,              |      | Change    |      | Change        |      | Percentage of Revenues
|                    |                            |                          |      |                            |      | Favorable |      | Favorable     |      |                       
|                    |                            |                          |      | 2003                       |      | 2002      |      | (Unfavorable) |      | (Unfavorable)          |     | 2003 |      | 2002
|                    |                            |                          |      |                            |      |           |      |               |      |                        |     |      |      |     
|Revenues            |                            | $                        | 52.8 |                            |      | $         | 46.7 |               |      | $                      | 6.1 |      |      |      | 13.1 | %     |       |    | 100.0 | %    |       |    | 100.0 | %   
|                    |                            |                          |      |                            |      |           |      |               |      |                        |     |      |      |      |      |       |       |    |       |      |       |    |       |     
|Operating expenses: |                            |                          |      |                            |      |           |      |               |      |                        |     |      |      |      |      |       |       |    |       |      |       |    |       |     
|                    | Network operations         |                          |      | 26.1                       |      |           |      | 18.9          |      |                        |     | (7.2 | )    |      |      | (38.1 | )%    |    |       | 49.4 | %     |    |       | 40.5 | %    
|                    | Sales and marketing        |                          |      | 3.6                        |      |           |      | 2.2           |      |                        |     | (1.4 | )    |      |      | (63.6 | )%    |    |       | 6.8  | %     |    |       | 4.7  | %    
|                    | General and administrative |                          |      | 28.2                       |      |           |      | 28.9          |      |                        |     | 0.7  |      |      |      | 2.4   | %     |    |       | 53.4 | %     |    |       | 61.9 | %    
|                    |                            |                          |      |                            |      |           |      |               |      |                        |     |      |      |      |      |       |       |    |       |      |       |    |       |     
|                    |                            | Total operating expenses |      |                            | 57.9 |           |      |               | 50.0 |                        |     |      | (7.9 | )    |      |       | (15.8 | )% |       |      | 109.6 | %  |       |      | 107.1 | % 
|                    |                            |                          |      |                            |      |           |      |               |      |                        |     |      |      |      |      |       |       |    |       |      |       |    |       |     
|                    |                            | Segment results          |      | $                          | (5.1 | )         |      | $             | (3.3 | )                      |     | $    | (1.8 | )    |      |       | (54.5 | )% |       |      | (9.6  | )% |       |      | (7.1  | )%
|                    |                            |                          |      |                            |      |           |      |               |      |                        |     |      |      |      |      |       |       |    |       |      |       |    |       |     

|                    |                            |                          |       |                           |       |           |       |               |       |                        |      |      |      |      |      |       |       |    |       |      |       |    |       |      |       |   
|------------------- | -------------------------- | ------------------------ | ----- | ------------------------- | ----- | --------- | ----- | ------------- | ----- | ---------------------- | ---- | ---- | ---- | ---- | ---- | ----- | ----- | -- | ----- | ---- | ----- | -- | ----- | ---- | ----- | --
|                    |                            |                          |       | For the nine months ended |       | Amount    |       | Percentage    |       |                        |      |      |      |      |      |      
|                    |                            |                          |       | September 30,             |       | Change    |       | Change        |       | Percentage of Revenues
|                    |                            |                          |       |                           |       | Favorable |       | Favorable     |       |                       
|                    |                            |                          |       | 2003                      |       | 2002      |       | (Unfavorable) |       | (Unfavorable)          |      | 2003 |      | 2002
|                    |                            |                          |       |                           |       |           |       |               |       |                        |      |      |      |     
|Revenues            |                            | $                        | 154.1 |                           |       | $         | 159.5 |               |       | $                      | (5.4 | )    |      |      | (3.4 | )%    |       |    | 100.0 | %    |       |    | 100.0 | %   
|                    |                            |                          |       |                           |       |           |       |               |       |                        |      |      |      |      |      |       |       |    |       |      |       |    |       |     
|Operating expenses: |                            |                          |       |                           |       |           |       |               |       |                        |      |      |      |      |      |       |       |    |       |      |       |    |       |     
|                    | Network operations         |                          |       | 71.6                      |       |           |       | 72.4          |       |                        |      | 0.8  |      |      |      | 1.1   | %     |    |       | 46.5 | %     |    |       | 45.4 | %    
|                    | Sales and marketing        |                          |       | 14.7                      |       |           |       | 8.1           |       |                        |      | (6.6 | )    |      |      | (81.5 | )%    |    |       | 9.5  | %     |    |       | 5.1  | %    
|                    | General and administrative |                          |       | 80.0                      |       |           |       | 86.3          |       |                        |      | 6.3  |      |      |      | 7.3   | %     |    |       | 51.9 | %     |    |       | 54.1 | %    
|                    |                            |                          |       |                           |       |           |       |               |       |                        |      |      |      |      |      |       |       |    |       |      |       |    |       |     
|                    |                            | Total operating expenses |       |                           | 166.3 |           |       |               | 166.8 |                        |      |      | 0.5  |      |      |       | 0.3   | %  |       |      | 107.9 | %  |       |      | 104.6 | % 
|                    |                            |                          |       |                           |       |           |       |               |       |                        |      |      |      |      |      |       |       |    |       |      |       |    |       |     
|                    |                            | Segment results          |       | $                         | (12.2 | )         |       | $             | (7.3  | )                      |      | $    | (4.9 | )    |      |       | (67.1 | )% |       |      | (7.9  | )% |       |      | (4.6  | )%
|                    |                            |                          |       |                           |       |           |       |               |       |                        |      |      |      |      |      |       |       |    |       |      |       |    |       |     

