##### Table of Contents



SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549


FORM 10-Q

(Mark One)[X]
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE PERIOD ENDED MARCH 31, 2003OR[  ]
    
    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
    
    59-3501119(State or other jurisdiction of incorporation or organization)
    
    (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 [  ]

The number of shares of the Registrants Common Stock outstanding as of
May 12, 2003 was approximately 35,301,553.





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TABLE OF CONTENTS



|                                         |                                                                                                   |                                                             |  |  |  |  |  | 
|---------------------------------------- | ------------------------------------------------------------------------------------------------- | ----------------------------------------------------------- |  |  |  |  |  | 
|                                         |                                                                                                   | Consolidated Balance Sheets                                
|                                         |                                                                                                   | Consolidated Statements of Operations                      
|                                         |                                                                                                   | Consolidated Statements of Changes in Stockholders Deficit
|                                         |                                                                                                   | Consolidated Statements of Cash Flows                      
|                                         |                                                                                                   | NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)     
|                                         | ITEM 2.    MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
|                                         | ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                               
|                                         | ITEM 4. CONTROLS AND PROCEDURES                                                                  
|PART II                                 
|                                         | ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                      
|                                         | ITEM 6.       EXHIBITS, AND REPORTS ON FORM 8-K                                                  
|                                         | SIGNATURES                                                                                       
|Ex-4.20 3/13/03 Series D Stock Amendment
|Ex-4.21 3/13/03 Series E Stock Amendment
|Ex-4.20 3/13/03 Series G Stock Amendment
|Ex-99.1 CEO Certification               
|Ex-99.2 CFO Certification               



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##### Table of Contents



TABLE OF CONTENTS

PART IItem 1.
    
    Financial StatementsConsolidated Balance Sheets at March 31, 2003 and December 31, 2002Consolidated Statements of Operations for the three months ended March 31, 2003 and 2002Consolidated Statement of Changes in Stockholders Deficit for the three months ended March 31, 2003Consolidated Statements of Cash Flows for the three months ended March 31, 2003 and 2002Notes to Consolidated Financial StatementsItem 2.
    
    Managements Discussion and Analysis of Financial Condition and Results of OperationsItem 3.
    
    Quantitative and Qualitative Disclosures about Market RiskItem 4.
    
    Controls and ProceduresPART IIItem 4.
    

Submission
of Matters to a Vote of Security HoldersItem 6.
    
    Exhibits, and Reports on Form 8-KSignatures


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Z-Tel Technologies, Inc. and Subsidiaries




Consolidated Balance Sheets


(In thousands, except share data)


March 31,
    
    December 31,2003
    
    2002(Unaudited)AssetsCurrent assets:Cash and cash equivalents
    
    $
    17,065
    
    
    $
    16,037Accounts receivable, net of allowance for doubtful
accounts of $14,629 and $17,401
    
    
    28,301
    
    
    
    26,749Prepaid expenses and other current assets
    
    
    5,952
    
    
    
    5,741Total current assets
    
    
    51,318
    
    
    
    48,527Property and equipment, net
    
    
    45,878
    
    
    
    48,320Intangible assets, net
    
    
    3,659
    
    
    
    4,116Other assets
    
    
    5,550
    
    
    
    5,748Total assets
    
    $
    106,405
    
    
    $
    106,711Liabilities, Mandatorily Redeemable Convertible Preferred
Stock and Stockholders DeficitCurrent liabilities:Accounts payable and accrued liabilities
    
    $
    49,613
    
    
    $
    51,771Deferred revenue
    
    
    14,977
    
    
    
    10,172Current portion of long-term debt
and capital lease obligations
    
    
    5,862
    
    
    
    5,964Total current liabilities
    
    
    70,452
    
    
    
    67,907Long- term deferred revenue
    
    
    7,413
    
    
    
    6,277Long-term debt and capital lease obligations
    
    
    2,828
    
    
    
    4,180Total liabilities
    
    
    80,693
    
    
    
    78,364Mandatorily redeemable convertible preferred stock, $.01 par value;
50,000,000 shares authorized; 8,855,089 issued; 8,805,089
outstanding (aggregate liquidation value of $148,563 and $145,503)
    
    
    131,682
    
    
    
    127,631Commitments and contingencies (Note 8)Stockholders deficit:Common stock, $.01 par value; 150,000,000
shares authorized; 35,609,803 and 35,609,803 shares issued;
35,268,253 outstanding
    
    
    356
    
    
    
    356Notes receivable from stockholders
    
    
    (1,120
    )
    
    
    (1,589
    )Additional paid-in capital
    
    
    201,040
    
    
    
    205,090Accumulated deficit
    
    
    (305,858
    )
    
    
    (302,753
    )Treasury stock, 341,550 shares at cost
    
    
    (388
    )
    
    
    (388
    )Total stockholders deficit
    
    
    (105,970
    )
    
    
    (99,284
    )Total liabilities, mandatorily redeemable convertible preferred
stock and stockholders deficit
    
    $
    106,405
    
    
    $
    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 endedMarch 31,2003
    
    2002Revenues
    
    $
    60,276
    
    
    $
    57,269Operating expenses:Network operations
    
    
    26,129
    
    
    
    27,243Sales and marketing
    
    
    4,494
    
    
    
    4,759General and administrative
    
    
    26,906
    
    
    
    29,842Wholesale development costs
    
    
    
    
    
    
    1,018Depreciation and amortization
    
    
    6,027
    
    
    
    5,579Total operating expenses
    
    
    63,556
    
    
    
    68,441Operating loss
    
    
    (3,280
    )
    
    
    (11,172
    )Nonoperating income:Interest and other income
    
    
    925
    
    
    
    1,177Interest and other expense
    
    
    (750
    )
    
    
    (612
    )Total nonoperating income
    
    
    175
    
    
    
    565Net loss
    
    
    (3,105
    )
    
    
    (10,607
    )Less mandatorily redeemable convertible
preferred stock dividends and accretion
    
    
    (4,237
    )
    
    
    (3,872
    )Less deemed dividend related to beneficial
conversion feature
    
    
    (46
    )
    
    
    (46
    )Net loss attributable to common stockholders
    
    $
    (7,388
    )
    
    $
    (14,525
    )Weighted average common shares outstanding
    
    
    35,268,253
    
    
    
    34,307,194Basic and diluted net loss per share
    
    $
    (0.21
    )
    
    $
    (0.42
    )


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)


NotesCommon Stock
    
    Receivable
    
    Additional
    
    
    
    
    
    
    
    
    
    Totalfrom
    
    Paid-In
    
    Accumulated
    
    Treasury
    
    Stockholders'Shares
    
    Par Value
    
    Stockholders
    
    Capital
    
    Deficit
    
    Stock
    
    DeficitBalance, December 31, 2002
    
    
    35,268,253
    
    
    $
    356
    
    
    $
    (1,589
    )
    
    $
    205,090
    
    
    $
    (302,753
    )
    
    $
    (388
    )
    
    $
    (99,284
    )Repayment of notes receivable
    
    
    
    
    
    
    
    
    
    
    469
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    469Mandatorily redeemable convertible preferred
stock dividends and accretion
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (4,050
    )
    
    
    
    
    
    
    
    
    
    
    (4,050
    )Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (3,105
    )
    
    
    
    
    
    
    (3,105
    )Balance, March 31, 2003
    
    
    35,268,253
    
    
    $
    356
    
    
    $
    (1,120
    )
    
    $
    201,040
    
    
    $
    (305,858
    )
    
    $
    (388
    )
    
    $
    (105,970
    )


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 Cash Flows


(In thousands)
(Unaudited)


Three months endedMarch 31,2003
    
    2002Cash flows from operating activities:Net loss
    
    $
    (3,105
    )
    
    $
    (10,607
    )Adjustments to reconcile net loss to net cash used in
operating activities:Depreciation and amortization
    
    
    6,027
    
    
    
    5,579Provision for bad debts
    
    
    2,396
    
    
    
    7,068Expense charged for granting of stock options
    
    
    
    
    
    
    118Change in operating assets and liabilities:Increase in accounts receivable
    
    
    (3,948
    )
    
    
    (3,253
    )Increase in prepaid expenses
    
    
    (211
    )
    
    
    (1,154
    )(Increase) decrease in other assets
    
    
    198
    
    
    
    (416
    )Decrease in accounts payable and accrued liabilities
    
    
    (2,157
    )
    
    
    (2,531
    )Increase in deferred revenue
    
    
    5,941
    
    
    
    6,324Total adjustments
    
    
    8,246
    
    
    
    11,735Net cash provided by operating activities
    
    
    5,141
    
    
    
    1,128Cash flows from investing activities:Purchases of property and equipment
    
    
    (3,128
    )
    
    
    (5,475
    )Net cash used in investing activities
    
    
    (3,128
    )
    
    
    (5,475
    )Cash flows from financing activities:Payments on long-term debt and capital lease obligations
    
    
    (1,454
    )
    
    
    (1,591
    )Principal repayments received on stockholders notes
    
    
    469
    
    
    
    Net cash used in financing activities
    
    
    (985
    )
    
    
    (1,591
    )Net increase (decrease) in cash and cash equivalents
    
    
    1,028
    
    
    
    (5,938
    )Cash and cash equivalents, beginning of period
    
    
    16,037
    
    
    
    18,892Cash and cash equivalents, end of period
    
    $
    17,065
    
    
    $
    12,954


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. 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 were incorporated in
Delaware on January 15, 1998.

