<PAGE>   1
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                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

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

                                   FORM 10-K

                                   (MARK ONE)

        [X]       ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
                      THE SECURITIES EXCHANGE ACT OF 1934
                      FOR THE YEAR ENDED DECEMBER 31, 2000


                                       OR


        [ ]   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       (I.R.S. EMPLOYER)
           INCORPORATION OR ORGANIZATION)     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 [ ]

         Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]

         The aggregate market value of the Registrant's Common Stock held by
non-affiliates of the Registrant on March 23, 2001 (assuming solely for these
purposes that only directors, executive officers and beneficial owners of
greater than 10% of the Registrant's Common Stock are affiliates), based on the
closing price of the Common Stock on the Nasdaq National Market as of such date,
was approximately $83,207,959.

         The number of shares of the Registrant's Common Stock outstanding as
of March 23, 2001 was approximately 33,780,910.

===============================================================================



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                               TABLE OF CONTENTS

PART I.

Item 1.     Business                                                         1

Item 2.     Properties                                                      20

Item 3.     Legal Proceedings                                               21

Item 4.     Submission of Matters to a Vote of
                Security Holders                                            21

PART II.

Item 5.     Market for the Registrant's Common Equity and
                Related Stockholder Matters                                 21

Item 6.     Selected Consolidated Financial Data                            22

Item 7.     Management's Discussion and Analysis of Financial
                Condition and Results of Operations                         24

Item 7A.    Quantitative and Qualitative Disclosures about
               Market Risk                                                  43

Item 8.     Financial Statements and Supplementary Data                    F-1

Item 9.     Changes in and Disagreements with Accountants on
            Accounting and Financial Disclosure                             44

PART III.

Item 10.    Directors and Executive Officers of the
                Registrant                                                  44

Item 11.    Executive Compensation                                          46

Item 12.    Security Ownership of Certain Beneficial Owners
                and Management                                              50

Item 13.    Certain Relationships and Related Transactions                  52

PART IV.

Item 14.    Exhibits, Financial Statement Schedule, and
                Reports on Form 8-K                                         54

Signatures                                                               57-58

<PAGE>   3

                                    PART I

ITEM 1.  BUSINESS

GENERAL

         Z-Tel Technologies, Inc. was incorporated under the laws of Delaware
in 1998. We are a provider of advanced, integrated communications services
primarily to residential customers. We offer local and long distance telephone
services in combination with enhanced communications features accessible
through the telephone, the Internet and certain personal digital assistants.
Through our uniquely designed web interface, our subscribers are able to manage
their communications through the power of the Internet and the visual, "point
and click" functionality of the personal computer. Our services are designed to
make communications easier and more efficient.

         Our business strategy takes advantage of statutory and regulatory
changes that enable us to gain access to the individual components of the
traditional local telephone service provider's (incumbent local exchange
carrier or ILEC) networks, referred to as the unbundled network element
platform. The Federal Communications Commission (the FCC) has mandated that the
incumbent local exchange carriers provide competing local telephone companies
such as us with the unbundled network element platform components at prices
based on a forward-looking, long-run incremental cost methodology. Access to
these components, in combination with our proprietary technology and advanced
communications network, enables us to provide cost-effective local and long
distance telephone services with enhanced features.

         We currently offer our Z-Line Home Edition(TM) service, which is our
primary service offering, in seventeen states in areas served by the Regional
Bell Operating Companies (the Bell operating companies). Within these markets,
we believe that we are one of few competitive local exchange carriers
specifically targeting the needs of residential customers. It is our intent to
expand service into additional states as pricing and implementation rules for
the unbundled network element platform become acceptable for market entry into
those states.

         Our other available service offerings are Touch 1 Long Distance,
Z-Line Anywhere(TM) and Z-Line Messenger(TM). Each of our service offerings
except for Touch 1 Long Distance are built around an enhanced service offering
called Z-Line Features. Z-Line Features includes multiple features that combine
the convenience of the telephone with the power of the Internet. Accessible by
telephone or the Internet, located at www.myzline.com or www.z-tel.com, Z-Line
Features enables our customers to direct, retrieve, deliver, compile and
otherwise manage their voice communications. One of the features offered
through Z-Line Features is the Z-Line Community(TM) feature, which allows us to
provide group messaging features to individual consumers as well as sponsored
communities such as colleges, civic organizations and businesses. We also
intend to offer in the future a bundled service offering that will be sold to
small businesses.

ACQUISITION OF TOUCH 1 COMMUNICATIONS, INC.

         Effective April 14, 2000, we acquired Touch 1 Communications, Inc.
(Touch 1) through merger of Touch 1 into one of our wholly owned subsidiaries.
The purchase price for Touch 1 consisted of 1,100,000 shares of Z-Tel common
stock and approximately $9 million in cash. We accounted for the merger as a
stock purchase, and have treated the merger as having been consummated on April
1, 2000 for accounting purposes.



<PAGE>   4


BANKRUPTCY OF TOUCH 1 AND DIRECTEL, INC.

         Touch 1 and its wholly owned subsidiary, direcTEL, Inc. (direcTEL),
filed voluntary petitions for relief under Chapter 11 of the Bankruptcy Code on
June 29, 1999 and July 9, 1999, respectively, in the United States Bankruptcy
Court for the Southern District of Alabama (the Bankruptcy Court). The
Bankruptcy Court entered an order confirming the joint plan of reorganization
of Touch 1 and direcTEL on August 6, 1999 and entered final decrees closing the
direcTEL case on October 5, 2000 and the Touch 1 case on October 30, 2000.

INDUSTRY BACKGROUND

         The Telecommunications Act of 1996 (the Telecommunications Act) was
passed principally to foster competition in the telecommunications markets. The
Telecommunications Act imposes a variety of duties upon the incumbent local
exchange carriers, including the duty to provide other communications companies
with access to their network elements on an unbundled basis at any feasible
point. Such access must be at rates and on terms and conditions that are just,
reasonable and nondiscriminatory. A network element is a facility or piece of
equipment of the local telephone company's network or the features, functions
or capabilities such facility or equipment provides. The Telecommunications Act
also establishes procedures under which the Bell operating companies will be
allowed to handle long distance calls originating from within their telephone
service area and terminating outside their area. The Bell operating companies
were divested by AT&T in 1984 pursuant to court order under which they were
prohibited from providing "in-region" long distance telephone service. With the
passage of the Telecommunications Act, a Bell operating company can provide
such in-region service if it demonstrates to the FCC and state regulatory
agencies that it has complied with a 14-point regulatory checklist, including
offering interconnection to other communications companies and providing access
to its unbundled network elements on terms approved by a state public service
commission.

         On November 5, 1999, the FCC released an order establishing the list of
unbundled network elements that incumbent local exchange carriers nationwide
must provide. Taken together, these unbundled network elements comprise the
essential facilities, features, functions and capabilities of an incumbent local
exchange carrier's network. Under the FCC's order, the incumbent local exchange
carriers must allow competing local telephone companies such as us to use the
unbundled network elements, in an individual or combined fashion, to provide
basic local telephone service and must price the elements using a
forward-looking, long-run incremental cost methodology. We expect both
individual network components and components in combined component service
packages to be available at attractive prices nationwide as state regulatory
authorities and incumbent local exchange carriers conform to the recent FCC
mandates. Pricing and implementation rules for unbundled network elements in
combined service packages or platform offerings that are at least acceptable for
market entry have been adopted in multiple states. The prices for the use of
individual network components and combined component service packages will
nevertheless vary from state to state, as will an individual state's oversight
of unbundled network element platform implementation and operation in regard to
individual unbundled network elements and elements provided in combinations.

BUSINESS OVERVIEW

         By integrating the simplicity of standard telephone service with the
robust features that our Internet applications deliver, we have created an
environment for managing communications that is accessible by the telephone or
personal computer. That environment includes the following elements:



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         COST-EFFECTIVE BUNDLED LOCAL AND LONG DISTANCE TELEPHONE SERVICE. We
provide a cost-effective bundled package of local and long distance telephone
services, which includes all the enhanced features of Z-Line Features as well
as enhanced telephone services such as call waiting and caller identification,
in markets that have favorable regulatory environments for residential
competition. We have typically leased facilities of the existing incumbent
local exchange carrier on a forward-looking, long-term incremental cost basis,
which enables us to avoid the need to invest significant capital into telephone
plant and equipment. As a result, we are able to provide a competitively
priced, bundled package that includes local and long distance telephone
services and enhanced services without significant up-front expense.

         SCALABLE PLATFORM FOR NEW MARKETS. The unbundling of network elements
allows us to access the incumbent local exchange carriers' facilities to
provision our service to our customers. As a result, we have the ability to
enter new markets quickly, and without a significant investment in equipment, as
regulatory authorities in those markets adopt favorable rules and pricing for
unbundled network elements. Using Z-Line Features, customers can manage and
configure their own enhanced calling features, thus minimizing our need for an
expanded customer service infrastructure.

         SEAMLESS INTEGRATION OF PERSONAL ORGANIZATIONAL TOOLS. The features
available in our Z-Line Features have been designed to allow users to download
their personal directories from a variety of software packages, including
Microsoft Outlook. In addition, directories from other personal contact
managers can be downloaded into Outlook and then downloaded into Z-Line
Features. Once this information has been downloaded, customers can use their
database of contacts to create easily sub-directories for special group
messaging. By utilizing Z-Line Features, customers can, with the click of a
mouse, initiate calls or forward messages to contacts that have been stored in
their personal directories.

         ADVANCED PROPRIETARY TECHNOLOGY. We have created an integrated and
proprietary software and advanced network architecture that enables the
enhanced features of our service. We have created software applications that
can control the basic functions of initiating and completing a telephone call
regardless of the access device, such as a telephone, personal computer or
personal digital assistant. These applications allow our customers to control
simultaneously all the basic functions of a telephone call using such device.
We are also in the process of developing and enhancing our customer care,
billing and provisioning software into one seamlessly integrated package.

         Our network architecture is designed to interconnect our main
enterprise management center in Tampa with the switching architecture of the
incumbent local exchange carrier. This allows us to provide telecommunications
services without the need to collocate network equipment in the central offices
of the incumbent local exchange carrier in our target markets and enhances our
ability to enter new markets quickly and cost effectively. Our network
architecture also is designed to accommodate a number of developing
technologies, such as telephone calls over Internet protocol, digital subscriber
line, asynchronous transfer mode, and coaxial cable systems as these
technologies gain mainstream acceptance.

         ENHANCED COMMUNICATION SERVICES FOR GROUPS AND INDIVIDUAL USERS
NATIONWIDE. We offer our Z-Line Community features to consumers, organizations
and business users nationwide through Z-Line Features, which features may be
accessed from most of our services. Z-Line Features also includes specialized
features for directories and group messaging that provide value to users within
sponsored communities by facilitating communication among dispersed community
members.