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Revenues.Revenues increased by $6.1 million to $52.8 million for the
three months ended September 30, 2003, compared to $46.7 million the prior year
period.

Revenues decreased by $5.4 million to $154.1 million for the nine months
ended September 30, 2003, compared to $159.5 million the prior year period.

The increase in revenue for the three months is primarily attributable to
an increase in the Bundled Service UNE-P revenue. The average number
of Bundled Service UNE-P lines in service increased by
48,000 lines to 247,000 for the three months ended September 30,
2003, compared
to 199,000 for the prior year period. Although the average lines in service
were higher, the revenue per line decreased by $3 to $68 per line for the three
months ended September 30, 2003, compared to $71 per line in the prior year
period. This decrease per line is a result of a rate reduction in access
billings that occurred in June 2003, coupled with the increased number of
customers on our unlimited domestic long distance product. Our 1+ revenues
decreased $1.8 million to $2.4 million for the three months ended September 30,
2003, compared to $4.2 million the prior year period, offsetting the overall
increase in retail revenue.

The
decrease in revenue for the nine months ended September 30, 2003, is
primarily a result of 1+ revenues decreasing by $3.7 million to $8.0 million
compared to $11.7 million the prior year period. Additionally, the rate
reduction in access billing and the increased number of customers on our
unlimited calling plan has reduced our Bundled Service UNE-P revenue by $1.7 million to $146.1
million for the nine months ended September 30, 2003, compared to $147.8 million
the prior year period. The average lines in service increased by 15,000 to
245,000 average Bundled Service UNE-P lines in service for the nine months ended September 30,
2003, compared 230,000 lines the prior year period. Our average monthly revenue
per line decreased by $5 per line to $66 per line for the nine months ended
September 30, 2003, compared to $71 per line the prior year period.

The
trend of our Bundled Service UNE-P lines for the three and nine months ended September 30,
2003 is important to understanding our overall revenue trend. Our lines for both
the three months ended September 30, 2003 and 2002 trended downward. The
difference was a reduction of 25,000 lines to 237,000 at
September 30, 2003,
compared to a reduction of 14,000 lines to 195,000 lines at September 30, 2002.
For the nine months ended September 30, 2003 Bundled Service
UNE-P lines began at 203,000 and
increased during the first and second quarter to 262,000 at June 30, 2003 and
then decreased to 237,000 during the third quarter of 2003. This compares to a
steady decrease in Bundled Service UNE-P lines for the nine months ended
September 30, 2002, beginning
with 254,000 and decreasing to 195,000 at September 30, 2002.

The trends in retail line count discussed in the prior paragraph were the
result of focusing our efforts on establishing and growing our wholesale
services business during 2002 and improving our internal processes rather than
growing lines. 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. In the third quarter of 2003, we decreased
our sales and marketing activity and focused on our wholesale and business
services and increased our subscriber management activities and customer
acceptance policies for our residential business, which resulted in a decrease
of lines but an improvement in operating costs to maintain those lines.

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 for 2003 compared to 2002,
but that retail revenue will still represent the majority of total consolidated
revenues during 2003, and the number of business lines will continue to grow at
faster rates, while the number of our residential lines are expected to stay
relatively flat or decline slightly the remainder of 2003.

Network Operations.Network operations expense increased by $7.2 million
to $26.1 million for the three months ended September 30, 2003, compared to
$18.9 million the prior year period. Our network operations as a percentage of
revenue increased by 8.9% to 49.4% for the three months ended September 30,
2003, compared to 40.5% in the prior year period.