We provide both retail and wholesale services. Our principal retail
services are Z-LineHOME®, Z-LineBUSINESS® and Touch 1 Long Distance.
Z-LineHOME, our flagship offering, is residential local and long distance
telephone service, bundled with enhanced services, including the Personal
Communications Center, a suite of our proprietary Internet-accessible and
voice-activated features. The Personal Communications Center includes
voicemail, Find Me call forwarding and our recently introduced Personal Voice
Assistant, or PVA, which utilizes voice-recognition technology so that users
can access and use their own secure, online address books with voice commands.
We expect that eventually all our enhanced features will be accessed and
managed via voice commands so that PVA will supplant the Personal
Communications Center. Z-LineBUSINESS is our local, long distance and enhanced
communications service designed primarily for small businesses. Touch 1 Long
Distance is a residential long distance telephone service. We offer our
Z-LineHOME and Z-LineBUSINESS services in forty-seven states. The majority of
our customers are primarily in ten states. We offer Touch 1 Long Distance
nationwide.

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

2.       BASIS OF PRESENTATION

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

RECLASSIFICATION

Certain amounts in the consolidated statements of operations for the three
months ended March 31, 2002 have been reclassified to conform to the
presentation for three months ended March 31, 2003.

RECENT ACCOUNTING PRONOUNCEMENTS

In November 2002, the Emerging Issues Task Force (EITF) of the FASB
reached a consensus on EITF No. 00-21, Accounting for Revenue Arrangements with
Multiple Element Deliverables. The Issue addresses how to account for
arrangements that may involve the delivery or performance of multiple products,
services and/or rights to use assets. Revenue arrangements with multiple
deliverables should be divided into separate units of accounting if the
deliverables in the arrangement meet certain criteria. Arrangement
consideration should be allocated among the separate units of accounting based
on their relative fair values. The Issue also supersedes certain guidance set
forth in Staff Accounting Bulletin No. 101 (SAB 101), 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 intend to adopt this new pronouncement effective July 1, 2003. We
are currently evaluating the impact of this interpretation but do not expect
adoption to have a material impact on our results of operations, financial
position or cash flows.

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In January 2003, the Financial Accounting Standards Board (FASB) issued
Interpretation No. 46 Consolidation of Variable Interest Entities, an
Interpretation of ARB No. 51 (FIN 46). FIN 46 requires certain variable
interest entities to be consolidated by the primary beneficiary of the entity
if the equity investors in the entity do not have the characteristics of a
controlling financial interest or do not have sufficient equity at risk for the
entity to finance its activities without additional subordinated financial
support from other parties. FIN 46 is effective for all new variable interest
entities created or acquired after January 31, 2003. For variable interest
entities created or acquired prior to February 1, 2003, the provisions of FIN
46 must be applied for the first interim or annual period beginning after June
15, 2003. Management does not anticipate that this new interpretation will
have a material effect on our results of operations or financial position.

Effective January 1, 2003, we adopted Statement of Financial Accounting
Standards (SFAS) No. 146, Accounting for Costs Associated with Exit or
Disposal Activities, which addresses financial accounting and reporting for
costs associated with exit or disposal activities and nullifies Emerging Issues
Task Force Issue (EITF) No. 94-3, Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (including Certain
Costs Incurred in a Restructuring). The principal difference between SFAS No.
146 and EITF No. 94-3 relates to SFAS No. 146s requirements for recognition of
a liability for a cost associated with an exit or disposal activity. SFAS No.
146 requires that a liability for a cost associated with an exit or disposal
activity be recognized when the liability is incurred. Under EITF 94-3, a
liability for an exit cost as generally defined in EITF 94-3 was recognized at
the date of an entitys commitment to an exit plan. There was not impact to our
results of operations or financial position as a result of the adoption of this
statement.

3.       WHOLESALE SERVICES

In February 2003, we executed an agreement for the resale of local
wireline telecommunications services and provision of ancillary services with
Sprint Communications Company L.P. (Sprint). Under this agreement, we will
provide Sprint access to our web-integrated enhanced communications platform
and operational support systems. This contract includes various per minute,
per line, and other charges that are being recorded as revenue as earned. We
are the primary obligor for expenses under the agreement and therefore, are
recording revenues using a gross presentation, consistent with the method used
for our agreement with MCI. This method results in all per line, per minute
and direct costs reimbursement to be recorded as revenues and the corresponding
expenses to be recorded in the appropriate operating expense line. As a result
of this treatment, it is important to understand that the direct cost
reimbursement has a zero net impact on net income as the amount is recorded in
both revenue and expense. It is also important to note that a decrease in
revenues related to direct costs reimbursement would not have a negative impact
on our statement of operations. This agreement is non-exclusive in nature.

We are deferring $1.0 million of revenues for pre-contract payments by
recognizing this amount ratably over the life of the agreement. Additionally,
we received a $1.0 million payment that could potentially be returned to Sprint
as a bill credit, over several months, as a stimulus for the achievement of
reaching certain line-count thresholds. The stimulus payment would be
recorded as revenue only if Sprint does not achieve the required line
thresholds upon termination of the contract. As of March 31, 2003, we have
recorded the $1.0 million stimulus payment as deferred revenue.

As of
March 31, 2003, under our contract with Sprint, we had approximately
$3.4 million of deferred revenue, of which $2.4 million is long-term deferred
revenue.

On November 1, 2002 we significantly amended the terms or our agreement
with MCI. This amendment was made as a result of MCIs bankruptcy filing on
July 21, 2002. The significant financial changes in this amendment are the
elimination of the $50 million limited-term technology license fee, increases
to various fees calculated on a per minute and per line basis, certain
additional fees for services provided, elimination of exclusivity clauses, a
reduction to the monthly minimum payments and forgiveness of certain amounts to
be repaid to MCI. Amounts received in advance of revenues being earned are now
being amortized through December 31, 2004, the amended termination date of the
agreement. The amended agreement is cancelable by MCI without cause on or after
April 1, 2002, given at least 90 days written notice to us.

As of March 31, 2003, under our contract with MCI, we had recorded
approximately $12.3 million in deferred revenue, of which $5.0 million is
long-term deferred revenue. We will recognize the entire amount of unamortized
deferred revenue in the period that the contract is terminated. Additionally,
we are in discussions to possibly further amend the contract to shorten the
term through the remainder of 2003, which would accelerate the recognition of
revenue from our current amortization period.

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
under substantially similar terms in July 2002. The current agreement expires
in July 2004. The purchase of the receivables is at the option of RFC and they
utilize selection

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criteria to determine which receivables will be purchased.
We sold receivables to RFC at a 28% discount from inception of the agreement
through March 2002. Since March of 2002 we have sold our receivables at a
discount rate of 19%; this rate is negotiable and may change according to
collection experience. The collection percentage for receivables sold to RFC
has been approximately 91.5% 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 have sold approximately $21.6 and $37.6 million of receivables to RFC,
for net proceeds of approximately $17.1 and $28.1 million, during the three
months ended March 31, 2003 and 2002, respectively. A net receivable servicing
asset of approximately $1.9 million is included in our accounts receivable
balance at March 31, 2003. We recorded costs related to the agreement of
approximately $0.2 and $0.3 million for the three months ended March 31, 2003
and 2002, respectively. Included in accounts payable and accrued liabilities
are advances for unbilled receivables in the amount of $2.3 million at March
31, 2003. We are responsible for the continued servicing of the receivables
sold.

5.       INTANGIBLE ASSETS

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

March 31, 2003Carrying
    
    Accumulated
    
    Net IntangibleAmount
    
    Amortization
    
    AssetsIntangible assets subject to amortization:Customer related intangible assets
    
    $
    9,145
    
    
    $
    5,486
    
    
    $
    3,659


The following table presents current and expected amortization expense of
the existing intangible assets for the three months ended March 31, 2003 and
for each of the following periods:

Aggregate amortization expense:For the three months ended March 31, 2002
    
    $
    457Expected amortization expense for the remainder of 2003
    
    
    1,372Expected amortization expense for the years ending
December 31,2004
    
    
    1,8292005
    
    
    458


We did
not record any impairments for the three months ended March 31,
2003.

6.       PLAN TO REPURCHASE COMMON SOCK

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

7.       RELATED PARTY

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

8.       COMMITMENTS AND CONTINGENCIES

We have disputed billings, access and transport charges from certain
inter-exchange carriers (IXCs) and incumbent local exchange carriers
(ILECs). We contend that the invoicing and billings of these particular
access charges were not in accordance with the interconnection, service level,
or tariff agreements entered between us and certain IXCs and ILECs. We have not
paid a portion of these disputed amounts and management believes that we will
prevail in these disputes. At March 31, 2003, the disputed amounts not recorded
in the financial statements were approximately $22.3 million.

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For the customers of our wholesale clients provisioned using our company
code, we are the customer of record for the regional bell operating companies
wholesale billing. It is very likely that the state commissions would require
us to continue providing services to wholesale customers for at least a 90-day
period, regardless of whether our wholesale customers continue in their
respective relationships with their customers.