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         We continue to pursue Z-Line Home Edition marketing and distribution
in new states as state regulatory authorities adopt favorable pricing,
implementation rules and acceptable operations support systems performance for
the unbundled network element platform components. Favorable implementation
requirements for providing the unbundled network element platform components
were a feature of the SBC Communications, Inc./Ameritech Corporation and the
Bell Atlantic/GTE (Verizon) merger order conditions adopted by the FCC.
Furthermore, Qwest Communications International Inc. (Qwest) and BellSouth
Corporation (BellSouth) have publicly announced the general availability of the
unbundled network element platform components as part of a general effort to
meet FCC requirements. Accordingly, as acceptable pricing and operations
support systems become available, we intend to move toward potential market
entry into Bell operating company territory in each state.



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SERVICES

Z-LINE HOME EDITION

         Z-Line Home Edition is our principal service offering and is currently
being offered, at least on an initial marketing basis, in Alabama, Arizona,
California, Florida, Georgia, Illinois, Kentucky, Louisiana, Maryland,
Massachusetts, Michigan, New York, Oregon, Pennsylvania, Texas, Virginia and
Washington, in most areas served by the Bell operating company operating in
those states. Z-Line Home Edition includes low-priced local and long distance
(1+) residential telephone services using a customer's existing telephone
number, typically bundled with enhanced features, which may include caller
identification, call forwarding, three-way calling, call waiting and speed
calling, remote access to long distance calling through our Z-Line Anywhere
access card service, the full functionality of Z-Line Features and, for an
additional fee, Internet access. We also intend to offer soon to all of our
Z-Line Home Edition subscribers the ability, through our City of America(TM)
program, to make unlimited long distance telephone calls to other Z-Line Home
Edition subscribers for an additional monthly fee.

         We intend to continue to pursue offering Z-Line Home Edition in
additional states as soon as favorable pricing and implementation rules are
adopted in those states. We are also developing other bundled combinations of
our services at varied price points in order to stimulate and expand customer
interest in our services. For example, we have begun to offer in several states
a lower priced version of Z-Line Home Edition that includes fewer bundled long
distance minutes and features. Additional long distance minutes and features
are being offered separately for an additional monthly price.

TOUCH 1 LONG DISTANCE

         Touch 1 Long Distance is a usage-based service that allows customers
to use us as their primary long distance calling provider to complete their
residential long distance (1+) calls. Touch 1 Long Distance is available
nationwide, although we are not actively marketing the service.

Z-LINE ANYWHERE

         Z-Line Anywhere is our access card service that allows a customer to
make long-distance calls using our network from any phone by dialing a
toll-free 800 number or local access number. No change in phone service is
required. Customers of Z-Line Anywhere also receive the full functionality of
Z-Line Features and, for an additional fee, Internet access. Z-Line Anywhere is
available nationwide, although we are not actively marketing the service.

Z-LINE MESSENGER

         Z-Line Messenger is a trial service we offer free of charge to
individuals and groups. Z-Line Messenger customers are limited to sixty minutes
of voice mail per month and cannot use certain enhanced services provided by
Z-Line Features, including the ability to complete a call using the web and the
"Find-Me" functionality. Customers may upgrade their service to Z-Line Anywhere
or Z-Line Home Edition, provided the latter service is offered in their
markets. Z-Line Messenger is available nationwide, although we are not actively
marketing the service.



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KEY FEATURES OF OUR SERVICES

Z-LINE FEATURES

         Z-Line Features is the core feature set of all of our service
offerings except for Touch 1 Long Distance, although only limited functionality
is provided to Z-Line Messenger customers. It is a suite of features
subscribers can access via any telephone, at our web site or, to a limited
extent, a Palm VII(TM) personal digital assistant through our Z-Line
Companion(TM) feature. Subscribers can retrieve, forward, deliver, store,
compile and otherwise manage their voice mail and other communication needs.
Using the "Find-Me" feature, subscribers can have our system attempt to locate
them at up to three numbers when they receive incoming calls, and notify them
via e-mail, pager or ICQ Internet Chat (instant messaging) when a new voice
mail message arrives. At our website, subscribers can view a list of their
voice mail messages and listen to them through their computer speakers, create
an on-line Address Book by inputting information directly or importing it from
other services, place calls with the click of a mouse, deliver voice messages
to groups of other subscribers, forward voicemails and view historical billing
statements. Subscribers also are provided an e-mail address and the ability to
receive faxes by e-mail. Z-Line Features also include functionality, through
our Z-Alerts(TM) feature, that allows subscribers to obtain customized news,
weather and financial information via voicemail, phone, pager and e-mail.

         An additional feature of Z-Line Features is Z-Line Community, which is
a set of features embedded within Z-Line Features that allows users or group
sponsors, such as colleges, civic organizations and businesses, to search for,
create or join "Communities," which are pre-defined groups of our users usually
based on professional or personal affinities. Users can also invite other of
our subscribers to join Communities and administrate the user access options of
a Community. Once the Communities are created, users can send group messages to
specific members of the communities or the entire group.

         We expect to provide additional functionality to Z-Line Features in
the future, including speech recognition capability, conference calling and
the ability to manipulate voicemail and other enhanced services settings from
the user's desktop.

MARKETING AND DISTRIBUTION

         We market our services to our customers through telemarketing, agent
programs, strategic business partnerships, direct mail and marketing and
traditional advertising campaigns promoting recognition and awareness of our "Z"
brand. We also have entered into joint marketing or co-branding arrangements
with organizations that have large, well-established relationships or customer
bases in our target markets. We intend to continue to explore the formation of
alliances or ventures with other companies, including Internet service
providers, paging operators, cable television companies, utilities, newspapers,
financial institutions, retailers and credit card companies, which we believe
will allow us to penetrate efficiently large customer bases with a relatively
small capital outlay and to lower customer acquisition costs. We also recently
have introduced an online sales channel and electronic agent program, called
"ztelonline.com," that affords any person the ability to send e-postcards to
prospective Z-Line Home Edition subscribers and earn compensation for those that
open new accounts with us and become active and billable customers.

BILLING AND COLLECTION

         We have three primary methods for billing and collecting from our
customers. For our Z-Line Home Edition customers, we can either (1) charge
their credit card account; (2) mail a bill to their address for payment by
check or money order or in person at certain payment




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locations proximate to the customer; or (3) set up an automatic withdrawal from
the customer's checking account. For our Z-Line Anywhere customers, we
currently require all new customers to pay by credit card or automatic
withdrawal; however, we had, in the past, allowed them to pay bills using all
three methods. Currently, the majority of our customers pay us by check or
money order. Our billing software can be customized to handle new and different
billing programs.

OPERATIONS SUPPORT SYSTEMS AND CUSTOMER SUPPORT

         We have invested substantially in our software platform, which
includes integrated customer ordering and provisioning, customer service and
billing functionality for our services. For our Z-Line Anywhere service, a new
subscriber can enroll via the Internet or our toll free number with service
immediately activated. Z-Line Features allows our Z-Line Home Edition and
Z-Line Anywhere customers to change their enhanced service feature
configurations. A subscriber may also update his or her enhanced service
configurations via the telephone and, to a limited extent, through selected
personal digital assistants.

         Z-Line Home Edition orders require us to interact with the applicable
local exchange carrier. Initially, after receiving a signed letter of
authorization or a verified verbal request for service, we entered orders using
an electronic web-based interface provided by the Bell operating company in
each operating territory. Our provisioning agents also entered the order in the
Z-Tel system.

         Over the last year, we improved our operations support systems to
include electronic gateways to the major incumbent local exchange carriers,
network element management software, and a standard internal provisioning
interface that can handle multiple incumbent local exchange carrier ordering
systems. This investment included outside integration and consulting assistance.
The electronic gateway allows us to reduce the number of steps, and therefore
the cost, required to provision a customer and increase the accuracy of our
provisioning process. We now have electronic gateways operational in Alabama,
California, Florida, Georgia, Illinois, Kentucky, Louisiana, Maryland,
Massachusetts, Michigan, Mississippi, New York, Pennsylvania and Texas, and are
testing the gateway in regions served by BellSouth and Quest.

INTELLECTUAL PROPERTY AND PROPRIETARY RIGHTS

         We have developed proprietary software that manages the integrated
features of our service offerings. Our software allows our network to interface
and interconnect with the systems of the incumbent local exchange carriers and
long-distance carriers. During the period covered by this report, we have
largely centralized our remote network communication facilities, which we call
"Z-Nodes," in our enterprise management center in Tampa, Florida, which
provides us the ability to maximize the productivity of and most effectively
manage the platform.

         We have entered into, and will continue to enter into, nondisclosure
agreements with our employees, independent contractors, business customers and
others. We believe these agreements will protect our confidential and
proprietary information, whether or not such information is copyrighted or
subject to trademark or patent protection. We intend to take all appropriate
legal action to protect our ownership and the confidentiality of all our
proprietary software, including, as appropriate, the filing of copyrights in
the U.S. Copyright Office.

         Our intellectual property reflects the know-how, work product and
inventions of our research and development team, based at our technology center
in Atlanta, Georgia, who have substantial experience in computer technology,


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telecommunications, web-based services, database management and integration,
and network development, architecture, operation and management.

         For the fiscal years ended December 31, 2000, 1999 and 1998, we
invested approximately $11,361,000, $8,356,000 and $4,728,000, respectively, in
company-sponsored research and development activities.

         We have filed trademark applications for federal registration of more
than fifty trademarks with the United States Patent and Trademark Office,
including Z-TEL TECHNOLOGIES, INC., Z-LINE HOME EDITION, Z-LINE ANYWHERE, CITY
OF AMERICA, Z-LINE COMPANION, Z-NODE, Z-LINE, Z-NOTIFY, Z-SITE, Z-TEL AND
DESIGN, Z-MAILBOX, Z-DIRECTORY, Z-NOW!, Z-NUMBER, Z-BILL PAYMENT SERVICES,
Z-NET, GENERATION Z, MYZLINE and YOUR PERSONAL TELECOMMUNICATIONS PORTAL. We
have received federal registration of the following trademarks: WEBDIAL, CLICK
& LISTEN, Z-TEL, YOUR PERSONAL COMMUNICATIONS CENTER, Z-TEL COMMUNICATIONS,
INC. AND DESIGN.


COMPETITION

OVERVIEW

         The telecommunications industry is highly competitive in many market
segments. However, at present, we believe few telecommunications carriers
provide the type of bundled packages that include the range of services and
features we offer, but various competitors offer one or more of the services
that make up our service offerings. Competition in the local telephone services
market is still emerging, but already has attracted many strong competitors.
Competition in the long distance and information services markets, which have
fewer entry barriers, is already intense and is expected to remain so.

         We believe the principal competitive factors affecting our business
will be the quality and reliability of our services, innovation, customer
service and price. Our ability to compete effectively will depend upon our
continued ability to offer innovative, high-quality, market-driven services at
prices generally equal to or below those charged by our competitors. Many of
our current and potential competitors have greater financial, marketing,
personnel and other resources than we do, as well as other competitive
advantages.