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Network operations expense decreased by $0.8 million to $71.6 million for
the nine months ended September 30, 2003, compared to $72.4 million the prior
year period. Our network operations as a percentage of revenue increased by
1.1% to 46.5% for the nine months ended September 30, 2003, compared to 45.4%
in the prior year period.

The increase in network operations expense for the three months ended
September 30, 2003 is primarily a result of having an additional
48,000 Bundled Service UNE-P lines
in service compared to the prior year period. Our network operations expense
as a percentage of revenues increased primarily as a result of the increased
long distance usage as a result of the growth from our unlimited service and
the mix of our customer base being spread across more states that have
favorable pricing but not as favorable as the states in which we had customers
in the prior year period. These increases have been offset by reductions to
network operations as a result of improved internal operations and processes to
minimize our network operations costs. The decrease of network operations for
the nine months ended September 30, 2003 is primarily attributed to the $2.5
million of certain retroactive rate reduction and billing errors that have been
offset by the increased average number of lines in service for the
nine months
of 15,000 lines and the increased usage of long distance services as a result
of the growth in customers using our unlimited domestic long distance service.
Additionally, during the third quarter of 2003 we settled various disputes with
Ameritech that resulted in a reduction to network operations expense in the
amount of $0.9 million.

Sales and Marketing.Sales and marketing expense increased $1.4 million to
$3.6 million for the three months ended September 30, 2003, compared to $2.2
million the prior year period.

Sales and marketing expense increased $6.6 million to $14.7 million for
the nine months ended September 30, 2003, compared to $8.1 million the prior
year period.

The increase in our sales and marketing for the three months ended
September 30, 2003 compared to the prior year period was a result of increased
commission payments of $1.9 million in 2003. This increase is primarily a
result of the increased use of independent sales contractors during 2003
compared to the prior year period and the increased Bundled Service
UNE-P lines in service from this
sales channel. Our other sales and marketing expenses offset the increase of
commission to improve our overall cash flow and plan the rollout
of our new PVA residential strategy and focus on our business and wholesale
services. The increase in sales and marketing for nine months ended September
30, 2003 compared to the prior year period was a result of our decision to grow
retail lines aggressively during first half of 2003 prior to our reduction of
these expenses during the third quarter of 2003.

Historically, we have used advertising and independent sales contractors to
drive the growth of our retail residential lines. While this channel will
continue to contribute to our growth, we are also focusing on leveraging the use
of our PVA product to market our residential lines, as outlined in more detail
above in the consolidated sales and marketing section. We expect to continue
focusing on our business lines and have built an internal sales force and
independent sales contractors network to increase our growth the remainder of
2003 and during 2004. We expect next quarters sales and
marketing expenses to stay
relatively consistent with the current quarter but to the extent that we have
excess cash available, we may fund sales and marketing efforts as a
discretionary item in order to manage our overall financial results and cash
flow.

General and Administrative.General and administrative expense decreased
$0.7 million to $28.2 million for the three months ended September 30, 2003,
compared to $28.9 million the prior year period. As a percentage
of revenues,
general and administrative expense decreased by 8.5% to 53.4% of revenues in
2003, compared to 61.9% in the prior year period.

General and administrative expense decreased $6.3 million to $80.0 million
for the nine months ended September 30, 2003, compared to $86.3 million the
prior year period. As a percentage of revenues, general and administrative
expense decreased by 2.2% to 51.9% of revenues in 2003, compared to 54.1% in the
prior year period.

27



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##### Table of Contents



The decrease in general and administrative expense for the three months
ended September 30, 2003 was primarily a result of the following items:



| |  |  | $1.8 million increase in payroll expense as a result of adding
employees to support our increased lines in service and our new
business services;                                                                                                                  
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | $1.7 million decrease to bad debt expense as result of our improved
customer acceptance process and subscriber management activities and
the sale of previously written-off receivables, which resulted in a
reduction to our bad debt expense of $1.0 million; and
|
| |  |  | $1.0 million decrease in tax expense as a result of certain tax
accruals recorded in the prior year;                                                                                                                                                               

The remaining differences are made up of various immaterial items.