9.       RESTRUCTURING CHARGES

In April of 2002, we approved and implemented a restructuring to enhance
our future cash flows and operating earnings. The restructuring included a
reduction of force coupled with the closure of our North Dakota call centers
and our New York sales office. In accordance with EITF 94-3, 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 employee termination expenses, lease
abandonment 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
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
    
    LeaseTermination
    
    Settlement
    
    AbandonmentBenefits
    
    Costs
    
    Costs
    
    TotalBalance at January 1, 2002
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    Plan Charges
    
    
    913
    
    
    
    325
    
    
    
    623
    
    
    
    1,861Cash paid
    
    
    (913
    )
    
    
    (325
    )
    
    
    (72
    )
    
    
    (1,310
    )Balance at December 31, 2002
    
    
    
    
    
    
    
    
    
    
    551
    
    
    
    551Cash paid
    
    
    
    
    
    
    
    
    
    
    (49
    )
    
    
    (49
    )Balance at March 31, 2003
    
    $
    
    
    
    $
    
    
    
    $
    502
    
    
    $
    502


10.       STOCK-BASED COMPENSATION

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

Had compensation cost for our stock options granted been determined based
on the fair value at the date of grant, consistent with the provisions of SFAS
No. 123, our net loss and loss per share of common, would have been increased
to the pro forma amounts shown below.

In accordance
with SFAS No. 148 Accounting for Stock-Based Compensation -
Transition and Disclosure, an Amendment of SFAS 123, Accounting for
Stock-Based Compensation, we present the following disclosures:

Three Months EndedMarch 31,2003
    
    2002Net LossAs presented
    
    $
    (7,388
    )
    
    $
    (14,525
    )As adjusted
    
    
    (10,548
    )
    
    
    (18,243
    )Basic and Diluted Net Loss
Per Common ShareAs presented
    
    $
    (0.21
    )
    
    $
    (0.42
    )As adjusted
    
    
    (0.30
    )
    
    
    (0.53
    )


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These adjusted amounts were determined using the Black-Scholes valuation model
with the following key assumptions:

Three Months EndedMarch 31,2003
    
    2002Discount rate
    
    
    2.8
    %
    
    
    3.1
    %Volatility
    
    
    98.5
    %
    
    
    92.6
    %Average Option Expected Life
    
    5 years
    
    5 years


There have been no options that have expired and no payment of dividends on
common stock since our inception.

11.       COMPUTATION OF NET LOSS PER SHARE

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

Net loss per share is calculated as follows:

Three Months EndedMarch 31,2003
    
    2002Basic and diluted net loss per share:Net loss
    
    $
    (3,105
    )
    
    $
    (10,607
    )Less mandatorily redeemable convertible preferred
stock dividends and accretion
    
    
    (4,237
    )
    
    
    (3,872
    )Less deemed dividend related to beneficial conversion feature
    
    
    (46
    )
    
    
    (46
    )Net loss attributable to common stockholders
    
    $
    (7,388
    )
    
    $
    (14,525
    )Weighted average common shares outstanding
    
    
    35,268,253
    
    
    
    34,307,194Basic and diluted net loss per share
    
    $
    (0.21
    )
    
    $
    (0.42
    )


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:

March 31,2003Unexercised stock options
    
    
    12,530,738Unexercised warrants
    
    
    8,153,907Mandatorily redeemable preferred stock
convertible into common shares
    
    
    28,465,218Total potentially dilutive shares of common
stock equivalents
    
    
    49,149,863


12.       LEGAL AND REGULATORY PROCEEDINGS

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



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 had received
additional, excessive and undisclosed commissions from, and 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 intend to
vigorously defend against this lawsuit. Furthermore, we believe we are entitled
to indemnification from our underwriters.

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 plummeted 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. We believe the lawsuit is without merit
and intend to vigorously oppose the allegations.

On August 6, 2002, we filed a complaint against Southwestern Bell
Telephone Company (SWBT) before the Public Utility Commission of Texas
(PUCT), requesting that the PUCT enjoin SWBT from disconnecting our access to
customers in Texas on the basis of a billing dispute between the parties. The
billing dispute centered on whether we owed SWBT certain amounts for
alternatively billed service from SWBT retail customers to our retail
customers. On August 23, 2002, the PUCT issued, in part, the injunctive relief
requested by us, making clear that service not be interrupted. Since that
injunction, we and SWBT have been involved in a dispute resolution process over
these and other billing disputes between SWBT and affiliates. There is no
assurance that these and other disputes with SWBT and affiliates will be
resolved without resort to further litigation and potential disruption to
service.

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

13.       SEGMENT REPORTING

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

The retail services segment includes our Z-LineHOME and Z-LineBUSINESS
services that offer 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. This segment also includes our Touch 1 residential
long-distance offering that is available nationwide.

The wholesale services segment allows other telephone companies to offer
telephone exchange and enhanced services to residential and small business
customers. This service is currently available in 47 states, Sprint and MCI are
the primary customers for this offering.

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

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The following summarizes the financial information concerning our
reportable segments:

Three Months ended March 31, 2003
    
    Three Months ended March 31, 2002Retail
    
    Wholesale
    
    
    
    
    
    Retail
    
    WholesaleServices
    
    Services
    
    Consolidated
    
    Services
    
    Services
    
    ConsolidatedRevenues
    
    $
    47,315
    
    
    $
    12,961
    
    
    $
    60,276
    
    
    $
    57,269
    
    
    $
    
    
    
    $
    57,269Operating income (loss)
    
    
    (9,866
    )
    
    
    6,586
    
    
    
    (3,280
    )
    
    
    (10,154
    )
    
    
    
    
    
    
    (10,154
    )Depreciation and amortization
    
    
    5,418
    
    
    
    609
    
    
    
    6,027
    
    
    
    5,579
    
    
    
    
    
    
    
    5,579Capital expenditures
    
    
    2,865
    
    
    
    263
    
    
    
    3,128
    
    
    
    5,475
    
    
    
    
    
    
    
    5,475Identifiable assets
    
    
    11,420
    
    
    
    94,985
    
    
    
    106,405
    
    
    
    106,711
    
    
    
    
    
    
    
    106,711


The following table reconciles segment information to the consolidated
financial statements:

Three Months Ended March 31,
2002Reconciliation of Operating loss:Consolidated segment operating loss
    
    $
    (10,154
    )Wholesale
development costs
    
    
    (1,018
    )Total consolidated operating loss
    
    $
    (11,172
    )





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

You should read the following discussion together with the consolidated
financial statements and related notes and other sections of this Quarterly
Report on Form 10-Q. This discussion contains forward-looking statements that
involve risks and uncertainties. Our actual results may differ materially from
those projected in the forward-looking statements as a result of various other
factors. Factors that may affect our results of operations include, but are not
limited to, our limited operating history and cumulative losses, uncertainty of
customer demand, rapid expansion, potential software failures and errors,
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. The nature of our business is evolving, and we have a limited
operating history.

We began providing our wholesale services during the first quarter of
2002. This service provides other companies with the opportunity 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.

CONSOLIDATED RESULTS OF OPERATIONS

The following is a discussion of significant changes in our results of
operations, which occurred in the three months ended March 31, 2003 compared to
the same period in the prior year. The following table summarizes the
approximate changes in selected operating items and include dollar changes,
percentage changes and percentage of revenues to facilitate our discussions
that follow.

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For the three months ended
    
    Amount
    
    PercentageMarch 31,
    
    Change
    
    Change
    
    Percentage of RevenuesFavorable
    
    Favorable2003
    
    2002
    
    (Unfavorable)
    
    (Unfavorable)
    
    2003
    
    2002(In Millions)Results of Operations:Revenues
    
    $
    60.3
    
    
    $
    57.3
    
    
    $
    3.0
    
    
    
    5.2
    %
    
    
    100.0
    %
    
    
    100.0
    %Operating expenses:Network operations
    
    
    26.1
    
    
    
    27.2
    
    
    
    1.1
    
    
    
    4.0
    %
    
    
    43.3
    %
    
    
    47.5
    %Sales and marketing
    
    
    4.5
    
    
    
    4.8
    
    
    
    0.3
    
    
    
    6.3
    %
    
    
    7.5
    %
    
    
    8.4
    %General and administrative
    
    
    26.9
    
    
    
    29.8
    
    
    
    2.9
    
    
    
    9.7
    %
    
    
    44.6
    %
    
    
    52.0
    %Wholesale development costs
    
    
    
    
    
    
    1.0
    
    
    
    1.0
    
    
    
    
    %
    
    
    
    %
    
    
    1.7
    %Depreciation and amortization
    
    
    6.0
    
    
    
    5.6
    
    
    
    (0.4
    )
    
    
    (7.1)
    %
    
    
    10.0
    %
    
    
    9.8
    %Total operating expenses
    
    
    63.5
    
    
    
    68.4
    
    
    
    4.9
    
    
    
    7.2
    %
    
    
    105.3
    %
    
    
    119.4
    %Operating loss
    
    
    (3.2
    )
    
    
    (11.1
    )
    
    
    7.9
    
    
    