LOCAL TELEPHONE SERVICE

         INCUMBENT LOCAL EXCHANGE CARRIERS. In each of our target markets, we
will compete with the incumbent local exchange carrier serving that area, which
may be one of the Bell operating companies. As a recent entrant in the
telecommunications services industry, we have not achieved and do not expect to
achieve a significant market share for any of our services in our markets in
the foreseeable future. In particular, the incumbent local exchange carriers
have long-standing relationships with their customers, have financial,
technical and marketing resources substantially greater than ours, have the
potential to subsidize services that compete with our services with revenue
from a variety of other unregulated businesses, and currently benefit from
certain existing regulations that favor the incumbent local exchange carriers
over us in certain respects.

         Recent regulatory initiatives that allow competitive local exchange
carriers, such as us, to interconnect with incumbent local exchange carrier
facilities and acquire and combine the unbundled network elements of an
incumbent local exchange carrier provide




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increased business opportunities for us. However, such interconnection
opportunities have been, and likely will continue to be, accompanied by
increased pricing flexibility and relaxation of regulatory oversight for the
incumbent local exchange carriers.

         COMPETITIVE LOCAL EXCHANGE CARRIERS. The Telecommunications Act
radically altered the market opportunity for competitive local exchange
carriers. Competitive access providers who entered the market prior to passage
of the Telecommunications Act built their own infrastructure to offer exchange
access services to large end-users. Since the passage of the Telecommunications
Act, many competitive access providers have added switches to become
competitive local exchange carriers in order to take advantage of the opening
of the local market. With the Telecommunications Act requiring unbundling of
the incumbent local exchange carrier's networks, competitive local exchange
carriers will now be able to enter the market more rapidly by leasing switches,
trunks and loop capacity until traffic volume justifies building facilities.
Newer competitive local exchange carriers, like us, will not have to replicate
existing facilities and can be more opportunistic in designing and implementing
networks, which could have the effect of increasing competition for local
exchange services.

         INTEREXCHANGE CARRIERS. We also expect to face competition from other
current and potential market entrants, including interexchange (long distance)
carriers such as AT&T, WorldCom, and Sprint, seeking to enter, reenter or
expand entry into the local exchange market. A continuing trend toward
consolidation of telecommunications companies and the formation of strategic
alliances within the telecommunications industry, as well as the development of
new technologies, could give rise to significant new competitors. For example,
in September 1998, WorldCom merged with MCI Communications Corp. In March
1999, AT&T acquired Tele-Communications, Inc., the largest provider of cable
television services in the United States. These types of consolidations and
strategic alliances could put us at a competitive disadvantage.

LONG DISTANCE TELEPHONE SERVICE

         The long distance telecommunications industry has numerous entities
competing for the same customers and a high average churn rate because
customers frequently change long distance providers in response to the offering
of lower rates or promotional incentives by competitors. Our primary
competitors in the long distance market include major interexchange carriers
such as AT&T, WorldCom and Sprint, certain incumbent local exchange carriers
and resellers of long distance services. We believe that pricing levels are a
principal competitive factor in providing long distance telephone service. We
hope to avoid direct price competition by bundling long distance telephone
service with a wide array of value-added services.

         Incumbent local exchange carriers that offer a package of local, long
distance telephone and information services will be particularly strong
competitors. Incumbent local exchange carriers, including Verizon and SBC
Communications, are currently providing both long distance and local services
as well as certain enhanced telephone services we offer. We believe that the
Bell operating companies will attempt to offset market share losses in their
local markets by attempting to capture a significant percentage of the long
distance market.

ENHANCED SERVICES

         We compete with a variety of enhanced service companies. Enhanced
services markets are highly competitive, and we expect that




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competition will continue to intensify. Our competitors in these markets
include Internet service providers, web-based communications service providers
and other telecommunications companies, including the major interexchange
carriers, incumbent local exchange carriers, competitive local exchange
carriers and wireless carriers.

OTHER MARKET ENTRANTS

         We may face competition in local, long distance and information
services from other market entrants such as electric utilities, cable
television companies, fixed and mobile wireless system operators, and operators
of private networks built for large end-users. All of these companies are free
to offer bundled services similar to those that we offer. Electric utilities
have existing assets and low cost access to capital that could allow them to
enter a market rapidly and accelerate network development. Cable television
companies are also entering the telecommunications market by upgrading their
networks with fiber optics and installing facilities to provide fully
interactive transmission of broadband voice, video and data communications.
Wireless companies have developed, and are deploying in the United States,
wireless technology as a substitute for traditional wireline local telephones.
The World Trade Organization agreement on basic telecommunications services
could increase the level of competition we face. Under this agreement, the
United States and 68 other member states of the World Trade Organization are
committed to open their respective telecommunications markets, including
permitting foreign companies to enter into basic telecommunications services
markets. This development may increase the number of established foreign-based
telecommunications carriers entering the U.S. markets.

         The Telecommunications Act includes provisions that impose certain
regulatory requirements on all local exchange carriers, including competitive
local exchange carriers. At the same time, the Telecommunications Act expands
the FCC's authority to reduce the level of regulation applicable to any or all
telecommunications carriers, including incumbent local exchange carriers. The
manner in which these provisions are implemented and enforced could have a
material adverse effect on our ability to compete successfully against
incumbent local exchange carriers and other telecommunications service
providers.

GOVERNMENT REGULATION

OVERVIEW

         Some of our services are regulated and some are not. In providing our
non-common carrier services such as voice mail, "Find-Me" notification and
directory services offered through Z-Line Features, we operate as an
unregulated provider of information services, as that term is defined in the
Communications Act of 1934, as amended by the Telecommunications Act of 1996,
and as an enhanced service provider, as that term is defined in the FCC rules.
These operations currently are not regulated by the FCC or the states where we
operate. In providing Z-Line Home Edition and our long distance services, we
are regulated as a common carrier at the state and federal level and are
subject to additional rules and policies not applicable to providers of
information services alone. We are certificated as a facilities-based
competitive local exchange carrier in a number of states, including Alabama,
Arizona, California, Colorado, Florida, Georgia, Illinois, Indiana, Iowa,
Kansas, Kentucky, Louisiana, Maryland, Massachusetts, Michigan, Minnesota,
Mississippi, Missouri, New York, Ohio, Oklahoma, Oregon, Pennsylvania, Rhode
Island, South Carolina, Tennessee, Texas, Utah, Vermont, Virginia, Washington
and Wisconsin. We are currently seeking this certification in additional states,
including Connecticut, New Jersey, New Mexico and North Carolina.



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<PAGE>   13

         The local and long distance telecommunications services we provide are
regulated by federal, state, and, to some extent, local government authorities.
The FCC has jurisdiction over all telecommunications common carriers to the
extent they provide interstate or international communications services. Each
state regulatory commission has jurisdiction over the same carriers with
respect to the provision of intrastate communications services. Local
governments sometimes seek to impose franchise requirements on
telecommunications carriers and regulate construction activities involving
public rights-of-way. Changes to the regulations imposed by any of these
regulators could have a material adverse effect on our business, operating
results and financial condition.

         In recent years, the regulation of the telecommunications industry has
been in a state of flux as the United States Congress and various state
legislatures have passed laws seeking to foster greater competition in
telecommunications markets. The FCC and state utility commissions have adopted
many new rules to implement this legislation and encourage competition. These
changes, which are still incomplete, have created new opportunities and
challenges for us and our competitors. The following summary of regulatory
developments and legislation is intended to describe the most important, but
not all, present and proposed federal, state and local regulations and
legislation affecting the telecommunications industry. Some of these and other
existing federal and state regulations are the subject of judicial proceedings
and legislative and administrative proposals that could change, in varying
degrees, the manner in which this industry operates. We cannot predict the
outcome of any of these proceedings or their impact on the telecommunications
industry at this time. Some of these future legislative, regulatory or judicial
changes may have a material adverse impact on our business.

         Specifically, as states re-evaluate pricing of network elements, it is
possible that some states could increase rates over existing levels. Currently,
Verizon, BellSouth, SBC and Qwest have rate cases pending before state
regulatory commissions in at least one state in each of their respective
territories. Ongoing rate cases in Florida, Illinois, New Jersey, New York and
Washington could significantly raise the existing rates for some network
elements and network element combinations. Our intent is to be an active
participant in these rate cases and any others that might be critical to our
operations. We anticipate joining other competitive service providers in
arguing that existing rates are overstated and do not reflect the true total
element long run incremental costing principles required by the FCC and the
Telecommunications Act. The FCC prescribed methodology for calculating forward
looking unbundled network element rates is currently before the United States
Supreme Court. While the prevailing trends within the industry would predict
the adoption of lower rates in association with the provision of unbundled
network elements and network element combinations, we cannot predict the
outcome of any pending or potential rate case or judicial proceeding. Increases
or decreases in rate levels charged by incumbent local exchange carriers as a
result of regulatory and/or judicial review through rate case, court case or
arbitration proceedings could significantly impact our business plans.

FEDERAL REGULATION

FCC POLICY ON ENHANCED AND INFORMATION SERVICES

         In 1980, the FCC created a distinction between basic
telecommunications services, which it regulates as common carrier services, and
enhanced services, which remain unregulated. The FCC exempted enhanced service
providers from federal regulations governing




                                      11
<PAGE>   14

common carriers, including the obligation to pay access charges for the
origination or termination of calls on carrier networks and the obligation to
contribute to universal service. The Telecommunications Act of 1996 established
a similar distinction between telecommunications services and information
services. Changing technology and changing market conditions, however,
sometimes make it difficult to discern the boundary between unregulated and
regulated services.

         In general, information services are value-added services that use
regulated transmission facilities only as part of a service package that also
includes network or computer software to change or enhance the information
transmitted. We believe that most of the services we provide, including voice
mail, "Find-Me" notification, and directory services offered through Z-Line
Features are information services under the FCC's definition. Because the
regulatory boundaries in this area are somewhat unclear and subject to dispute,
however, the FCC could seek to characterize some of our information services as
"telecommunications services." If that happens, those services would become
subject to FCC regulation, although the impact of that reclassification is
difficult to predict.

         In general, the FCC does not regulate the rates, services, and market
entry and exit of non-dominant telecommunications carriers, but does require
them to contribute to universal service and comply with other regulatory
requirements. We are currently regulated as non-dominant with respect to both
our local and long distance telephone services.

FCC REGULATION OF COMMON CARRIER SERVICES

         We currently are not subject to price cap or rate of return regulation
at the federal level and are not currently required to obtain FCC authorization
for the installation, acquisition or operation of our domestic exchange or
interexchange network facilities. However, we must comply with the requirements
of common carriage under the Communications Act of 1934. We are subject to the
general requirement that our charges and terms for our telecommunications
services be "just and reasonable" and that we not make any "unjust or
unreasonable discrimination" in our charges or terms. The FCC has jurisdiction
to act upon complaints against any common carrier for failure to comply with
its statutory obligations.

         Comprehensive amendments to the Communications Act of 1934 were made
by the Telecommunications Act of 1996, which was signed into law on February 8,
1996. The Telecommunications Act effected changes in regulation at both the
federal and state levels that affect virtually every segment of the
telecommunications industry. The stated purpose of the Telecommunications Act
is to promote competition in all areas of telecommunications. While it may take
years for the industry to feel the full impact of the Telecommunications Act,
it is already clear that the legislation provides us with new opportunities and
challenges.