The decrease in general and administrative expense for the nine months
ended September 30, 2003 was primarily a result of the following items:



| |  |  | $6.1 million increase in payroll expenses as a result of adding
employees to support our increased lines in service and our new business
services;                                                                                                             
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | $2.0 million increase in contract development for work on new
products and various improvements and updates to our retail service
offerings;                                                                                                                   
|
| |  |  | $1.6 million increase in health insurance, and other insurance items
as a result of the increase cost to cover employee health expenses and
the increased insurance cost of being a public company;                                                            
|
| |  |  | $9.9 million decrease to bad debt expense as result of our improved
customer acceptance process and subscriber management activities and the
sale of previously written-off receivables, which resulted in a
reduction to our bad debt expense of $1.0 million;
|
| |  |  | $2.5 million decrease in ILEC credits that we received on ILEC bills
for the failure of the ILECs to meet certain regulatory requirements for
the service provided to unbundled network element platform customers;                                            
|
| |  |  | $4.0 million decrease in tax expense for certain tax accruals made in
the prior year;                                                                                                                                                                          
|
| |  |  | $1.0 million decrease in billing expense as a result of renegotiating
our contracts and improved billing practices; and                                                                                                                                        
|
| |  |  | $1.4 million increase to other general and administrative charges
that are primarily higher due to our increased payroll and slightly
higher lines in services during 2003 compared to 2002.                                                                   

We
expect residential lines to remain flat to slightly lower the remainder of 2003,
while we focus on growing our business lines. We also expect general and
administrative expense to decrease as a percentage of revenues as we continue
to further leverage certain elements of our fixed cost structure, although we
expect a small increase in total expenses as we incur more charges for
incremental costs such as billing, collection, and headcount related expenses
for the remainder of 2003 and increased non-direct wholesale expenses.

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, will represent a smaller
percentage of consolidated general and administrative expense.

28



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##### Table of Contents



Wholesale Services Segment

The
following table, in millions, provides our wholesale services segment
for the periods presented:

|                    |                            |                          |      |                            |      |           |      |               |     |                        |      |      |       |      |       |        |        |    |       |      |      |   |       |      |      |  
|------------------- | -------------------------- | ------------------------ | ---- | -------------------------- | ---- | --------- | ---- | ------------- | --- | ---------------------- | ---- | ---- | ----- | ---- | ----- | ------ | ------ | -- | ----- | ---- | ---- | - | ----- | ---- | ---- | -
|                    |                            |                          |      | Wholesale Services Segment
|                    |                            |                          |      |                           
|                    |                            |                          |      | For the three months ended |      | Amount    |      | Percentage    |     |                        |      |      |       |      |       |       
|                    |                            |                          |      | September 30,              |      | Change    |      | Change        |     | Percentage of Revenues
|                    |                            |                          |      |                            |      | Favorable |      | Favorable     |     |                       
|                    |                            |                          |      | 2003                       |      | 2002      |      | (Unfavorable) |     | (Unfavorable)          |      | 2003 |       | 2002
|                    |                            |                          |      |                            |      |           |      |               |     |                        |      |      |       |     
|Revenues            |                            | $                        | 28.7 |                            |      | $         | 12.0 |               |     | $                      | 16.7 |      |       |      | 139.2 | %      |        |    | 100.0 | %    |      |   | 100.0 | %   
|                    |                            |                          |      |                            |      |           |      |               |     |                        |      |      |       |      |       |        |        |    |       |      |      |   |       |     
|Operating expenses: |                            |                          |      |                            |      |           |      |               |     |                        |      |      |       |      |       |        |        |    |       |      |      |   |       |     
|                    | Network operations         |                          |      | 12.4                       |      |           |      | 4.9           |     |                        |      | (7.5 | )     |      |       | (153.1 | )%     |    |       | 43.2 | %    |   |       | 40.8 | %   
|                    | General and administrative |                          |      | 7.4                        |      |           |      | 2.8           |     |                        |      | (4.6 | )     |      |       | (164.3 | )%     |    |       | 25.8 | %    |   |       | 23.3 | %   
|                    |                            |                          |      |                            |      |           |      |               |     |                        |      |      |       |      |       |        |        |    |       |      |      |   |       |     
|                    |                            | Total operating expenses |      |                            | 19.8 |           |      |               | 7.7 |                        |      |      | (12.1 | )    |       |        | (157.1 | )% |       |      | 69.0 | % |       |      | 64.2 | %
|                    |                            |                          |      |                            |      |           |      |               |     |                        |      |      |       |      |       |        |        |    |       |      |      |   |       |     
|                    |                            | Segment results          |      | $                          | 8.9  |           |      | $             | 4.3 |                        |      | $    | 4.6   |      |       |        | 107.0  | %  |       |      | 31.0 | % |       |      | 35.8 | %
|                    |                            |                          |      |                            |      |           |      |               |     |                        |      |      |       |      |       |        |        |    |       |      |      |   |       |     