    71.2
    %
    
    
    (5.3)
    %
    
    
    (19.4)
    %Nonoperating income:Interest and other income
    
    
    0.9
    
    
    
    1.2
    
    
    
    (0.3
    )
    
    
    (25.0)
    %
    
    
    1.5
    %
    
    
    2.1
    %Interest and other expense
    
    
    (0.8
    )
    
    
    (0.6
    )
    
    
    (0.2
    )
    
    
    (33.3)
    %
    
    
    (1.3)
    %
    
    
    (1.0)
    %Total nonoperating income
    
    
    0.1
    
    
    
    0.6
    
    
    
    (0.5
    )
    
    
    (83.3)
    %
    
    
    0.2
    %
    
    
    1.1
    %Net loss
    
    
    (3.1
    )
    
    
    (10.5
    )
    
    
    7.4
    
    
    
    70.5
    %
    
    
    (5.0)
    %
    
    
    (18.3)
    %Less mandatorily redeemable convertible
preferred stock dividends and accretion
    
    
    (4.2
    )
    
    
    (3.9
    )
    
    
    (0.3
    )
    
    
    (7.7)
    %
    
    
    (7.0)
    %
    
    
    (6.8)
    %Less deemed dividend related to beneficial
conversion feature
    
    
    (0.1
    )
    
    
    (0.1
    )
    
    
    
    
    
    
    
    %
    
    
    (0.2)
    %
    
    
    (0.2)
    %Net loss attributable to common stockholders
    
    $
    (7.4
    )
    
    $
    (14.5
    )
    
    $
    7.1
    
    
    
    49.0
    %
    
    
    (12.2)
    %
    
    
    (25.3)
    %EBITDA
    
    $
    2.8
    
    
    $
    (5.5
    )
    
    $
    8.3
    
    
    
    150.9
    %
    
    
    4.6
    %
    
    
    (9.6)
    %Cash Flow Data:Net cash provide by operating activities
    
    $
    5.1
    
    
    $
    1.1
    
    
    $
    4.0
    
    
    
    (363.6)
    %
    
    
    *
    
    
    
    *Net cash used in investing activities
    
    
    (3.1
    )
    
    
    (5.5
    )
    
    
    2.4
    
    
    
    (43.6)
    %
    
    
    *
    
    
    
    *Net cash used in financing activities
    
    
    (1.0
    )
    
    
    (1.6
    )
    
    
    0.6
    
    
    
    (37.5)
    %
    
    
    *
    
    
    
    *Net increase (decrease) in cash and cash equivalents
    
    $
    1.0
    
    
    $
    (6.0
    )
    
    $
    7.0
    
    
    
    116.7
    %
    
    
    *
    
    
    
    *


* Not meaningful

Revenues.Revenues increased by $3.0 million to $60.3 million for the
three months ended March 31, 2003, compared to $57.3 million the prior year.
The increase was primarily attributable to our wholesale services, which
contributed revenues of $13.0 million in 2003 compared to zero for the same
period in the prior year. This was primarily the result of our existing
wholesale services contract with MCI and our new contract with Sprint. The
revenue from our Z-LineHOME and Z-LineBUSINESS (Z-Line) lines decreased by
$8.8 million to $44.3 million for 2003, compared to $53.1 million the prior
year. Additionally, the decrease in Touch 1 (1+) long distance lines in
service contributed an additional decrease of $1.2 million to our 2003
revenues.

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##### Table of Contents



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

For the Three Months Ended March 31,Type of Revenues
    
    2003
    
    2002Z-Line
    
    $
    44.3
    
    
    $
    53.1Touch 1 (1+) Long
Distance Services
    
    
    3.0
    
    
    
    4.2Wholesale Services
    
    
    13.0
    
    
    
    -0-Total
    
    $
    60.3
    
    
    $
    57.3


Our Z-Line accounts made up 73.5% of our total revenues in the first
quarter of 2003, compared to 92.7% the prior year. These offerings are
currently available in 47 states. We expect Z-Line revenue to continue to
increase as a percentage of total retail revenues, relative to our Touch 1 (1+)
Long Distance Services, but decrease as an overall percentage of total revenues
as we expect growth in our wholesale service business.

Network Operations.Network operations expense decreased by $1.1 million
to $26.1 million for the three months ended March 31, 2003, compared to $27.2
million the prior year. Our network costs as a percentage of revenues,
decreased to 43.3% for the three months ended March 31, 2003 compared to 47.5%
in the prior year. Our network operations expense primarily consists of fixed
and variable transmission expenses for interconnection agreements with ILECs,
service level agreements with IXCs, and transmission services based on tariffed
arrangements. The decrease in network operation expenses was primarily the
result of having an overall lower average number of subscribers in service for
the three months ended March 31, 2003 compared to the prior year.

Sales and Marketing.Sales and marketing expense decreased $0.3 million to
$4.5 million for the three months ended March 31, 2003, compared to $4.8
million the prior year. The sales and marketing expense primarily consists of
telemarketing, direct mail, brand awareness advertising, independent sales
contractors commissions, salaries and benefits paid to employees engaged in
sales and marketing activities.

Although sales and marketing costs were nearly flat, there was a decrease
of $1.8 million primarily attributable to the savings from the closing of our
telemarketing centers in the second quarter of 2002. The first quarter of 2002
includes this cost compared to no expenses in 2003 for telemarketing centers.
These savings were offset by a $2.7 million increase to one-time and recurring
commissions paid to independent sales contractors during the first quarter of
2003. These contractors were primarily responsible for the 41,000 line
increase to our Z-Lines during the first quarter of 2003. The remaining
decrease of $1.0 million was the result of less direct mail, billboard and
other advertising costs during 2003 compared to 2002. During the first
quarter of 2003, we continued our primary focus toward line growth and began a
multi-faceted marketing campaign in Atlanta, Georgia that combined radio,
billboard, and television advertising to launch our new service offering,
Personal Voice Assistant (PVA). In addition to our marketing campaign we
also contracted with several independent sales contractors during the latter
half of 2002 that largely contributed to our line growth for the first quarter
of 2003. We are also planning to increase our focus on growing our
Z-LineBUSINESS service offering during 2003. Up until recently we have focused
our sales and marketing efforts on residential customers only.

We expect to continue to focus our sales and marketing efforts to maintain
acceptable acquisition costs per subscriber. We expect to increase our
advertising levels, grow our independent sales contractors sales force, market
new services and increase our partnering opportunities throughout 2003. 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
increase during 2003, over that experienced during 2002, as we use our expected
increase in cash flow from our retail and wholesale business to fund sales and
marketing efforts in additional metropolitan areas, including our recent
expansion into Indianapolis, IN and Nashville, TN, and to attract more small
business customers.

General and Administrative.General and administrative expense decreased
$2.9 million to $26.9 million for the three months ended March 31, 2003,
compared to $29.8 million the prior year. General and administrative expense
primarily consists of employee salaries and benefits, temporary services, bad
debt expense, billing and collection costs, occupancy costs, and provisioning
costs.

The decrease in general and administrative expense was primarily
attributed to a $4.9 million decrease in bad debt expense. This improvement
was off set by a $1.1 million increase to payroll with the remaining increases
being spread between head-count related and several other general and
administrative expenses. General and administrative expense, as a percentage
of total revenue, improved to 44.6% for the three months ended March 31, 2003
compared to 51.1% in the prior year. We anticipate general and administrative
expenditures will continue to increase in the future to support our expanding
service offerings and our expected increase in retail and wholesale lines
during 2003. We will continue to evaluate our operations for efficiencies and
our employee staffing requirements as they relate to increased efficiencies or
needs to expand or outsource. We expect to continue reductions to our general
and administrative expense as a percentage of revenues in 2003. This reduction
is necessary for our achievement of profitability and the continued generation
of positive cash flow.

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##### Table of Contents



Wholesale development costs.Wholesale development costs were $1.0 million
in 2002. We incurred these costs, related to the initiation of our wholesale
services offerings, during the first quarter of 2002.

Depreciation and Amortization.Depreciation and amortization expense
increased $0.4 million to $6.0 million for the three months ended March 31,
2003, compared to $5.6 million the prior year. The slight increase in
depreciation and amortization is primarily a result of increased capital
expenditures during the last two years. We anticipate a flat to slightly
increased depreciation and amortization expense during 2003 depending on our
requirements to purchase additional computer equipment, switching equipment,
furniture and leasehold improvements as a result of our retail line growth, the
line growth of our wholesale services clients or the introduction of new
services.

Interest and Other Income.Interest and other income decreased $0.2
million to $1.0 million for the three months ended March 31, 2003, compared to
$1.2 million the prior year. Interest and other income consists of interest
charged to our Z-Line customers for not paying their bills on-time and income
from interest earned from our cash balance. The decrease for 2003 was primarily
due to our having fewer average customers in service during the first quarter
of 2003 compared to the prior year and our improved subscriber management
activities.