         INTERCONNECTION. The Telecommunications Act greatly expands the
interconnection requirements applicable to the incumbent local exchange
carriers, i.e., generally, those existing local exchange carriers that, in the
past, enjoyed virtual or legal monopoly status. The Telecommunications Act
requires the incumbent local exchange carriers to:

         o   provide physical collocation, which allows companies such as us
             and other competitive local exchange carriers to install and
             maintain our own network termination equipment in incumbent local
             exchange carrier central offices or, if requested or if physical
             collocation is demonstrated to be technically infeasible, virtual
             collocation;



                                      12
<PAGE>   15

         o   offer components of their local service networks on an unbundled
             basis so that other providers of local service can use these
             elements in their networks to provide a wide range of local
             services to customers; and

         o   establish "wholesale" rates for their services to promote resale
             by competitive local exchange carriers.

         In addition, all local exchange carriers must

         o   interconnect with the facilities of other carriers;

         o   establish number portability, which will allow customers to retain
             their existing phone numbers if they switch from the local
             exchange carrier to a competitive local service provider;

         o   provide nondiscriminatory access to telephone poles, ducts,
             conduits and rights-of-way; and

         o   compensate other local exchange carriers on a reciprocal basis for
             traffic originated by one local exchange carrier and terminated by
             another local exchange carrier.

         The FCC is charged with establishing national guidelines to implement
certain portions of the Telecommunications Act. The FCC issued its
interconnection order on August 8, 1996. Among other rules, the FCC established
a list of seven network elements, comprising most of the significant
facilities, features, functionalities, or capabilities of the network, that the
incumbent local exchange carriers must unbundle. It is possible for competitors
to provide competitive local exchange service using only these unbundled
network elements. In addition, the FCC mandated a particular forward looking
pricing methodology for these network elements that produces relatively low
element prices that are favorable to competitors.

         On July 18, 1997, however, the United States Court of Appeals for the
Eighth Circuit issued a decision vacating the FCC's pricing rules, as well as
certain other portions of the FCC's interconnection rules, on the grounds that
the FCC had improperly intruded into matters reserved for state jurisdiction. On
January 25, 1999, the Supreme Court largely reversed the Eighth Circuit's order,
holding that the FCC has general jurisdiction to implement the local competition
provisions of the Telecommunications Act. In so doing, the Supreme Court stated
that the FCC has authority to set pricing guidelines for unbundled network
elements, to prevent incumbent local exchange carriers from physically
separating existing combinations of network elements, and to establish "pick and
choose" rules regarding interconnection agreements. "Pick and choose" rules
would permit a carrier seeking interconnection to pick and choose among the
terms of service from other interconnection agreements between the incumbent
local exchange carriers and other competitive local exchange carriers. This
action reestablished the validity of many of the FCC rules vacated by the Eighth
Circuit.

         Although the Supreme Court affirmed the FCC's authority to develop
pricing guidelines, the Supreme Court did not evaluate the specific
forward-looking pricing methodology mandated by the FCC and has remanded the
case to the Eighth Circuit for further consideration.




                                      13
<PAGE>   16
Some incumbent local exchange carriers have argued that this pricing
methodology does not allow adequate compensation for the provision of unbundled
network elements. The Eighth Circuit heard oral arguments on this pricing issue
on September 16, 1999 and issued a ruling on July 18, 2000. In that ruling, the
Eighth Circuit upheld the FCC's use of forward-looking incremental costs as the
basis for establishing rates for interconnection and unbundled network
elements. The Court further agreed with the FCC's interpretation of the
Telecommunications Act as rejecting "historical costs" as the basis for setting
rates. However, the Eighth Circuit vacated the FCC's regulation, codified at 47
C.F.R. Sec. 51.505(b), setting forth the FCC's approach to computing
forward-looking incremental costs, and directed the FCC to review its approach
so that it is based on the costs incurred by the incumbent local exchange
carrier to provide the actual facilities and equipment that will be used by the
requesting carrier instead of the lowest cost based on the most efficient
technologies currently available. On January 23, 2001, the United States
Supreme Court granted a writ of certiorari to the Eighth Circuit. If the United
States Supreme Court affirms the Eighth Circuit's decision, there is a risk
that, upon remand, the FCC will issue less favorable pricing rules, and state
public utility commissions, some of whom have relied on the FCC's existing
rules, may revisit their pricing methodologies. As a result, the prices we have
to pay for unbundled network elements may increase, which increase could have a
materially adverse effect on our business.

         In its January 25, 1999 decision, the Supreme Court also remanded the
list of unbundled network elements to the FCC for further consideration of the
necessity of each one under the Telecommunications Act's statutory standard for
unbundling. On November 5, 1999, the FCC released an order largely retaining its
list of unbundled network elements, but eliminating the requirement that
incumbent local exchange carriers provide unbundled access to operator services
and directory assistance as an unbundled network element and limited unbundled
access to operator services and directory assistance as an unbundled network
element and limited unbundled access to local switching. With regard to operator
services and directory assistance, the FCC concluded that the market has
developed since 1996 such that competitors can and do self-provision these
services, or acquire them from alternative sources. The FCC also noted that
incumbent local exchange carriers remain obligated under the non-discrimination
requirements of the Communications Act of 1934 to comply with the reasonable
request of a carrier that purchases these services from the incumbent local
exchange carriers to rebrand or unbrand those services, and to provide directory
assistance listings and updates in daily electronic batch files. With regard to
unbundled local switching, the FCC concluded that, notwithstanding the incumbent
local exchange carriers' general duty to provide unbundled local circuit
switching, an incumbent local exchange carrier is not be required to unbundle
local circuit switching for competitors for end-users with four or more voice
grade (DSO) equivalents or lines, provided that the incumbent local exchange
carrier provides nondiscriminatory access to combinations of unbundled loops and
transport (also known as the Enhanced Extended Link) throughout Density Zone 1,
and the incumbent local exchange carrier's local circuit switches are located in
(i) The top 50 Metropolitan Statistical Areas as set forth in Appendix B of the
Third Report and Order and Fourth Further Notice of Proposed Rulemaking in FCC
Docket No. 96-98, and (ii) in Density Zone 1, as defined in the FCC's rules. For
operator services and directory assistance, as well as for unbundled local
switching, the FCC noted that the competitive checklist contained in Section 271
of the Communications Act of 1934 requires Bell operating companies to provide
nondiscriminatory access to these services. Thus, Bell operating companies must
continue to provide these services to competitors; however, Bell operating
companies may charge different rates for these offerings.

         The FCC's November 5, 1999 ruling on unbundled network elements was
appealed by several parties to the DC Circuit, and has been remanded to the FCC
for voluntary reconsideration of certain findings made. These and other FCC
determinations are likely to be the subject of further appeals. Thus, while the
Supreme Court resolved many issues, including aspects of the FCC's
jurisdictional authority, other issues remain subject to further consideration
by the courts and the FCC. We cannot predict the ultimate disposition of these
matters.

         INTERCONNECTION AGREEMENTS. The Telecommunications Act obligates
incumbent local exchange carriers to negotiate with us in good faith to enter
into interconnection agreements. Competitive local exchange carriers like us
can purchase unbundled network elements under such an agreement or under a
tariff or a Statement of Generally Available Terms filed with the state
regulators. Interconnection agreements are a prerequisite to obtaining
access to the incumbent local exchange carrier's unbundled network elements and
to provide the connectivity to our network necessary to provision local
exchange services, including Z-Line Home Edition. To this end, we have entered
into interconnection agreements with the Bell operating company in all states
where we currently operate except New York and Michigan, where we purchase the
unbundled network element platform under Verizon's and




                                      14
<PAGE>   17
Ameritech's respective tariffs. Interconnection agreements between Z-Tel and
the primary incumbent local exchange carrier have been signed and are currently
awaiting approval in Mississippi, North Carolina, Oklahoma, Rhode
Island, South Carolina and Tennessee. Z-Tel currently is reviewing available
contracts or negotiating new contracts in a number of additional states. If we
cannot reach agreement, either side may petition the applicable state
commission to arbitrate remaining disagreements. These arbitration proceedings
can last for a substantial period of time. Moreover, state commission approval
of any interconnection agreement resulting from negotiation or arbitration is
required, and any party may appeal an adverse decision by the state commission
to federal district court, although some federal district courts have refused
to exercise jurisdiction over such cases. The potential cost in resources and
delay from this process could harm our ability to compete in certain markets,
and there is no guarantee that a state commission would resolve disputes,
including pricing disputes, in our favor.

         COLLOCATION, LINE SHARING AND LINE SPLITTING. The FCC has adopted rules
designed to make it easier and less expensive for competitive local exchange
carriers to obtain collocation at incumbent local exchange carriers' central
offices by, among other things, restricting the incumbent local exchange
carriers' ability to prevent certain types of equipment from being collocated
and requiring incumbent local exchange carriers to offer alternative collocation
arrangements. On November 18, 1999, the FCC also adopted an order requiring
incumbent local exchange carriers to provide line sharing, which will allow
competitive local exchange carriers to offer data services over the same line
that a consumer uses for voice services without the competitive local exchange
carriers' having to provide the voice service. In an Order on Reconsideration,
issued January 19, 2001, the FCC reaffirmed its prior decision to support line
sharing for provision of digital subscriber line (DSL) services. In addition, in
this January 19, 2001 decision, the FCC stated that incumbent local exchange
carriers must permit competitive local exchange carriers to engage in line
splitting arrangements, where a competitive local exchange carrier provides
voice and another provides data service to end users over a "split" loop
purchased as an unbundled network element from the incumbent local exchange
carrier. While we expect that the FCC's rules will be beneficial to competitive
local exchange carriers, we cannot be certain that these rules will be
implemented by the incumbent local exchange carrier in a timely or favorable
manner. Moreover, several key issues regarding line sharing, including the
provision of line sharing in instances where loop facilities have fiber
components and where remote terminals do not have sufficient space for
collocation, remain in light of the FCC's Further Notice of Proposed Rulemaking
issued in conjunction with its January 19, 2001 Order on Reconsideration.
Further, on March 17, 2000, the United States Court of Appeals for the District
of Columbia Circuit vacated portions of the FCC's collocation rules.
Specifically, the court found that the FCC's interpretation of the statutory
terms "necessary" and "physical collocation" are impermissibly broad, and
remanded those portions of the order to the FCC for reconsideration. The FCC has
not yet issued an order on reconsideration. We cannot predict the outcome of
these actions or the effect they may have on our business.

         BELL OPERATING COMPANY ENTRY INTO THE LONG DISTANCE MARKET. The
Telecommunications Act permitted the Bell operating companies to provide long
distance services outside their local service regions immediately, and will
permit them to provide in-region long distance service upon demonstrating to
the FCC and state regulatory agencies that they have adhered to the
Telecommunication Act's Section 271 14-point competitive checklist. Pursuant to
the Telecommunications Act, Bell operating companies typically seek approval
from state public utility commissions prior to filing an application for
Section 271 relief before the FCC. To date, some states have denied these
applications while others have approved them. The Bell operating company can
file an application with the FCC for Section 271 relief regardless of the
outcome of the state's review. Based on its own review as well as
recommendations from the United States Department of




                                      15
<PAGE>   18

Justice and the involved state public utility commission, the FCC then either
approves or denies the application.