|                    |                            |                          |      |                           |      |           |      |               |                        |               |      |       |       |      |       |        |        |    |       |      |      |   |     |      |      |  
|------------------- | -------------------------- | ------------------------ | ---- | ------------------------- | ---- | --------- | ---- | ------------- | ---------------------- | ------------- | ---- | ----- | ----- | ---- | ----- | ------ | ------ | -- | ----- | ---- | ---- | - | --- | ---- | ---- | -
|                    |                            |                          |      | For the nine months ended |      | Amount    |      | Percentage    |                        |               |      |       |       |      |       |       
|                    |                            |                          |      | September 30,             |      | Change    |      | Change        | Percentage of Revenues
|                    |                            |                          |      |                           |      | Favorable |      | Favorable     |                        |               |      |       |       |      |       |       
|                    |                            |                          |      | 2003                      |      | 2002 (1)  |      | (Unfavorable) |                        | (Unfavorable) |      | 2003  |       | 2002
|                    |                            |                          |      |                           |      |           |      |               |                        |               |      |       |       |     
|Revenues            |                            | $                        | 57.5 |                           |      | $         | 18.7 |               |                        | $             | 38.8 |       |       |      | 207.5 | %      |        |    | 100.0 | %    |      |   | 100 | %   
|                    |                            |                          |      |                           |      |           |      |               |                        |               |      |       |       |      |       |        |        |    |       |      |      |   |     |     
|Operating expenses: |                            |                          |      |                           |      |           |      |               |                        |               |      |       |       |      |       |        |        |    |       |      |      |   |     |     
|                    | Network operations         |                          |      | 23.9                      |      |           |      | 6.5           |                        |               |      | (17.4 | )     |      |       | (267.7 | )%     |    |       | 41.6 | %    |   |     | 34.8 | %   
|                    | General and administrative |                          |      | 14.4                      |      |           |      | 7.0           |                        |               |      | (7.4  | )     |      |       | (105.7 | )%     |    |       | 25.0 | %    |   |     | 37.4 | %   
|                    |                            |                          |      |                           |      |           |      |               |                        |               |      |       |       |      |       |        |        |    |       |      |      |   |     |     
|                    |                            | Total operating expenses |      |                           | 38.3 |           |      |               | 13.5                   |               |      |       | (24.8 | )    |       |        | (183.7 | )% |       |      | 66.6 | % |     |      | 72.2 | %
|                    |                            |                          |      |                           |      |           |      |               |                        |               |      |       |       |      |       |        |        |    |       |      |      |   |     |     
|                    |                            | Segment results          |      | $                         | 19.2 |           |      | $             | 5.2                    |               |      | $     | 14.0  |      |       |        | 269.2  | %  |       |      | 33.4 | % |     |      | 27.8 | %
|                    |                            |                          |      |                           |      |           |      |               |                        |               |      |       |       |      |       |        |        |    |       |      |      |   |     |     

Revenues.Revenues increased by $16.7 million to $28.7 million for the
three months ended September 30, 2003, compared to $12.0 million the prior year
period.

Revenues increased by $38.8 million to $57.5 million for the nine months
ended September 30, 2003, compared to $18.7 million the prior year period.

We signed our wholesale services agreement with Sprint in February of
2003. Sprint contributed $22.7 million and $34.9 million of revenue for the
three and nine months ended September 30, 2003, respectively. MCI revenue
decreased by $6.1 million and increased by $3.4 million for the three and nine
months ended September 30, 2003,

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respectively, compared to the prior year periods. On August 7, 2003, we
amended our contract with MCI to terminate the contract on December 31, 2003.
On August 15, 2003, MCI provided us with notice that they were terminating the
contract effective October 15, 2003. As a result of these events, we
accelerated the recognition of deferred revenue to the termination date of
October 15, 2003. Prior to MCIs decision to terminate the
agreement early, this revenue was being recognized ratably over
the life of the agreement with an original termination date of December 31, 2005. During the
third quarter of 2003 we recognized an additional $3.7 million of revenue as a
result of the termination notice from MCI. This increase in revenue while MCI
is decreasing its activity with us is a result of the recognition of revenue
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 have increased, however, there was no increase to our cash for
this revenue as it was already paid in prior periods. This also resulted in
there being only $1.6 million of short-term deferred revenue attributable to
MCI recorded at September 30, 2003. The deferred revenue will be recognized
during the fourth quarter of 2003.

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
period.

Network Operations.Network operations expense increased by $7.5 million
to $12.4 million for the three months ended September 30, 2003, compared to
$4.9 million the prior year period.