Interest and Other Expense.Interest and other expense decreased $0.3
million to $0.9 million for the three months ended March 31, 2003, compared to
$0.6 million the prior year. Our interest expense is a result of late fees for
vendor payments, charges related to our RFC Capital Corporation (RFC)
accounts receivable agreement, capital leases and our debt obligations. The
overall decrease in interest expense is a result of increased liquidity that
has allowed us to make more timely payments of our network costs while
simultaneously reducing our reliance on our RFC accounts receivable agreement.
We also have less outstanding term debt obligations, which has contributed to
lower interest payments. We anticipate that interest expense will decrease in
the near future as we continue to reduce our debt obligations and improve our
cash flow. This decrease may be offset to the extent that we are able to
borrow money to support growth through new funding sources and to finance any
significant capital expenditures necessary to grow our business during 2003. We
expect the continued utilization of our RFC accounts receivable agreement
during 2003.

Income Tax Benefit.No provision for federal or state income taxes has
been recorded due to the full valuation allowance recorded against the deferred
tax asset for the three months ended March 31, 2003 and 2002.

Net Loss.Our net loss improved $7.4 million to a loss of $3.1 million for
the three months ended March 31, 2003, compared to $10.5 million the prior
year.

Net Loss Attributable to Common Stockholders.Our net loss attributable to
common stockholders improved $7.1 million to a loss of $7.4 million for the
three months ended March 31, 2003, compared to $14.5 million the prior year.
This decrease was primarily discussed above, however, the decrease was offset
by an increase of $0.3 million for the dividends and accretion of the preferred
stock in 2003.

EBITDA.Many securities analysts use the measure of earnings before
deducting interest, income taxes, depreciation and amortization, also commonly
referred to as EBITDA, as a way of evaluating financial performance. EBITDA
is not a measure under GAAP, is not meant to be a replacement for GAAP and
should not be considered an alternative to net income as a measure of
performance. We have included EBITDA data because it is a measure commonly used
in the telecommunications industry and is presented to assist in understanding
our operating results. Our EBITDA improved by $8.3 million to positive $2.8
million for the three months ended March 31, 2003, compared to negative $5.5
million the prior year. We expect to continue to improve our positive EBITDA
quarter over quarter during 2003. The generation of positive EBITDA is expected
to be driven by increases in subscriber lines, operating efficiencies, and the
contribution of existing and new wholesale services and possibly other new
service offerings.

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

For the three months endedMarch 31,2003
    
    2002Net loss
    
    $
    (3,105
    )
    
    $
    (10,607
    )Nonoperating income
    
    
    (175
    )
    
    
    (565
    )Depreciation and amortization
    
    
    6,027
    
    
    
    5,579EBITDA
    
    $
    2,747
    
    
    $
    (5,593
    )


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RESULTS OF OPERATIONS BY SEGMENT

Management evaluates the performance of each 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 their nonrecurring or
nonoperational nature. We have broken these special items out at the bottom of
this table 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, in millions, present our reportable segments. These
tables will facilitate our discussion of our
results by segment. It is important to understand that we only record direct
expenses in our wholesale services segment, therefore, all employee benefits,
occupancy, insurance, and other indirect or overhead related expenses are
reflected in the retail services segment. We are in the process of reviewing
and possibly adopting a methodology for internal reporting purposes that would
allocate these indirect and overhead related expenses to the respective units
or possibly separating these expenses from our future segment analysis.

Three Months Ended March 31, 2003
    
    Three Months Ended March 31, 2002Retail
    
    Wholesale
    
    Consolidated
    
    Retail
    
    Wholesale
    
    ConsolidatedServices
    
    Services
    
    Results
    
    Services
    
    Services (1)
    
    ResultsRevenues
    
    $
    47.3
    
    
    $
    13.0
    
    
    $
    60.3
    
    
    $
    57.3
    
    
    $
    
    
    
    $
    57.3Operating expenses:Network operations
    
    
    22.0
    
    
    
    4.1
    
    
    
    26.1
    
    
    
    27.2
    
    
    
    
    
    
    
    27.2Sales and marketing
    
    
    4.5
    
    
    
    
    
    
    
    4.5
    
    
    
    4.8
    
    
    
    
    
    
    
    4.8General and administrative
    
    
    25.3
    
    
    
    1.6
    
    
    
    26.9
    
    
    
    29.9
    
    
    
    
    
    
    
    29.9Depreciation and amortization
    
    
    5.4
    
    
    
    0.6
    
    
    
    6.0
    
    
    
    5.6
    
    
    
    
    
    
    
    5.6Total operating expenses
    
    
    57.2
    
    
    
    6.3
    
    
    
    63.5
    
    
    
    67.5
    
    
    
    
    
    
    
    67.5Segment results
    
    $
    (9.9
    )
    
    $
    6.7
    
    
    
    (3.2
    )
    
    $
    (10.2
    )
    
    $
    
    
    
    
    (10.2
    )Reconciling Items:Interest and other income
    
    
    
    
    
    
    
    
    
    
    0.9
    
    
    
    
    
    
    
    
    
    
    
    1.2Interest and other expenses
    
    
    
    
    
    
    
    
    
    
    (0.8
    )
    
    
    
    
    
    
    
    
    
    
    (0.6
    )Wholesale development costs
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1.0
    )Net loss
    
    
    
    
    
    
    
    
    
    $
    (3.1
    )
    
    
    
    
    
    
    
    
    
    $
    (10.6
    )




|(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 three months ended March 31, 2003 compared to the prior year.

Retail Services SegmentFor the three months ended
    
    Amount
    
    PercentageMarch 31,
    
    Change
    
    Change
    
    Percentage of RevenuesFavorable
    
    Favorable2003
    
    2002
    
    (Unfavorable)
    
    (Unfavorable)
    
    2003
    
    2002Revenues
    
    $
    47.3
    
    
    $
    57.3
    
    
    $
    (10.0
    )
    
    
    (17.5
    )%
    
    
    100.0
    %
    
    
    100.0
    %Operating expenses:Network operations
    
    
    22.0
    
    
    
    27.2
    
    
    
    5.2
    
    
    
    19.1
    %
    
    
    46.5
    %
    
    
    47.4
    %Sales and marketing
    
    
    4.5
    
    
    
    4.8
    
    
    
    0.3
    
    
    
    6.3
    %
    
    
    9.5
    %
    
    
    8.4
    %General and administrative
    
    
    25.3
    
    
    
    29.8
    
    
    
    4.5
    
    
    
    15.1
    %
    
    
    53.5
    %
    
    
    52.0
    %Depreciation and amortization
    
    
    5.4
    
    
    
    5.6
    
    
    
    0.2
    
    
    
    3.6
    %
    
    
    11.4
    %
    
    
    9.8
    %Total operating expenses
    
    
    57.2
    
    
    
    67.4
    
    
    
    10.2
    
    
    
    15.1
    %
    
    
    120.9
    %
    
    
    117.6
    %Segment results
    
    $
    (9.9
    )
    
    $
    (10.1
    )
    
    $
    0.2
    
    
    
    2.0
    %
    
    
    (20.9
    )%
    
    
    (17.6
    )%


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##### Table of Contents



Revenues.Revenues decreased by $10.0 million to $47.3 million for the
three months ended March 31, 2003, compared to $57.3 million the prior year.
The decrease was primarily attributable to a decline in Z-LineHOME subscriber
lines in service for the first quarter 2003 compared to the prior year. Our
lines in service for the first quarter 2003 increased by 41,000 lines to
244,000 as of March 31, 2003 from 203,000 at December 31, 2002 for average
Z-Lines in service of 223,500. This compared to an increase by 32,000 lines to
286,000 as of March 31, 2002 from 254,000 at December 31, 2001 for average
Z-Lines in service of 270,00. The decrease in Touch 1 (1+) long distance lines
in service contributed an additional decrease of $1.2 million for the three
months ended March 31, 2003, compared to the prior year.

These decreases were the result of focusing our efforts on establishing
and growing our wholesale services, launched in 2002, and improving our
internal processes rather than growing lines for most of 2002. We changed our
primary focus to increasing our line growth for our retail services in the
fourth quarter of 2002 and expect to see increases sequentially to revenues
during 2003. We expect retail service revenues to grow at a slower rate than
our wholesale services revenues, resulting in retail services being a smaller
percentage of total consolidated revenues during 2003 compared to 2002, but
that retail revenue will still represent the majority of total consolidated
revenues during 2003.

Network Operations.Network operations expense decreased by $5.2 million
to $22.0 million for the three months ended March 31, 2003,
compared to $27.2 million the prior year. Our gross margin percentage increased to 53.5% for the
three months ended March 31, 2003, compared to 52.5% in the prior year. Our
network operations expense as a percentage of revenues decreased primarily as a
result of decreases in the unbundled network element platform rates we pay to
lease lines from the ILECs in the states we are operating and more specifically
the rate reduction in New York, our largest market. Other reductions resulted
from improvements we have made to internal operations and processes that
minimize our network operations costs.

Sales and Marketing.Sales and marketing expense increased $0.3 million to
$4.8 million for the three months ended March 31, 2003,
compared to $4.8
million the prior year. Although there was little change in our sales and
marketing expense during the first quarter of 2003 compared to the prior year,
sequentially we have increased our advertising activity and independent sales
contractors programs. We intend to increase our overall marketing activity
during 2003 compared to 2002, in an effort to increase lines in service, but
the extent of our increase will depend on our overall cash flow as we expect to
fund marketing with our increased cash generated from operations.