         Prior to December 1999, the FCC had denied each of the Bell operating
company applications brought before it because it found that the particular Bell
operating company had not sufficiently made its local network available to
competitors. In late December 1999, the FCC approved Verizon's Section 271
application for the state of New York. Since that time, the FCC has similarly
approved applications of SBC for the states of Texas, Kansas and Oklahoma. At
this time, an application filed by Verizon with the state of Massachusetts is
currently pending FCC review. Several state public utility commissions
(including, among others, Arizona, California, Georgia, Florida and
Pennsylvania) have proceedings underway in association with anticipated Section
271 applications. While we cannot predict the outcome of any Section 271
applications before the FCC or any individual state, it is generally expected
that long distance competition will increase as the Bell operating companies
enter the market. We also expect other Bell operating companies to file with the
FCC similar applications for long distance authority in 2001 and 2002.

         UNIVERSAL SERVICE. In May 1997, the FCC released an order establishing
a significantly expanded universal service regime to subsidize the cost of
telecommunications service to high cost areas, as well as to low-income
customers and qualifying schools, libraries and rural health care providers.
Providers of interstate telecommunications services, like us, as well as certain
other entities, must pay for these programs. We are also eligible to receive
funding from these programs if we meet certain requirements, but we do not
currently have plans to do so. Our share of the payments into these subsidy
funds will be based on our share of certain defined interstate
telecommunications end-user revenues. Currently, the FCC is assessing such
payments on the basis of a provider's revenue for the previous year. The FCC
adjusts payment requirements and levels periodically. Various states are also in
the process of implementing their own universal service programs. We are
currently unable to quantify the amount of subsidy payments that we will be
required to make to individual states. On July 30, 1999, the United States Court
of Appeals for the Fifth Circuit overturned certain of the FCC's rules governing
the basis on which the FCC collects subsidy payments from telecommunications
carriers and recovery of those payments by incumbent local exchange carriers. In
October 1999, on remand, the FCC issued new universal service rules. These or
other changes to the universal service program could affect our costs. One or
more parties may seek review of the FCC rules by the Fifth Circuit and
subsequently by the Supreme Court. The Fifth Circuit also remanded other rules
to the FCC for further consideration.

         TARIFFS AND RATES. In 1996, the FCC issued an order that required
nondominant interexchange carriers, like us, to cease filing tariffs for our
domestic interexchange services. The order required mandatory detariffing and
gave carriers nine months to withdraw federal tariffs and move to contractual
relationships with their customers. A federal appeals court subsequently stayed
this order. Currently, the FCC, through its Common Carrier Bureau, has extended
the transition period to July 31, 2001 for interexchange carriers to complete
the process of detariffing mass-market consumer services. In June 1997, the
FCC issued another order stating that nondominant local exchange carriers, like
us, could withdraw their tariffs for interstate access services provided to
long distance carriers. If the FCC's orders become effective, nondominant
interstate services providers will no longer be able to rely on the filing
of tariffs with the FCC as a means of providing notice to customers of prices,
terms and conditions under which they offer their interstate services. If we
cancel our FCC tariffs as a result of the FCC's orders, we may need to
implement customer contracts, which could result in substantial administrative
expenses.



                                      16
<PAGE>   19

         In March 1999, the FCC adopted further rules that, while still
maintaining mandatory detariffing, nonetheless require interexchange carriers
to make specific public disclosures on their web sites of their rates, terms
and conditions for domestic interstate services. The effective date for these
rules was initially delayed until a court decision on the appeal of the FCC's
detariffing order. That appeal is still pending.

         JURISDICTIONAL NATURE OF INTERNET TRAFFIC. Recently, the FCC has
determined that both continuous access and dial-up calls from a customer to an
Internet service provider are interstate, not local, calls, and, therefore, are
subject to the FCC's jurisdiction. The FCC has initiated a proceeding to
determine the effect that this regulatory classification will have on the
obligation of local exchange carriers to pay reciprocal compensation for dial-up
calls to Internet service providers that originate on one local exchange carrier
network and terminate on another local exchange carrier network. Moreover, many
states have or are considering this issue, and several states have held that
local exchange carriers do not need to pay reciprocal compensation for calls
terminating at Internet service providers. A majority of state commissions have
ruled that reciprocal compensation should be paid on such traffic. On March 24,
2000, the Court of Appeals for the District of Columbia remanded for
reconsideration the FCC's determination that calls to Internet service providers
are interstate for jurisdictional purposes rather than local. Specifically, the
Court indicated that the FCC has not provided a satisfactory explanation why
calls to Internet service providers are not local telecommunications traffic and
why such traffic is exchange access rather than telephone exchange service. We
cannot predict the effect that the FCC's resolution of these issues will have on
our business.

         NUMBERING AND NUMBER PORTABILITY. In August 1997, the FCC issued rules
transferring responsibility for administering and assigning local telephone
numbers from the Bell operating companies and other incumbent local exchange
carriers to a neutral entity in each geographic region in the United States. In
August 1996, the FCC issued new numbering regulations that prohibit states from
creating new area codes that could unfairly hinder competitive local exchange
carriers by requiring their customers to use 10 digit dialing while existing
incumbent local exchange carrier customers use seven digit dialing. In
addition, each carrier is required to contribute to the cost of numbering
administration through a formula based on net telecommunications revenues.
Beginning in March 2000, contributions for this purpose will be based on end
user telecommunications revenues and will be submitted in association with FCC
Lifeline, Universal Service and the Schools and Libraries Funds.

         In July 1996, the FCC released rules requiring all local exchange
carriers to have the capability to permit both residential and business
consumers to retain their telephone numbers when switching from one local
service provider to another, known as "number portability." Number portability
has been implemented in most of the areas in which we provide service, but has
not been implemented everywhere in the United States. Some carriers have
obtained waivers of the requirement to provide number portability, and others
have delayed implementation by obtaining extensions of time before compliance
is required. Lack of number portability in a given market could adversely
affect our ability to attract customers for our competitive local exchange
service offerings, particularly business customers, should we seek to provide
services to such customers.

         In May 1999, the FCC also initiated a proceeding to address the
problem of the declining availability of area codes and phone numbers. On
December 29, 2000, the FCC issued a Further Notice of Proposed Rulemaking that
proposed adoption of a "market-based" approach for




                                      17
<PAGE>   20
optimizing number resources. In that Further Notice the FCC seeks input on its
tentative conclusion that, through the introduction of charges associated with
the allocation of number resources, carriers might be better incentivized to
take and retain only as many numbers as they need. If a "market-based" approach
to number allocation is introduced, as the FCC has proposed, it could result in
added administrative expenses for us.

         RESTRICTIONS ON BUNDLING. Current FCC rules prohibit dominant carriers
from bundling their non-competitive regulated telecommunications services with
their unregulated enhanced or information services. The Commission has never
enforced this rule with respect to competitive local exchange carriers and has
proposed eliminating the rule for all carriers.

         SLAMMING. A customer's choice of local or long distance
telecommunications company is encoded in a customer record, which is used to
route the customer's calls so that the customer is served and billed by the
desired company. A user may change service providers at any time, but the FCC
and some states regulate this process and require that specific procedures be
followed. When these procedures are not followed, particularly if the change is
unauthorized or fraudulent, the process is known as "slamming." Slamming is
such a significant problem that it has been addressed in detail by Congress in
the Telecommunications Act, by some state legislatures, and by the FCC in
recent orders. The FCC has levied substantial fines for slamming. The risk of
financial damage, in the form of fines, penalties and legal fees and costs, and
to business reputation from slamming is significant. Even one slamming
complaint could cause extensive litigation expenses for us. The FCC recently
decided to apply its slamming rules (which originally covered only long
distance) to local service as well.

         NETWORK INFORMATION. The Communications Act of 1934 and FCC rules
protect the privacy of certain information about telecommunications customers
that a telecommunications carrier such as us acquires by providing
telecommunications services to such customers. Such protected information,
known as Customer Proprietary Network Information (CPNI), includes information
related to the quantity, technological configuration, type, destination and the
amount of use of a telecommunications service. Under the FCC's original rules,
a carrier may not use the Customer Proprietary Network Information acquired
through one of its offerings of telecommunications services to market certain
other services without the approval of the affected customers. The United
States Court of Appeals for the Tenth Circuit recently overturned the FCC's
rules regarding the use and protection of Customer Proprietary Network
Information. The FCC recently relaxed its customer proprietary network
information rules somewhat, but it also has sought reconsideration of the Tenth
Circuit decision. Further, FCC rules regarding handling of CPNI could result in
significant administrative expense in modifying internal customer systems to
meet such requirements.

         INTERSTATE ACCESS CHANGES. Since passage of the Telecommunications Act
of 1996, the FCC has fundamentally restructured the "access charges" that ILECs
charge to interexchange carriers and end-user customers to connect to the ILEC's
network. The FCC revised access charges for the largest ILECs in May 1997,
reducing per-minute access charges and increasing flat-rated monthly charges
paid by both long-distance carriers and end users. Further changes in access
charges were effected for the largest ILECs when the FCC adopted the Coalition
for Affordable Local and Long-Distance Service (CALLS) proposal in May 2000.
CALLS, which reflected a negotiated settlement between AT&T and most of the Bell
operating companies, reduced per-minute charges by 60 percent. It further
increased flat-rated monthly charges to end users, in particular, multi-line
business users. However, most of the reductions resulted from shifting access
costs away from interexchange carriers onto end-user customers. Currently under
FCC consideration is the Guaranteed Reduced Exchange Access Tariffs (GREAT)
Proposal, proposed by the Association for Local Telecommunications Services
(ALTS), which, if adopted, would significantly reduce average CLEC access charge
rates. If these additional plans are adopted by the FCC, they should reduce
access charges litigation, although they cannot be expected to end all rate
disputes.

         Currently two interchange carriers have refused to pay our access
charges or are doing so at a reduced rate. Other competitive local exchange
carriers have experienced similar problems and the FCC has ruled on a complaint
against AT&T that it must pay access charges at the competitive local exchange
carriers tariffed rate. In reaction, 14 competitive local exchange carriers
jointly, filed suit against AT&T and Sprint in federal district court for the
Eastern District of Virginia in April 2000. The case currently is stayed until
July 19, 2001, while the FCC considers several matters related to the suit. We
filed a similar action against AT&T on March 15, 2001.

         OTHER ISSUES. There are a number of other issues and proceedings that
could have an effect on our business in the future, including the fact that

         o   The FCC has adopted rules to require telecommunications service
             providers to make their services accessible to individuals with
             disabilities, if readily achievable.

         o   The FCC has also ordered telecommunications service providers to
             provide law enforcement personnel with a sufficient number of
             ports and technical assistance in connection with wiretaps. We
             cannot predict the cost to us of complying with this order.