Network operations expense increased by $17.4 million to $23.9 million for
the nine months ended September 30, 2003, compared to $6.5 million the prior
year period.

The increase in network operations is the result of increased wholesale
lines in service for both the three and nine months ended September 30, 2003
compared to the prior year periods. We expect this expense to vary depending on
each individual wholesale contract. We incur these expenses in leasing
unbundled network elements from the ILECs, long distance services and certain
other costs associated with providing on going telecommunications services. 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 a direct return of these
expenses under our current wholesale service agreements, an increase or decrease in
these costs has no impact on our net income.

General and Administrative.General and administrative expense increased
$4.6 million to $7.4 million for the three months ended September 30, 2003,
compared to $2.8 million the prior year period.

General and administrative expense increased $7.4 million to $14.4 million
for the nine months ended September 30, 2003, compared to $7.0 million the
prior year period.

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.

The increase in general and administrative expense is the result of
increased payroll expense, outsourcing of certain functions to limit our cost
exposure and increased non-recurring provisioning expenses to establish service
for our wholesale customers. We expect to steadily increase headcount to
support our existing growing wholesale customer and the addition of new
wholesale customers expected in the coming quarters. We may transfer
existing employees from our retail services to wholesale services. As a result of this
growth, we expect general and administrative expense to increase in total
dollars and as a percentage of our consolidated

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expenses. 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 we do not expect any material changes to
our approach, as under our current agreements, we receive a substantial portion
of our payments from our wholesale services customers in advance.

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. However, we are
exploring certain next generation networks that would be more capital-intensive
in nature than our historical capital expenditures and would involve the
purchasing of switches and other equipment. We continue to devote a
significant amount of our capital resources to continued operations, software
development, new service offerings and sales and marketing efforts.

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 September 30, 2003, we had an accumulated
deficit of $314.4 million and $14.5 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. 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 decreased by $3.0 million to
$10.0 million for the nine months ended September 30, 2003, compared to $13.0
million the prior year period. The decrease in operating activities is
primarily a result of the reduction to accounts payable and accrued liabilities
by $7.3 million, a decrease in cash from the improved net loss after
reconciling non-cash items totaling $3.3 million and a $6.0 million improvement
from collections of receivables. Included in our accounts receivable
collections was the payment of $0.6 million related to a $1.0 million sale of
old previously written-off receivables. We received the additional $0.4
million in October. The remaining differences are a result of other changes
in working capital.

Included in our net cash provided by operating activities was the sale of
$43.3 million and $94.8 million of receivables, for net proceeds of $34.2
million and $77.0 million, for the nine months ended September 30, 2003 and
2002, respectively. A net receivable servicing asset of $12.9 is included in
accounts receivable and $5.2 million of advances on unbilled receivables are
included in accounts payable and accrued liabilities as of September 30, 2003.
The costs relating to the RFC receivable financing agreement of $0.7 and $1.0
million are included in interest and other expense for nine months ended
September 30, 2003 and 2002, respectively.

Our net cash used in investing activities improved by $6.4 million to $7.7
million for the nine months ended September 30, 2003 compared to $14.1 million
the prior year period. Nearly all the improvement was attributable to the
purchasing of less property and equipment during 2003 and the financing of $1.3
million of equipment purchases during the third quarter. 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 $0.5 million to $3.8

million for the nine months ended September 30, 2003, compared to $4.3 million
the prior year period. 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

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fulfillment of a note payable for the
issuance of common stock, while payments
on long-term debt and capital leases were flat. We expect to maintain a low
amount of long-term debt but are currently in discussions to obtain additional
financing and working to restructure our current accounts receivable agreement
to an asset-based loan. Most of our existing debt has a fixed interest rate
that is payable in monthly installments.

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 are
currently under audit by the State of New York for our sales and use
taxes.  Although this process is still on going, we currently
disagree on the calculation of sale and use tax on our bundled
products.  We have made accruals based on our best estimates of the
facts, but are unable to determine the final outcome.

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 had originally not imposed any penalties as
provided under the agreement. However, in October 2003, we received
correspondence from WilTel Communications, Inc. (WilTel) stating that they
believe we are not fulfilling our minutes of use commitment with them under our
agreement signed with them on February 22, 2003. They have alleged we owe them
$3.1 million for our minutes-of-use commitment shortfall as of September 30,
2003. We have disputed this amount and believe that these charges are without
merit and that WilTel was the cause for any shortfalls in
minutes-of-use,
they failed to provide the service under the agreement. Additionally, WilTel
provided no notice of the alleged shortfalls as required under the contract.
Finally, we also believe that WilTel has overbilled us for transport charges
and owes us a credit for certain charges we incurred in order to utilize
WilTels network as agreed to in our contract. We are continuing to work with
this carrier to resolve this issue and do not expect a material adverse impact
on our financial statements.