General and
Administrative.General and administrative expense decreased
$4.5 million to $25.3 million for the three months ended March 31, 2003,
compared to $29.8 million the prior year. As a percentage of revenues general
and administrative expense increased to 53.5% of revenues in 2003 compared to
52.0% in the prior year. The increase was a result of the combined effect of
our reduced retail revenue and increases from the non-direct wholesale service
expenses. The increase to general and administrative expenses was offset
primarily as a result of a $4.9 million decrease in bad debt expense. We
reduced our bad debt expense through improved subscriber management
procedures. Additionally, in the first quarter of 2003 we reversed a reserve
related to a large access customer receivable that made a $2.0 million
payment in April 2003. This resulted in a decrease to our bad debt expense
by $1.4 million for the three months ended March 31, 2003.

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

Depreciation and Amortization.Depreciation and amortization expense
decreased $0.2 million to $5.4 million for the three months ended March 31,
2003, compared to $5.6 million the prior year. The slight decrease in
depreciation and amortization is primarily a result of a small decrease in
purchasing of capital assets over the last two years that are applicable to the
retail segment. We anticipate depreciation to remain relatively flat during
2003, although we are contemplating various options for new services and
innovations to our current services that may require the purchase of additional
hardware and software, that could result in a change to our level of
depreciation expense.

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##### Table of Contents



Wholesale Services Segment

The 2002 wholesale services segment has no results because our wholesale
services did not begin until the second quarter of 2002. The following table,
in millions, provides our wholesale services segment for 2003 compared to 2002
to facilitate our discussion of results for our wholesale services segment:

Wholesale Services SegmentFor the three months ended
    
    Amount
    
    PercentageMarch 31,
    
    Change
    
    Change
    
    Percentage of RevenuesFavorable
    
    Favorable2003
    
    2002
    
    (Unfavorable)
    
    (Unfavorable)
    
    2003
    
    2002Revenues
    
    $
    13.0
    
    
    $
    
    
    
    $
    13.0
    
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    
    %Operating expenses:Network operations
    
    
    4.1
    
    
    
    
    
    
    
    (4.1
    )
    
    
    (100.0
    )%
    
    
    31.6
    %
    
    
    
    %General and administrative
    
    
    1.6
    
    
    
    
    
    
    
    (1.6
    )
    
    
    (100.0
    )%
    
    
    12.3
    %
    
    
    
    %Depreciation and amortization
    
    
    0.6
    
    
    
    
    
    
    
    (0.6
    )
    
    
    (100.0
    )%
    
    
    4.6
    %
    
    
    
    %Total operating expenses
    
    
    6.3
    
    
    
    
    
    
    
    (6.3
    )
    
    
    (100.0
    )%
    
    
    48.5
    %
    
    
    
    %Segment results
    
    $
    6.7
    
    
    $
    
    
    
    $
    6.7
    
    
    
    100.0
    %
    
    
    51.5
    %
    
    
    
    %


Revenues.Revenues were $13.0 million or 21.6% of consolidated revenues
for the three months ended March 31, 2003. We derived $11.2 and $1.6 million
of our revenues from our wholesale contracts with MCI and Sprint, respectively.
We signed our wholesale services agreement with Sprint in February of 2003.
We expect the revenues from MCI to decrease considerably for the remainder of
2003 as MCI is actively migrating customers from our systems. We recognize the
possibility of contract termination, however, we expect that Sprint should make
up for any shortfall in revenues should MCI terminate their contract. In
addition, our business development group is actively pursuing other potential
wholesale partners and working to develop new wholesale services. We expect
wholesale services to become a larger percentage of overall revenues during
2003.

Network Operations.Network operations expense was $4.1 million or 15.7%
of consolidated network operations expense. We expect this expense to vary
depending on each individual wholesale contract. We incur these expenses in
leasing unbundled network elements from the ILECs. We use these elements in
providing our telephone exchange services to our wholesale customers. Certain
wholesale customers may not utilize this service or may only use this service
for a period of time under the contract. Therefore, it is difficult to
anticipate the change to this expense during 2003.

General and Administrative.General and administrative expense was $1.6
million or 5.9% of consolidated segment general and administrative expense for
the three months ended March 31, 2003. The significant components of this
expense mirror our consolidated expenses, however, we only record the direct
expenses associated with our wholesale services. 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.

We expect general and administrative expense to increase in total dollars
and as a percentage of our consolidated expenses. We began to increase
headcount during the first quarter of 2003 to address the expected increase in
wholesale services and we also will begin to outsource certain functions
currently handled internally during the second quarter of 2003 to mange the
anticipated growth of our wholesale services in an effort to limit our cost
exposure. We are receiving pre-prepayments from MCI and have just begun our
wholesale services for Sprint and have not recorded any bad debt for wholesale
services. We will continue to monitor our wholesale services and determine the
appropriate bad debt methodology based on each individual wholesale contract.

Depreciation and Amortization.Depreciation and amortization expense was
$0.6 million or 10.0% of consolidated depreciation and amortization. Although
we do not expect significant increases in our total capital expenditures during
2003 we may have an increase in capital expenditures for our wholesale services
compared to retail services, which would lead to an increased percentage of our
consolidated depreciation expense being attributable to wholesale services. We
are also contemplating new wholesale service offerings and additional clients
that may require additional capital expenditures that would also contribute to
higher depreciation and amortization expense.

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LIQUIDITY AND CAPITAL RESOURCES

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

We have incurred accumulated losses since our inception as a result of
developing our business, research and development, building and maintaining
network infrastructure and technology, sales and promotion of our services, and
administrative expenditures. As of March 31, 2003, we had an accumulated
deficit of $305.9 million and $17.1 million in cash and cash equivalents. We
have funded our expenditures primarily through operating revenues, private
securities offerings, a sale-leaseback credit facility, sales of accounts
receivable and an initial public offering that raised net proceeds of $109.1
million. We intend to continue building our organization in anticipation of
future growth and believe that our operating expenditures will also continue to
increase.

Net cash provided by operating activities improved by $4.0 million to $5.1
million for the three months ended March 31, 2003, compared to $1.1 million the
prior year. The improvement resulted from our overall improvement to net loss
and our overall financial condition.

Included in our net cash operating activities was the sale of $21.6 and
$37.6 million of receivables, for net proceeds of $17.1 and $28.1 million, for
the three months ended March 31, 2003 and 2002, respectively. A net receivable
servicing asset of $1.9 and $14.6 million is included in accounts receivable
and $2.3 and $4.2 million of advances on unbilled receivables are included in
accounts payable and accrued liabilities as of March 31, 2003 and 2002,
respectively. The costs relating to the RFC receivable financing agreement of
$0.2 and $0.3 million is included in interest and other expense for three
months ended March 31, 2003 and 2002, respectively.

Our net cash used in investing activities improved by $2.4 million to $3.1
million for the three months ended March 31, 2003 compared to $5.5 million the
prior year. The improvement was fully attributed to the purchasing of less
property and equipment during 2003. We expect to maintain similar levels of
purchases of property and equipment, but may invest in additional resources if
additional cash is available as a result of our improved operating activities.

Our net cash used in financing activities decreased by $0.6 million to
$1.0 million for the three months ended March 31, 2003 compared to $1.6 million
the prior year. This decrease is primarily a result of receiving the repayment
of $0.5 million from an executive who is also a member of the board of
directors in fulfillment of a note for the issuance of common stock. We expect
to maintain a low amount of long-term debt although if appropriate terms became
available to obtain a more traditional loan we would likely replace our
existing accounts receivable agreement. Our existing debt is
primarily with a related
party, with fixed interest that is payable in monthly installments.

In January 2002, we entered into an agreement with a company that provided
us with software to automate the processing, auditing, dispute tracking,
management reporting and various other functions with respect to our ILEC and
long-distance network costs. In addition to the set-up and implementation
fees, under this agreement, we have committed to minimum cash payments of $0.6
million for 2003. In accordance with the contract we make monthly payments
based on a schedule that correlates to net monthly carrier invoice volume. We
made payments under this agreement totaling $0.2 million for the three months
ended March 31, 2003 and 2002.

On August 6, 2002, we filed a complaint against Southwestern Bell
Telephone Company (SWBT) before the Public Utility Commission of Texas
(PUCT), requesting that the PUCT enjoin SWBT from disconnecting our access to
customers in Texas on the basis of a billing dispute between the parties. The
billing dispute centered on whether we owed SWBT certain amounts for collect
calls from SWBT retail customers to our retail customers. On August 23, 2002,
the PUCT issued, in part, the injunctive relief requested by us, making clear
that service not be interrupted. Since that injunction, we and SWBT have been
involved in a dispute resolution process over these and other billing disputes
between SWBT and affiliates. There is no assurance that these and other
disputes with SWBT and affiliates will be resolved without resorting to further
litigation and potential disruption to service. We believe that it is
reasonably possible that the outcome of this litigation could be between $0.2
and $0.8 million from a cash perspective but will not have a material impact on
our results of operations once settled.