                                      18
<PAGE>   21


         o   The FCC has adopted new rules designed to make it easier for
             customers to understand the bills of telecommunications carriers.
             These new rules establish certain requirements regarding the
             formatting of bills and the information that must be included on
             bills. These rules have been appealed in Federal court.

         o   We are subject to annual regulatory fees assessed by the FCC, and
             must file an annual employment report to comply with the FCC's
             Equal Employment Opportunity policies.

         o   The FCC has adopted an order granting limited pricing flexibility
             to large incumbent local exchange carriers, and is considering
             granting additional pricing flexibility and price deregulation
             options. These actions could increase competition for some of our
             services.

         The foregoing is not an exhaustive list of proceedings or issues that
could materially affect our business. We cannot predict the outcome of these or
any other proceedings before the courts, the FCC, or state or local
governments.

STATE REGULATION

         To the extent that we provide telecommunications services that
originate and terminate in the same state, we are subject to the jurisdiction of
that state's public service commission. As our local service business and
product lines expand, we will offer more intrastate service and may become
increasingly subject to state regulation. The Telecommunications Act maintains
the authority of individual state utility commissions to preside over rate and
other proceedings, and to impose their own regulation on local exchange and
intrastate interexchange services, so long as such regulation is not
inconsistent with the requirements of federal law. For instance, states may
require us to obtain a Certificate of Public Convenience and Necessity before
commencing service in the state. We have obtained such authority in all states
in which we operate, and, as a prelude to market entry in additional states, we
have obtained such authority to provide facilities-based service in several
states, including Connecticut, Delaware, Maine, New Hampshire, New Jersey, New
Mexico, North Carolina and Tennessee. No assurance can be made that the
individual state regulatory authorities will approve these or additional
certification requests in a timely manner. In addition to requiring
certification, state regulatory authorities may impose tariff and filing
requirements, consumer protection measures, and obligations to contribute to
universal service and other funds. State commissions also have jurisdiction to
approve negotiated rates, or establish rates through arbitration, for
interconnection, including rates for unbundled network elements.

         We are subject to requirements in some states to obtain prior approval
for, or notify the state commission of, any transfers of control, sales of
assets, corporate reorganizations, issuance of stock or debt instruments and
related transactions. Although we believe such authorizations could be obtained
in due course, there can be no assurance that state commissions would grant us
authority to complete any of these transactions.

         The Telecommunications Act generally preempts state statutes and
regulations that restrict the provision of competitive services. As a result of
this broad preemption, we will be generally free to provide the full range of
local, long distance, and data services in



                                      19
<PAGE>   22

any state. While this action greatly increases our potential for growth, it
also increases the amount of competition to which we may be subject. States,
however, may still restrict competition in some rural areas.

         In particular, we expect to expand our Z-Line Home Edition service by
starting to market this service in several new states during 2001. To effect
entry into these markets, we have obtained proper state regulatory
certification and entered into interconnection agreements with the Bell
operating companies in Kansas, Mississippi, Oklahoma, Missouri, Minnesota,
Rhode Island and South Carolina. In each of these jurisdictions we anticipate
that the incumbent local exchange carrier will provide the unbundled network
element platform components in a manner similar to that provided in states
where we currently operate. However, pricing and terms and conditions adopted
by the incumbent local exchange carrier in each of these states may preclude
our ability to offer a competitively viable and profitable product within these
and other states on a going-forward basis.

         In order to enter new market areas not mentioned above, we may be
required to negotiate interconnection contracts with incumbent local exchange
carriers on an individual state basis. While current FCC rules and regulations
require the incumbent provider to provide the network elements on an individual
and combined basis necessary for us to provision end-user services, no
assurance can be made that the individual local exchange providers will provide
these components in a manner and at a price that will support competitive
operations. If the incumbent providers do not readily provide network
functionality in the manner required, we have regulatory and legal
alternatives, including arbitration before state public service commissions, to
force provision of services in a manner required to support our service
offerings. However, if we are forced to litigate in order to obtain the
combinations of network elements required to support our service, we are likely
to incur significant incremental costs and delays in entering such markets.

LOCAL GOVERNMENT REGULATION

         In some of the areas where we provide service, we may be subject to
municipal franchise requirements requiring us to pay license or franchise fees
either on a percentage of gross revenue, flat fee or other basis. We may be
required to obtain street opening and construction permits from municipal
authorities to install our facilities in some cities. The Telecommunications
Act prohibits municipalities from discriminating among telecommunications
service providers in imposing fees or franchise requirements. In some
localities, the FCC has preempted fees and other requirements determined to be
discriminatory or to effectively preclude entry by competitors, but such
proceedings have been lengthy and the outcome of any request for FCC preemption
would be uncertain.

EMPLOYEES

         As of March 23, 2001, we had approximately 1,947 employees. None of
our employees is covered under collective bargaining agreements, and we believe
that our relationships with our employees are good.

ITEM 2.  PROPERTIES

         We currently lease our principal executive offices in Tampa, Florida,
our principal engineering offices in Atlanta, Georgia and our principal
outbound sales offices in Minot, North Dakota. We own our principal consumer
services offices in Atmore, Alabama.



                                      20
<PAGE>   23

ITEM 3.  LEGAL PROCEEDINGS

         We are a party to various routine administrative proceedings. For more
information, please refer to the section entitled "Item 1. Business-Government
Regulation."

1.       Civil Action File No. 8:00 CV-1148-T-24B; PTEK Holdings, Inc., f/k/a
         Premiere Technologies, Inc., and Premiere Communications, Inc. v. Z-Tel
         Technologies, Inc., Z-Tel Communications, Inc., David Gregory Smith,
         James Kitchen and Eduard Mayer; in the United States District Court for
         the Middle District of Florida, Tampa Division.

         On November 14, 2000, the parties reached an agreement to resolve in
full all claims asserted by each party against the other. In connection with
that settlement, the parties executed mutual releases and agreed to dismiss the
claims against each other with prejudice. Z-Tel also agreed to issue a warrant
to PTEK Holdings, Inc. for the purchase of 175,000 shares of Z-Tel common
stock.

2.       Case No. 98-12260; In re Touch 1 Communications, Inc.; in the United
         States Bankruptcy Court for the Southern District of Alabama

         Case No. 98-12402; In re direcTEL; in the United States Bankruptcy
         Court for the Southern District of Alabama

         Touch 1 Communications, Inc. ("Touch 1") and its wholly owned
subsidiary, direcTEL, Inc. ("direcTEL") (collectively, the "Debtors"), filed
voluntary petitions for relief under chapter 11 of the Bankruptcy Code on June
29, 1999 and July 9, 1999, respectively, in the United States Bankruptcy Court
for the Southern District of Alabama (the "Bankruptcy Court"). The Bankruptcy
Court entered final decrees closing the direcTEL case on October 5, 2000 and
the Touch 1 case on October 30, 2000.

3.       Case Number 1:01CV00551; Z-Tel Communications, Inc. v AT&T Corp.; in
         the United States District Court for the District of Columbia.

         On March 15, 2001, we filed the captioned suit. In that suit, we have
alleged that AT&T has received originating and terminating access service from
us and has unlawfully withheld access charges for such services from us. We
seek damages from AT&T in the current amount of approximately $7 million, and
have alleged we are entitled to late fees and interest on such amount and any
future amounts, consequential damages, punitive damages, attorney's fees and
costs. We also have asked the Court to enter an order directing AT&T to pay
access charges to us in the future if AT&T continues to use our services.

4.       In March 2001, management informed John Hutchens, our Senior Vice
President-Chief Financial Officer, that we had commenced a search that could
result in his possible replacement as Chief Financial Officer. On March 21,
2001, after he began negotiations with members of management regarding the terms
of a proposed severance arrangement, Mr. Hutchens raised with management in
written form certain issues that he believed required prompt resolution. After
raising these issues, Mr. Hutchens refused our repeated requests to meet with
management or outside counsel to further explain the issues he raised. We have
reviewed in detail Mr. Hutchens' issues in coordination with outside counsel
and believe that each of the issues either had already been appropriately
addressed by management or were based upon misunderstandings
or errors on the part of Mr. Hutchens as to the facts or the law. While
discussions regarding proposed severance arrangements are ongoing, as of the
date of this filing, Mr. Hutchens remains employed as our Senior Vice
President-Chief Financial Officer. We are unable to assess at this time the
likelihood of whether any claims will be asserted in the future by Mr. Hutchens
arising out of his employment with us or the possible termination thereof, the
amount of any such claims or the likely result of any such claims.


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

         None.


                                    PART II

ITEM 5.  MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

         The Company's Common Stock is traded on the Nasdaq National Market
under the symbol "ZTEL."

         The following table sets forth, for the periods indicated, the range
of high and low closing sale prices for the Common Stock, as reported on the
Nasdaq National Market since trading began on December 15, 1999 in connection
with the Company's initial public offering, under the symbol ZTEL:


                                                        HIGH            LOW
                                                      --------        --------

FISCAL YEAR 1999:
Fourth Quarter (from December 15, 1999)               $ 42.375        $ 33.125

FISCAL YEAR 2000:
First Quarter                                         $  47.25        $25.8125
Second Quarter                                        $ 41.625        $  11.00
Third Quarter                                         $ 15.125        $  7.125
Fourth Quarter                                        $  9.625        $ 3.4375

FISCAL YEAR 2001:
First Quarter (until March 23, 2001)                  $ 6.9375        $  3.875


         On March 23, 2001, the last reported sales price of the Common
Stock on the Nasdaq National Market was $4.375 per share. As of March 23,
2001, there were approximately 293 holders of record of the Common Stock.

         We have not paid dividends on our common stock since our inception and
do not intend to pay any cash dividends for the foreseeable future but instead
intend to retain earnings, if any, for the future operation and expansion of
our business. Any determination to pay dividends in the future will be at the
discretion of our Board of Directors and will be dependent upon our results of
operations, financial condition, restrictions imposed by applicable law and
other factors deemed relevant by the Board of Directors. In addition, our
ability to pay cash dividends is limited by provisions of our Series D and E
Convertible Preferred Stock, which have dividend preferences over our common
stock.



                                      21
<PAGE>   24
RECENT SALES OF UNREGISTERED SECURITIES

         On November 13, 2000, we sold 4,166,667 shares of $0.01 par value
Series E Convertible Preferred Stock (the Series E Preferred) and a warrant
(the "Warrant") for the purchase of up to 2,083,333 shares of our common stock,
for aggregate proceeds of $50.0 million. We claim an exemption from
registration under Section 4(2) of the Securities Act of 1933 because the
transaction was by an issuer and did not involve a public offering.

         The Series E Preferred is initially convertible into 4,166,667 shares
of Common Stock. The Warrant is initially exercisable at an exercise price of
$13.80 per share. The conversion rates of the Series E Preferred and the
exercise price of the Warrant are subject to adjustment upon the occurrence of
certain events that would cause dilution in the ownership of the holder of the
Series E Preferred and the Warrant.

ITEM 6.  SELECTED CONSOLIDATED FINANCIAL DATA

         The following selected historical consolidated financial data should
be read in conjunction with the financial statements, related notes and other
financial information contained in this document. You should also read
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," contained later in this document.