We received a billing for $2.3 million from Verizon relating to the
back-billing of dispatch charges believed to relate to the period from August
2000 to February 2002 and from March 2003 to September 2003. We do not know if
this is the entire amount they will bill us for these back-billed charges. We
have disputed these charges. We expect that if any of these charges are valid,
a potion of these charges may be subject to being billed to our wholesale
services customers for services that we provided under our contracts with them.
We have not received any detail related to these charges from Verizon and
therefore, are unable to determine their validity.

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 underlying expenses that are included in
connection with 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 accounting
treatment, increases or decreases in pricing or volume that impact direct costs
that are incurred in connection with this agreement 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.

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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 we have returned $0.8 million to Sprint
as a bill credit during the third quarter of 2003 for the achievement of
reaching certain line-count thresholds. As of September 30, 2003, there was
$0.2 million of the stimulus payment remaining which is recorded in short-term
deferred revenue. We expect this amount to be returned to Sprint via bill
credits in the fourth quarter of 2003.

On August 7, 2003, we amended our contract with MCI to terminate the

contract on December 31, 2003. On August 15, 2003, MCI provided us with notice
that they were terminating the contract effective October 15, 2003. As a
result of these events, we accelerated the recognition of deferred revenue to
the termination date of October 15, 2003. Prior to this, we were recognizing
the deferred revenue ratably over the life of the agreement with a termination
date of December 31, 2005. During the third quarter of 2003 we recognized an
additional $3.7 million of revenue as a result of the termination notice from
MCI. 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 have increased,
however, there was no increase to our cash for this revenue, as it was already
paid in prior periods. This resulted in there only being $1.6 million of
short-term deferred revenue recorded attributable to MCI at September 30, 2003
that will be recognized during the fourth quarter of 2003.

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, and currently have no plans to make any
purchases.

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 October 2, 2003, the Federal Communications Commissions decision in
FCC CC Docket No. 01-338 (referred to as the Triennial Review) became
effective. That decision establishes a new framework for identifying and
ordering unbundled network element access to incumbent local telephone company
networks. In particular, the Federal Communications Commission (FCC) made a
national finding that companies like us were entitled to unbundled access to
the constituent components of the Unbundled Network Element Platform (UNE-P)
to serve analog customers (what the FCC calls the mass market). The FCCs
regulatory framework does not require access to many unbundled network elements
that had been previously ordered, particularly elements that would be utilized
by entrants to provide broadband services, such as digital subscriber line
(DSL). The FCCs Triennial Review framework provides for state commission
review of many of these network elements (including loops, transport, and
switching) in 9-month proceedings, which have begun in many of the states in
which we operate, as well as continuing review. We expect that state
commissions will in the coming months engage in a detailed and fact-intensive
review of the availability of UNE-P for the services we currently provide. The
results of these state commission proceedings are uncertain at this time and
the results will certainly impact our business. In particular, any state
commission action that restricts the availability of UNE-P or any of its
constituent network elements could have a material adverse impact on our
business. In addition, several parties, including us, have filed appeals of
the FCCs Triennial Review Order, which have been consolidated in United States
Telecom Assn. v. FCC, Nos. 00-0012, 03-1310 and consolidated cases, now
pending before the D.C. Circuit. We intend to appeal the FCCs standard for
identifying unbundled network elements, the ostensible preemptive nature of the
Order, and the FCCs failure to recognize fully that section 271 obligates Bell
operating companies that have obtained authorization to provide interLATA
services have an obligation to provide unbundled loops, switching, transport
and signaling, regardless of section 251 requirements. Verizon, SBC, Qwest and
USTA have filed for a stay of the FCCs rules related to UNE-P and other
elements and have also requested that the D.C. Circuit issue an immediate writ
of mandamus reversing the Triennial Review Order on these points. The impact
of any such stay or grant of

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mandamus is uncertain at this time, but any such action that results in the
vacating of any unbundling rules could have an immediate and adverse impact
upon our business. BellSouth and other parties have filed petitions before the
FCC for reconsideration of the Triennial Review Order on section 271 grounds
and broadband unbundling rules; granting of any of those petitions in whole or
in part similarly could impact our business.