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

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##### Table of Contents



outlined in one of these
contracts for technical reasons, the carrier has not imposed any penalties as
provided under the agreement. We are continuing to work with this carrier and
believe that we are quickly ramping to meet the minimum volume commitments
during 2003 and do not expect any financial penalty to be applied by the
carrier during the course of the agreement.

In February 2003, we executed an agreement for the resale of local
wireline telecommunications services and provision of ancillary services with
Sprint Communications Company L.P. (Sprint). Under this agreement, we will
provide Sprint access to our web-integrated enhanced communications platform
and operational support systems. This contract includes various per minute,
per line, and other charges that are being recorded as revenue as earned. We
are the primary obligor for expenses under the agreement and therefore, are
recording revenues using a gross presentation, consistent with the method used
for our agreement with MCI. This method results in all per line, per minute
and direct costs reimbursement to be recorded as revenues and the corresponding
expenses to be recorded in the appropriate operating expense line. As a result
of this treatment, it is important to understand that the direct cost
reimbursement has a zero net impact on net income as the amount is recorded in
both revenue and expense. It is also important to note that a decrease in
revenues related to direct costs reimbursement would not have a negative impact
on our statement of operations. This agreement is non-exclusive in nature.

We are deferring $1.0 million of revenues for pre-contract payments by
recognizing this amount ratably over the life of the agreement. Additionally,
we received a $1.0 million payment that could potentially be returned to Sprint
as a bill credit, over several months, as a stimulus for the achievement of
reaching certain line-count thresholds. The stimulus payment would be
recorded as revenue only if Sprint does not achieve the required line
thresholds upon termination of the contract. As of March 31, 2003, we have
recorded the $1.0 million stimulus payment as deferred revenue.

As of
March 31, 2003, under our contract with Sprint, we had approximately
$3.4 million of deferred revenue, of which $2.4 million is long-term deferred
revenue.

On November 1, 2002 we significantly amended the terms or our agreement
with MCI. This amendment was made as a result of MCIs bankruptcy filing on
July 21, 2002. The significant financial changes in this amendment are the
elimination of the $50 million limited-term technology license fee, increases
to various fees calculated on a per minute and per line basis, certain
additional fees for services provided, elimination of exclusivity clauses, a
reduction to the monthly minimum payments and forgiveness of certain amounts to
be repaid to MCI. Amounts received in advance of revenues being earned are now
being amortized through December 31, 2004, the amended termination date of the
agreement. The amended agreement is cancelable by MCI without cause on or after
April 1, 2003, given at least 90 days written notice to us.

As of March 31, 2003, under our contract with MCI, we had recorded
approximately $12.3 million in deferred revenue, of which $5.0 million is
long-term deferred revenue. We will recognize the entire amount of unamortized
deferred revenue in the period that the contract is terminated. Additionally,
we are in discussions to possibly further amend the contract to shorten the
term through the remainder of 2003, which would accelerate the recognition of
revenue from our current amortization period.

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 yet purchased any stock under this plan.

Our short-term liquidity relies heavily upon our accounts receivable
agreement, cash provided from operations, cash management strategies, and if
needed, our ability to reduce certain discretionary capital and marketing
expenses costs and growth of our retail and wholesale services. We have
improved our cash flows during the last three quarters to generate positive
cash flows not only from operating activities but an overall increase to total
cash. Our net cash position has improved and we expect this trend to continue
during the course of 2003. We are aware of the risks, discussed throughout
this document, of not achieving our goals and the potential impact thereof on
our liquidity.

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 we have
developed to other companies seeking the capability of offering residential and
small business telecommunication services. As growth and opportunities arise,
we expect to make strategic investments in technology and our network
architecture and enter potential strategic alliances or partnerships with other
entities.

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

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ITEM 3.       QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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

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

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




ITEM 4.       CONTROLS AND PROCEDURES

EVALUATION OF CONTROLS AND PROCEDURES

We maintain disclosure controls and procedures, which we have designed to
ensure that material information related to us, including our consolidated
subsidiaries, is made known to our disclosure committee on a regular basis. In
response to recent legislation and proposed regulations, we reviewed our
internal control structure and our disclosure controls and procedures. Although
we believe our pre-existing disclosure controls and procedures were adequate to
enable us to comply with our disclosure obligations, as a result of such
review, we implemented minor changes, primarily to formalize and document the
procedures already in place. We also established a disclosure committee, which
consists of certain members of our management.

Within 90 days prior to the filing of this report, management carried out
an evaluation, under the supervision of our Chief Executive Officer, D. Gregory
Smith, and Chief Financial Officer, Horace J. Davis, III, of the effectiveness
of the design and operation of the our disclosure controls and procedures.
Based upon that evaluation, Mr. Smith and Mr. Davis concluded that our
disclosure controls and procedures are effective in causing material
information to be recorded, processed, summarized, and reported by our
management on a timely basis and to ensure that the quality and timeliness of
our public disclosures complies with its SEC disclosure obligations.

CHANGES IN CONTROLS AND PROCEDURES

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




PART II




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

The following amendments to our series D, E and G preferred stock allow us
to repurchase common shares without violating restrictive covenants contained
in the preferred designations.

Amendment to Series D Preferred Stock

The Corporations Certificate of Designations, Preferences and Relative
Rights, Qualifications, Limitations and Restrictions, Series D Convertible
Preferred Stock, was amended, effective March 13, 2003, by inserting the
following provision as Section 2(e):

(e)       Notwithstanding anything in this Certificate of
Designation to the contrary, the Corporation may during any twelve
month period redeem, purchase or otherwise acquire for
consideration not more than 1,000,000 shares of the Common Stock.

The foregoing amendment was approved by written consent of holders
representing 3,246,773 of the Series D Preferred shares pursuant to
Section 228 of the Delaware General Corporation Law.

Amendment to Series E Preferred Stock

The Corporations Amended and Restated Certificate of Designation of 8%
Convertible Preferred Stock, Series E, was amended, effective March 13, 2003,
by removing Section 4(b) in its entirety and inserting in lieu thereof the
following:

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(b)       No Redemption. Whenever dividends payable on shares of
Series E Preferred as provided in Section 2(a) are not paid in full
in cash, at such time and thereafter until all unpaid dividends
payable, whether or not declared, on the outstanding shares of
Series E Preferred shall have been paid in full in cash or declared
and set apart in cash for payment, or whenever the Corporation shall
not have converted or exchanged shares of Series E Preferred at a
time required by Section 8 or 10, at such time and thereafter until
all conversion and exchange obligations provided in section 8 or 10
that have come due shall have been satisfied, the Corporation shall
not redeem, purchase or otherwise acquire for consideration any
shares of Junior Stock or Parity Stock; provided, however, that (A)
the Corporation may accept shares of any Senior Stock, Parity Stock
or Junior Stock for conversion into Junior Stock, (B) the
Corporation may at any time redeem, purchase or otherwise acquire
shares of any Parity Stock pursuant to any mandatory redemption,
put, sinking fund or similar obligation contained in such Parity
Stock, pro rata with the Series E Preferred in proportion to the
total amount then required to be applied by the Corporation to
redeem, repurchase, convert, exchange or otherwise acquire shares of
Series E Preferred and shares of such Parity Stock, and (C) the
Corporation may during any twelve month period redeem, purchase or
otherwise acquire for consideration not more than 1,000,000 shares
of the Common Stock.

The foregoing
amendment was approved by written consent of the sole holder
of all of the Series G Preferred shares pursuant to Section 228 of
the Delaware General Corporation Law.

Amendment to Series G Preferred Stock

The Corporations Certificate of Designation of 12% Junior Redeemable
Convertible Preferred Stock, Series G, has was amended, effective March 13,
2003, by removing Section 4(b) in its entirety and inserting in lieu thereof
the following:

(b)       No Redemption. Whenever dividends payable on shares of Series G
Preferred as provided in Section 2(a) are not paid in full in cash (whether or
not such payment is permitted by the terms hereof), at such time and thereafter
until all unpaid dividends payable, whether or not declared, on the outstanding
shares of Series G Preferred shall have been paid in full in cash or declared
and set apart in cash for payment, or whenever the Corporation shall not have
converted or exchanged shares of Series G Preferred at a time required by
Section 8 or 10, at such time and thereafter until all conversion and exchange
obligations provided in section 8 or 10 that have come due shall have been
satisfied, the Corporation shall not redeem, purchase or otherwise acquire for
consideration any shares of Junior Stock or Parity Stock; provided, however,
that (A) the Corporation may accept shares of any Parity Stock or Junior Stock
for conversion into Junior Stock, (B) the Corporation may at any time redeem,
purchase or otherwise acquire shares of any Parity Stock pursuant to any
mandatory redemption, put, sinking fund or similar obligation contained in such
Parity Stock, pro rata with the Series G Preferred in proportion to the total
amount then required to be applied by the Corporation to redeem, repurchase,
convert, exchange or otherwise acquire shares of Series G Preferred and shares
of such Parity Stock and (C) the Corporation may during any twelve month
period.

The foregoing amendment was approved by written consent of holders
representing 173.5 of the Series G Preferred shares pursuant to Section 228 of
the Delaware General Corporation Law.