                                      22
<PAGE>   25
The following table is in thousands, except for share and per share data:

<TABLE>
<CAPTION>
                                                                                                                PERIOD
                                                                                                           JANUARY 15, 1998
                                                                 YEAR ENDED           YEAR ENDED             (INCEPTION)
                                                                DECEMBER 31,         DECEMBER 31,        THROUGH DECEMBER 31,
                                                                    2000                 1999                    1998
                                                                ------------         ------------         -------------------
<S>                                                             <C>                  <C>                  <C>

Revenues                                                        $    177,668         $      6,615             $       140
                                                                ------------         ------------             -----------

Operating expenses:
        Network operations                                           107,077                6,518                     382
        Sales and marketing                                           45,018                8,898                   2,201
        Research and development                                       8,276                3,562                   4,728
        General and administrative                                    91,330               16,493                   4,718
        Depreciation and amortization                                 17,166                4,372                   1,283
                                                                ------------         ------------             -----------

            Total operating expenses                                 268,867               39,843                  13,312
                                                                ------------         ------------             -----------

            Operating loss                                           (91,199)             (33,228)                (13,172)
                                                                ------------         ------------             -----------

Nonoperating income (expense):
        Interest and other income                                      5,475                  608                     228
        Interest and other expense                                    (2,313)              (3,351)                   (178)
                                                                ------------         ------------             -----------

            Total nonoperating income (expense)                        3,162               (2,743)                     50
                                                                ------------         ------------             -----------

            Net loss                                                 (88,037)             (35,971)                (13,122)

            Less mandatorily redeemable convertible
                  preferred stock dividends and accretion             (3,644)              (1,654)                   (190)
            Less deemed dividend related to beneficial
                  conversion feature                                 (20,027)                  --                      --
                                                                ------------         ------------             -----------

            Net loss attributable to common stockholders        $   (111,708)        $    (37,625)            $   (13,312)
                                                                ============         ============             ===========

Weighted average common shares outstanding                        33,066,538           15,099,359               6,554,499
                                                                ============         ============             ===========

Basic and diluted net loss per share                            $      (3.38)        $      (2.49)            $     (2.03)
                                                                ============         ============             ===========


CONSOLIDATED BALANCE SHEET DATA

Cash and cash equivalents                                             46,650              101,657                   7,973
Working capital (deficit)                                             59,245               95,315                   3,328
Total assets                                                         246,461              137,677                  20,274
Total debt                                                            20,417               14,134                     724
Mandatorily redeemable convertible preferred stock                    84,585                   --                  15,154
Total stockholder's equity (deficit)                                  89,100              114,378                      (6)

OTHER FINANCIAL DATA

EBITDA (1)                                                           (74,033)             (28,856)                (11,889)
Net cash used in operating activities                                (96,860)             (32,681)                 (7,769)
Net cash used in investing activities                                (40,602)              (5,182)                (11,393)
Net cash provided by financing activities                             82,455              131,547                  27,135
</TABLE>

---------------
(1)  EBITDA consists of earnings before interest, income taxes, depreciation
     and amortization. While not a measure under generally accepted accounting
     principles, EBITDA is a measure commonly used in the telecommunications
     industry and is presented to assist in understanding our operating
     results. Although EBITDA should not be construed as a substitute for
     operating income (loss) determined in accordance with generally accepted
     accounting principles, it is included herein to provide additional
     information with respect to our ability to meet future debt service,
     capital expenditures and working capital requirements. The calculation of
     EBITDA does not include our commitments for capital expenditures and
     payment of debt and should not be deemed to represent our available funds.
     See "Management's Discussion and Analysis of Financial Condition and
     Results of Operations" for a discussion of the financial operations and
     liquidity of the Company as determined in accordance with generally
     accepted accounting principles.



                                      23
<PAGE>   26

ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
         RESULTS OF OPERATIONS.

         You should read the following discussion together with the "Selected
Consolidated Financial Data," financial statements and related notes included
in this document. 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 certain
factors, including, but not limited to, those discussed in "Item 1. Business,"
as well as "Cautionary Statements Regarding Forward-Looking Statements," "Risks
Related to our Financial Condition and our Business" and "Risks Related to our
Industry," below, and other factors relating to our business and us that are
not historical facts. 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, uncertainty of government regulation, legal and regulatory
uncertainties, and competition. We disclaim any obligation to update
information contained in any forward-looking statement.

OVERVIEW

         We are an emerging provider of advanced, integrated telecommunications
services targeted primarily to residential subscribers. For management
purposes, we are organized into one reportable operating segment. We offer
local and long distance telephone services in combination with enhanced
communication features accessible through the telephone or the Internet. The
nature of our business is rapidly evolving, and we have a limited operating
history. As a result, we believe that period-to-period comparisons of our
revenues and operating results, including our network operations and other
operating expenses as a percentage of total revenue, are not meaningful and
should not be relied upon as indicators of future performance. We do not
believe that our historical growth rates are indicative of future results.

         Z-Line Home Edition is our principal service offering. Z-Line Home
Edition includes low-priced local and long distance (1+) residential telephone
services using a customer's existing telephone number, bundled with enhanced
features, including caller identification, call forwarding, three-way calling,
speed calling, and remote access to long distance calling through our Z-Line
Anywhere access card service, the full functionality of the Z-Line Features
and, for an additional fee, Internet access. We offer Z-Line Home Edition
service, at least on an initial marketing basis, in the following seventeen
states: Alabama, Arizona, California, Florida, Georgia, Illinois, Kentucky,
Louisiana, Maryland,




                                      24
<PAGE>   27
Massachusetts, Michigan, New York, Oregon, Pennsylvania, Texas, Virginia, and
Washington. We also intend to offer to all of our Z-Line Home Edition
subscribers the ability, through our City of America program, to make unlimited
long distance telephone calls to other Z-Line Home Edition subscribers for an
additional monthly fee.

         We intend to continue to pursue offering Z-Line Home Edition in
additional states as soon as favorable pricing and implementation rules are
imposed in those states. We are also developing other bundled combinations of
our services at varied price points in order to stimulate and expand customer
interest in our services. For example, we have begun to offer in five states
a lower price version of Z-Line Home Edition that includes fewer bundled long
distance minutes and features. Additional long distance minutes and features
are being offered separately for an additional monthly fee.

         Z-Line Anywhere is our access card service that allows a customer to
make long-distance calls using our network from any phone simply by dialing a
local access or toll-free 1-800 number. No change in phone service is required.
Subscribers of Z-Line Anywhere also receive the full functionality of our Z-Line
Features. Z-Line Anywhere customers are billed monthly in arrears, and the
associated revenue is recognized in the month of service. Z-Line Anywhere is
available nationwide, although we are not actively marketing the service.

         Touch 1 Long Distance is a usage-based service that allows customers
to use us as their primary long distance calling provider to complete their
residential long distance (1+) calls. Touch 1 Long Distance is available
nationwide, although we are not actively marketing the service.

         We completed the acquisition of Touch 1 Communications, Inc. ("Touch
1"), on April 14, 2000. The purchase price of Touch 1 consisted of 1.1 million
shares of our common stock and $9.0 million in cash. Touch 1 provides employees
in sales, provisioning, and customer service. We anticipate that this
acquisition will provide operating efficiencies and lower customer acquisition
costs. We believe that Touch 1 also has provided us with the opportunity to
further grow our back-office operations to provide capacity for market entry
into new states.

         We used the purchase accounting method for our acquisition of Touch 1.
Therefore, the below discussions of the results of operations and liquidity and
capital resources do not include any discussions regarding Touch 1 prior to our
acquisition of Touch 1, which is treated as being closed for accounting
purposes, on April 1, 2000. This treatment is in accordance with the adoption of
the purchase method of accounting. A pro forma discussion and schedule is
included in Footnote 3 to the financial statements, which displays the pro forma
operations information of us and Touch 1 for the years ended December 31, 2000
and 1999.



                                      25
<PAGE>   28

RESULTS OF OPERATIONS

YEAR ENDED DECEMBER 31, 2000 COMPARED TO YEAR ENDED DECEMBER 31, 1999


         REVENUE. Revenue increased by $171.1 million to $177.7 million for the
year ended December 31, 2000, compared to $6.6 million last year. The increase
is attributable to the average Home Edition customer count of 190,000 for the
year ended December 31, 2000, compared to 20,000 for the same period in the
prior year. The purchase of Touch 1 provided an additional increase in revenue
of $30.0 million from its existing 1+ long-distance offering for the year ended
December 31, 2000. The following tables outline the approximate number of
subscriber lines for Z-Line Home Edition, Z-Line Anywhere and Touch 1 (1+) long
distance services as of the end of the period:


TYPE OF SERVICE                         December 31, 2000   December 31, 1999
-------------------------------------   -----------------   ------------------

Z-Line Home Edition                           340,000             40,000
Z-Line Anywhere and Touch 1 (1+)
   Long Distance Services                     255,000             26,000


         NETWORK OPERATIONS. Network operations expense increased by $100.6
million to $107.1 million for the year ended December 31, 2000, compared to
$6.5 million last year. The gross margin increased to 39.7% for the year ended
December 31, 2000, compared to 1.46% for the prior year. The network operations
expense primarily consists of fixed and variable transmission expenses for
interconnection agreements with incumbent local exchange carriers (ILECs),
service level agreements with inter-exchange carriers (IXCs), and transmission
services based on tariff arrangements. The increase in network operation
expenses and improved margins is the result of our subscriber growth.

         SALES AND MARKETING. Sales and marketing expense increased $36.1
million to $45.0 million for the year ended December 31, 2000, compared to $8.9
million last year. The sales and marketing expense primarily consists of
telemarketing, direct mail, brand awareness advertising, agent commission and
salaries and benefits paid to employees engaged in sales and marketing
activities.

         The increase in sales and marketing expense is attributable to entering
new states more rapidly than anticipated, which drove increased telemarketing,
direct




                                      26
<PAGE>   29
mail efforts, and brand awareness. We also launched a marketing campaign for our
City of America service that provides unlimited calling between Z-Line Home
Edition members, for an additional monthly fee. This campaign has been
introduced in Texas and is expected to be rolled out to all of the other states
in which we offer Z-Line Home Edition service.

         We are focusing our sales and marketing efforts toward lower
acquisition costs per subscriber for 2001. We have reduced our direct mail
campaigns that resulted in higher than anticipated acquisition costs. We believe
the roll-out of the City of America campaign to all states in which we offer
Z-Line Home Edition, coupled with the introduction of our online sales channel
and electronic agent program, should contribute to lower acquisition costs. We
will continue to build our overall awareness of our "Z" brand, and continue to
explore alliances and ventures with other companies. Although acquisition cost
is expected to decrease per subscriber in 2001, the overall sales and marketing
expenditures will increase over last year as a result of increased subscribers.

         RESEARCH AND DEVELOPMENT. Research and development expenses increased
$4.7 million to $8.3 million for the year ended December 31, 2000, compared to
$3.6 million last year. Our research and development expenses consist primarily
of salaries and benefits paid to employees engaged in research and development
activities and outside third party development costs.