In October 2003, we received notice that Textron Financial was closing the
office of its subsidiary RFC Capital, LLC, the entity with which we have our
accounts receivable sales agreement. In discussions with Textron we have been
told that they are going to continue to honor the accounts receivable
agreement, although they are under no obligation to purchase our receivables.
Additionally, we have begun discussions to exit the sale of receivables
facility and transform it into an asset-based loan. This transition could
result in an incremental increase in our liquidity. We are also pursuing and
currently undertaking discussions to further improve our short-term liquidity
and working capital through additional loans and financing.

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 and growth of our retail and wholesale services. We have generated
cash flow from operating activities for eight consecutive quarters and overall
positive cash flow four of the last five quarters, including a very small
positive cash flow for the three months ended September 30, 2003. However, we
had overall negative cash flow for the nine months ended
September 30, 2003,
primarily as a result of our investment in sales and marketing and
other growth-related expenses. As we continue to slow our retail line growth and have fully
utilizing our accounts receivable agreement at our current accounts receivable
level, during the third quarter, we expect cash to decrease during the fourth
quarter, unless we are able to secure additional loans. Although cash flow
from our wholesale and business lines are expected to improve, this
improvement will not be
enough to offset the decrease in residential lines. However, we expect this trend to
change during 2004. We expect equipment purchases to stay consistent
during the fourth quarter and our debt payments to be relatively flat for
the remainder of the year. We are aware of the risks, discussed throughout
this document, of not achieving our goals and their potential impact on our
liquidity and the various factors and circumstances that could cause us to
alter from this approach.

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 telecommunications services on a private label basis to
residential and business customers. 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.

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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, and established an internal audit department.

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 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



|   |  |                                                                                                                                                                                  
|-- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|1. |  | 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)

Developments relating to the foregoing proceeding was reported in our Form
10-Q for the quarter ended June 30, 2003.



|   |  |                                                                                                                                                                                                                                                                                                   
|-- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|2. |  | Case No 8:02 CV 1708 T 27 MS The Metropolitan Government of Nashville and Davidson
County, Tennessee, suing on behalf of Metropolitan Nashville Employee Benefit Board v Z-Tel Technologies, Inc. in the United States District
Court for the Middle District of Florida filed September 20, 2002.

Developments
relating to the foregoing proceeding were reported in our
Form 10-Q for the quarter ended June 30, 2003.



|   |  |                                                                                                                                                                                                                                                                          
|-- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|3. |  | 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.

Settlement of foregoing proceeding was reported Form 10-Q for the quarter
ended June 30, 2003.



|   |  |                                                                                                                                                                       
|-- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------
|4. |  | C.A. No5:03CV229, Z-Tel Communications Inc. v. SBC Communications, Inc.,
in the United States District Court for the Eastern District of Texas, filed
October 9, 2003.

On October 9, 2003, Z-Tel Communications, Inc., our wholly-owned
subsidiary corporation, filed a lawsuit against SBC Communications, Inc. and
several of its subsidiaries (collectively, SBC) in federal court in Texas,
where both SBC and Z-Tel do business. The lawsuit alleges SBCs violation of
the federal antitrust laws, the Racketeering Influenced Corrupt Organizations
Act (RICO), the Lanham Act, and other federal and state laws. The complaint
seeks damages and an injunction against SBC. We cannot with any certainty
predict the outcome of this litigation.

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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 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                                                                                                                                                                                                                                                                                                                                  

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|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|EXHIBIT |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|NUMBER  |  | DESCRIPTION                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|        |  | 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.                                                                                                                                                                                                                                                                                                                                                                                    
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|4.7     |  | 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.                                                                                                                                                                                                                                                                                          
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|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.                                                                                                                                                                                                                                                               

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|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                              |                                                                                  |                                                                                                                                                                                                                                                                                                                                                                                                                                           
|------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ | -------------------------------------------------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|EXHIBIT |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                              |                                                                                  |                                                                                                                                                                                                                                                                                                                                                                                                                                           
|NUMBER  |  | DESCRIPTION                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|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.                                                                                                                                                                                           
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                              |                                                                                  |                                                                                                                                                                                                                                                                                                                                                                                                                                           
|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

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|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|EXHIBIT |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|NUMBER  |  | DESCRIPTION                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|        |  | 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.                                                                                                                                                                                                                                                                            
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|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.                                                                                                                                                                                                                           

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|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|EXHIBIT |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|NUMBER  |  | DESCRIPTION                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|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                                                                                                                                                                                                                                                                                                                                                                                                                        
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|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 August 12, 2003, we filed a Form 8-K in connection with our earnings
release and the subsequent earnings conference call.

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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 November 2003.

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

41