ITEM 6.       EXHIBITS, AND REPORTS ON FORM 8-K

EXHIBITNUMBER
    
    DESCRIPTION3.1
    
    Amended and Restated Certificate of Incorporation of Z-Tel, as
amended(A)*3.2
    
    Amended and Restated Bylaws of Z-Tel(B)*4.1
    
    Form of Common Stock Certificate(B)*4.2
    
    See Exhibits 3.1 and 3.2 of this report for provisions of the Amended
and Restated Certificate of Incorporation, as amended, and our Bylaws
defining rights of security holders4.3
    
    Stock Purchase Agreement, dated July 6, 2000, by and between us and the
various purchasers of our Series D Convertible Preferred Stock(C)*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(C)* See
amendment at Exhibit 4.20 for the amendment4.5
    
    Form of Registration Rights Agreement by and between us and each of the
purchasers of our Series D Convertible Preferred Stock(C)*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(C)*


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4.7
    
    Stock and Warrant Purchase Agreement, dated October 19, 2000, by and
among us and The 1818 Fund III, L.P.(D)*4.8
    
    Certificate of Designation of 8% Convertible Preferred Stock, Series E,
Setting Forth the Powers, Preferences, Rights, Qualifications,
Limitations and Restrictions of such preferred shares, as amended March
13, 2003(A)* See amendment at Exhibit 4.21. of this report4.9
    
    Registration Rights Agreement between and among us and The 1818 Fund
III, L.P.(D)*4.10
    
    Warrant issued to The 1818 Fund III, L.P. for the purchase of shares of
our common stock(D)*4.11
    
    Certificate of Designation of Series F Junior Participating Preferred
Stock(E)*4.12
    
    Rights Agreement dated as of February 19, 2001 between us and American
Stock Transfer Trust Company, as Rights Agent, as amended July 2,
2001(E)*4.13
    
    Stock and Warrant Purchase Agreement, dated as of July 2, 2001, by and
between us, D. Gregory Smith, and others(F)*4.14
    
    Warrant for the Purchase of Shares of Common Stock of Z-Tel, dated as
of July 2, 2001(G)*4.15
    
    Certificate of Designation for the Series G Preferred Stock, as amended
March 13, 2003(H)* See amendment at Exhibit 4.22. of this report4.16
    
    Backup Purchase Agreement, dated as of July 2, 2001, by and among Z-Tel
Communications, Inc., a Delaware corporation andour wholly owned
subsidiary, Touch 1 Communications, Inc., an Alabama corporation and
our wholly owned subsidiary, D. Gregory Smith and others(I)*4.17
    
    Additional Investor Registration Rights Agreement, dated as of July 2,
2001, between Z-Tel, D. Gregory Smith and others(J)*4.18
    
    Voting Agreement, dated as of June 29, 2001, between us and certain of
our stockholders(K)*4.19
    
    Employee Stock Restriction Agreement, dated September 1, 1999, by and
between us and D. Gregory Smith(L)*4.20
    
    Amendment, effective March 13, 2003, to Certificate of Designations of
the Series D Convertible Preferred Stock4.21
    
    Amendment, effective March 13, 2003, to Certificate of Designation of
the Series E Convertible Preferred Stock4.22
    
    Amendment, effective March 13, 2003, to Certificate of Designation of
the Series G Preferred Stock10.2.1
    
    1998 Equity Participation Plan(B)*10.2.2
    
    2000 Equity Participation Plan(M)*10.3
    
    Employment Agreement of D. Gregory Smith, dated July 30, 2002(N)*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(O)*10.5
    
    Form of Indemnification Agreement for our executive officers and
directors(E)*10.6
    
    Employment Agreement of Ned Dumas Garrett, dated August 14, 2002(N)*10.7
    
    Employment Agreement of J. Bryan Bunting, dated August 14, 2002(N)*10.8
    
    Employment Agreement of Charles W. McDonough, dated August 14, 2002(N)*10.9
    
    Employment Agreement of Robert A. Curtis, dated July 30, 2002(N)*10.10
    
    Promissory Note, dated May 11, 1999, between Touch 1 Communications,
Inc. and Corman Elegre Capital(D)* 10.11Promissory Note, dated
September 10, 1999, from Touch 1 Communications, Inc. and William F.
Corman (First Revocable Trust)(D)*10.12
    
    Promissory Note, dated September 10, 1999, from Touch 1Communications,
Inc. and James F. Corman(D)*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.(P)*99.1
    
    Written Statement of the Chief Executive Officer Pursuant to 18
U.S.C.ss.135099.2
    
    Written Statement of the Chief Financial Officer Pursuant to 18
U.S.C.ss.1350




---

|*   |  |                                                                                                                                                                                                                    
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|(A) |  | 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.                                              
|   
|(B) |  | 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.
|   
|(C) |  | Incorporated by reference to the correspondingly numbered exhibits
to our Quarterly Report on Form 10-Q for the
quarterly period ended June 30, 2000, filed on August 14, 2000.                                    

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|(D) |  | Incorporated by reference to the correspondingly numbered exhibits
to our Quarterly Report on Form 10-Q for the
quarterly period ended September 30, 2000, filed on November 14, 2000.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|(E) |  | Incorporated by reference to the correspondingly numbered exhibits
to our Annual Report on Form 10-K for the annual
period ended December 31, 2000, filed on March 30, 2001.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|   
|(F) |  | 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.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|   
|(G) |  | 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.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|   
|(H) |  | 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.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|   
|(I) |  | 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.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|   
|(J) |  | 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.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|   
|(K) |  | 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.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|   
|(L) |  | 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.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|   
|(M) |  | Incorporated by reference to Appendix B to our Preliminary Proxy
Statement filed on April 14, 2000, with the
following amendment effective May 31, 2001:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|   
|    |  | Section 2.1(a) of the Plan is hereby amended in its entirety to read as
follows:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|   
|    |  | The shares of stock subject to Options, awards of Restricted Stock,
Performance Awards, Dividend Equivalents, awards of Deferred Stock, Stock
Payments or Stock Appreciation Rights shall be Common Stock, initially shares
of the Companys Common Stock, par value $0.01 per share. The aggregate number
of such shares which may be issued upon exercise of such
options or rights or upon any such awards under the Plan shall be Four
Million Five Hundred Thousand (4,500,000) plus an annual increase to be added
on the first day of the Companys fiscal year beginning in 2001 equal to the
lesser of (i) Three Million (3,000,000) shares of the Companys Common Stock,
(ii) 6% of the outstanding shares on such date, or (iii) a lesser amount
determined by the Board. The shares of Common Stock issuable upon exercise of
such options or rights or upon any such awards may be either previously
authorized but unissued shares or treasury shares.
|   
|(N) |  | Incorporated by reference to the correspondingly numbered exhibits to
our Quarterly Report on Form 10-Q for the
quarterly period ended September 30, 2002, filed on November 14, 2002.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|   
|(O) |  | Incorporated by reference to the correspondingly numbered exhibit to our
Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2000,
filed on August 14, 2000, as amended extending the agreement until
July 27, 2004.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|   
|(P) |  | Incorporated by reference to the correspondingly numbered exhibit to our
Quarterly Report on Form 10-Q for the quarterly period ended March 31, filed on
May 15, 2002                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                



|(b) |  | Reports on Form 8-K
|--- |  | -------------------



| |  | On February 12, 2003, we furnished a Form 8-K to disclose the execution of
our wholesale agreement with Sprint.
| |  | ---------------------------------------------------------------------------------------------------------------




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 15th
day of May 2003.

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


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CERTIFICATIONS

I, D. Gregory Smith, certify that

1.           I have reviewed this quarterly report on Form 10-Q of Z-Tel
Technologies, Inc.;

2.           Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact necessary
in order to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period covered by
this quarterly report;

3.           Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;

4.           The registrants other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have

a)       designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this quarterly report is being prepared;

b)       evaluated the effectiveness of the registrants disclosure controls and
procedures as of a date within 90 days prior to the filing of this quarterly
report (the Evaluation Date); and

c)       presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;

5.           The registrants other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrants auditors and the audit
committee of the registrants board of directors (or persons fulfilling the
equivalent function)

a)       all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrants ability to record,
process, summarize, and report financial data and have identified for the
registrants auditors any material weaknesses in internal controls; and

(B)       any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrants internal controls;
and

6.    
       The registrants other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.

Date: May 15, 2003/s/ D. GREGORY SMITHD. Gregory SmithChief Executive Officer


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I, Horace J. Davis, certify that

1.           I have reviewed this quarterly report on Form 10-Q of Z-Tel
Technologies, Inc.;

2.           Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact necessary
in order to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period covered by
this quarterly report;

3.           Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;

4.           The registrants other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have

a)       designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this quarterly report is being prepared;

b)       evaluated the effectiveness of the registrants disclosure controls and
procedures as of a date within 90 days prior to the filing of this quarterly
report (the Evaluation Date); and

c)       presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;

5.           The registrants other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrants auditors and the audit
committee of the registrants board of directors (or persons fulfilling the
equivalent function)

a)       all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrants ability to record,
process, summarize, and report financial data and have identified for the
registrants auditors any material weaknesses in internal controls; and

b)       any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrants internal controls;
and

6.           The registrants other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.

Date:
    
    May 15, 2003/s/ HORACE J. DAVIS IIIHorace J. DavisChief Financial Officer


27