         The enhancement of our current product offerings, development of new
products and services and internal use software development have contributed to
increased research and development costs for the year ended December 31, 2000.
We introduced Z-Alerts during 2000 and will continue to develop new product
offerings. We adopted the provisions of Statement of Position ("SOP") 98-1,
"Accounting for the Cost of Computer Software Developed or Obtained for Internal
Use," at the beginning of 1999. As a result, $3.1 and $0.5 million of salary and
related costs for research and development relating to the development of
internal use software was capitalized, rather than expensed, for the years ended
December 31, 2000 and 1999, respectively.

         Research and development will continue to play an important role in our
operations and customer support. We built an electronic gateway that was
substantially completed in December 2000 that will increase our efficiency to
provision and perform other services for our customers in 2001. This technology
improvement led to a staff reduction in 2001 that should decrease some payroll
related general and administrative expenses. In addition to assisting with
operations, our research and development team is working to develop speech
recognition and other new service offerings and pricing plans which provide
customers with more options and reasons to become and remain our customers.



                                      27
<PAGE>   30
         GENERAL AND ADMINISTRATIVE. General and administrative expense
increased $74.8 million to $91.3 million for the year ended December 31, 2000,
compared to $16.5 million last year. Increased expenses in employee salaries,
temporary services, bad debt expense, billing and collection expense, occupancy
costs, and provisioning costs were necessary to support the growth we
experienced.

         The acquisition of Touch 1 and an increase of approximately 300,000 net
subscriber lines in 2000 contributed to increased general and administrative
expense. We increased our capacity for back-office operations to provide for our
growth, and introduced our Z-Line Home Edition offering to eleven new states in
2000. The later than expected implementation of our electronic gateway and the
overall increase in bad debts from increased customers were all contributing
factors to our increased general and administrative expenses.

         We anticipate general and administrative expenditures will continue to
increase in the future to support our increase in subscriber lines, expanding
services and entrance into new states. We have experienced an improved
operating efficiency from the development of our electronic gateway and other
improvements to our customer provisioning, customer billing, and collection
efforts. We expect these efforts will provide us with efficiencies that will
allow us to provide an overall reduced cost per subscriber.

         DEPRECIATION AND AMORTIZATION. Depreciation and amortization expense
increased $12.8 million to $17.2 million for the year ended December 31, 2000,
compared to $4.4 million last year. The increase in depreciation and
amortization is a result of the acquisition of Touch 1 and our purchases of
equipment. Intangible assets, which are composed of $9.2 million and $58.6
million allocated to customer lists and goodwill, respectively, and amortized
over 5 and 20 year lives, respectively, resulted in amortization of $3.6 million
for the year ended December 31, 2000. In addition, the purchase of computer
equipment, switching equipment, furniture and leasehold improvements required to
maintain our growth and expand our operations has also contributed to the
increased depreciation and amortization expense for the year ended December 31,
2000. Although we are not a facilities based provider, we expect incremental
increases to depreciation and amortization to continue to increase as our
subscriber base increases.

         INTEREST AND OTHER INCOME. Interest and other income increased $4.9
million to $5.5 million for the year ended December 31, 2000, compared to $0.6
million last year. Interest and other income consists of income from interest
earned from our cash balance and any gains from the sale of investments or
securities. The increase was primarily due to a $2.7 million gain on the sale
of an equity investment in 2000. The remaining increase in 2000 is a result of
larger cash reserves from our initial public offering and our Series D and E
Preferred shares offerings. We




                                      28
<PAGE>   31

raised net proceeds of $109.1 million after underwriting discounts and
commissions in our initial public offering in late December 1999, and net
proceeds of $55.9 and $49.0 million in our Series D and E Preferred share
offerings during 2000, respectively.

         INTEREST AND OTHER EXPENSE. Interest and other expense decreased $1.1
million to $2.3 million for the year ended December 31, 2000, compared to $3.4
million last year. Our interest expense is a result of the interest charged on
our capital lease and other debt obligations. We anticipate interest expense to
increase in the future as a result of our assumption of debt from the Touch 1
acquisition and the borrowing of money to support operations through potential
new funding sources.

         INCOME TAX EXPENSE. 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 year ended December 31, 2000 and last year.

         NET LOSS. Our net loss increased $52.0 million to $88.0 million for
the year ended December 31, 2000, compared to $36.0 million last year. This
increase was due primarily to the increases in expenses described above.

         NET LOSS ATTRIBUTABLE TO COMMON STOCKHOLDERS. Our net loss attributable
to common stockholders increased $74.1 million to $111.7 million for the year
ended December 31, 2000, compared to $37.6 million for the same period in the
prior year. This increase was due primarily to the increases in expenses
described above and the issuance of the Series D and E Preferred. In conjunction
with the Series D and E Preferred we incurred $23.7 million of non-cash charges
relating to net loss attributable to common stockholders in 2000. The non-cash
charges relating to a beneficial conversion, cumulative dividend and preferred
stock accretion were composed of $20.0, $1.1 and $2.5 million compared to $0.0,
$1.7, and $0.0 million, for the years ended December 31, 2000, 1999 and the
period January 31, 1998 (Inception) through December 31, 1998, respectively. In
November 2000, the Emerging Issues Task Force 00-27 "Application of Issue No.
98-5 to Certain Convertible Instruments" required that all beneficial
conversions be calculated using the "accounting conversion price" method. The
Company recorded a $12.6 million cumulative catch-up adjustment, included in the
$20.0 million beneficial conversion as a result of the Securities and Exchange
Commission requiring retroactive application of this method.

         EBITDA. Many securities analysts use the measure of earnings before
deducting interest, taxes, depreciation and amortization, also commonly referred
to as "EBITDA," as a way of evaluating our financial performance. EBITDA is not
a measure under generally accepted accounting principles, is not meant to be a
replacement for generally accepted accounting principles and should not be
considered an alternative to net income as a measure of performance or to cash
flows as a measure of liquidity. 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


                                       29
<PAGE>   32
negative EBITDA increased $45.1 million to $74.0 million for the year ended
December 31, 2000, compared to $28.9 million last year. We expect to achieve
positive EBITDA on a monthly basis during late second quarter or early third
quarter of 2001. The positive EBITDA will primarily be attributed to increases
in subscribers and operating efficiencies.

Comparison of the year ended December 31, 1999 and the period January 15, 1998
(Inception) through December 31, 1998:

         REVENUE. Revenue increased by $6.5 million to $6.6 million for the year
ended December 31, 1999, compared to $0.1 million for the period January 15,
1998 (Inception) through December 31, 1998. The following tables outline the
approximate number of subscriber lines for Z-Line Home Edition and Z-Line
Anywhere:


TYPE OF SERVICE                    DECEMBER 31, 1999    DECEMBER 31, 1998
-------------------------------    -----------------    -----------------

Z-LINE HOME EDITION                     40,000                   0
Z-LINE ANYWHERE                         26,000               5,800


         NETWORK OPERATIONS. Network operations expense increased by $6.1
million to $6.5 million for the year ended December 31, 1999, compared to $0.4
million for the period January 15, 1998 (Inception) through December 31, 1998.
The increase in network operations expense was due primarily to growth in the
number of subscribers resulting from the introduction of our Z-Line Home
Edition services.

         SALES AND MARKETING. Sales and marketing expense increased $6.7
million Compared to $8.9 million for the year ended December 31, 1999, compared
to $2.2 million for the period January 15, 1998 (Inception) to December 31,
1998. The increase in sales and marketing expense is attributable to our
expanded sales and marketing efforts to increase our subscribers. We increased
our telemarketing and advertising expenses in 1999 in connection with the
introduction of our Z-Line Home Edition service. To meet the demands of our
growth we increased our personnel in this department from approximately 10 at
December 31, 1998 to approximately 20 at December 31, 1999. This increase is
also attributable to the fact that marketing of our services did not begin in
earnest until the fourth quarter of 1998.

         RESEARCH AND DEVELOPMENT. Research and development expenditures
decreased $1.1 million to $3.6 million for the year ended December 31, 1999,
compared to $4.7 million, for the period January 15, 1998 (Inception) to
December 31, 1998. We adopted the provisions of Statement of Position (SOP)
98-1, "Accounting for the



                                      30
<PAGE>   33
Cost of Computer Software Developed or Obtained for Internal Use," at the
beginning of 1999. As a result, $0.5 million of salary and related costs for
research and development relating to the development of internal use software
was capitalized, rather than expensed, for the year ended December 31, 1999,
compared to $0 for the period January 15, 1998 (Inception) through December 31,
1998.

         In 1998, we expensed internal software development costs, as we were
developing our Z-Line Anywhere and Z-Line Home Edition services and had not
fulfilled the requirements for capitalization. The development of our Z-Line
Home Edition, and the integration of our customer care and billing software
required significant expenditures from employee compensation and outside
consulting fees. These efforts were spent adding functionality and making
significant enhancements to our technology. A portion of these services and
purchases of software were capitalized in 1999 compared to 1998, as a result of
the adoption of SOP 98-1 discussed in the prior paragraph, causing research and
development expenses to decrease in 1999.

         GENERAL AND ADMINISTRATIVE. General and administrative expense
increased $11.8 million to $16.5 million for the year ended December 31, 1999,
compared to $4.7 million for the period January 15, 1998 (Inception) to
December 31, 1998. The increase in general and administrative expense was
primarily due to increases in its primary components of employee salaries,
temporary services, bad debt expense, and occupancy costs.

         We increased the number of employees in general and administrative
functions to 83 employees at December 31, 1999, from 22 employees at December
31, 1998. We increased our provision for bad debts during 1999, primarily
because of our increase in subscribers for the year. We have implemented
revised credit policies and are closely monitoring collection procedures to
help minimize these expenses in the future. We have increased our leased
facilities utilized to meet our increased personnel and growing need for
infrastructure to support our current and future needs.

         DEPRECIATION AND AMORTIZATION. Depreciation and amortization expense
increased $3.1 million to $4.4 million for the year ended December 31, 1999,
compared to $1.3 million for the period January 15, 1998 (Inception) through
December 31, 1998. The increase was due to purchases of equipment, facilities,
and the capitalized costs associated with internal software development
totaling $21.2 million for the year-ended December 31, 1999, compared to $11.4
million for the period January 15, 1998 (Inception) through December 31, 1998.

         INTEREST AND OTHER INCOME. Interest and other income increased $0.4
million to $0.6 million for the year ended December 31, 1999, compared to $0.2
million for the period January 15, 1998 (Inception) through December 31, 1998.
This increase was due primarily to the closing of two private securities
offerings in 1999 and our initial public



                                      31
<PAGE>   34
offering on December 15, 1999, which offering provided net proceeds of $109.1
million after underwriting discount and commissions. These transactions in 1999
provided for larger cash balances compared to 1998.

         INTEREST AND OTHER EXPENSE. Interest and other expense increased $3.2
million to $3.4 million for the year ended December 31, 1999, compared to $0.2
million for the period January 15, 1998 (Inception) through December 31, 1998.
The increase in our interest expense is primarily a result of our payments on
the CMB Capital, LLC sale-leaseback agreement. We anticipate a reduction in the
amount of interest expense in the future due to the extinguishment of our CMB
Capital, LLC $35.2 million revolving sale-leaseback credit facility on February
14, 2000.

         INCOME TAX EXPENSE. 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 year ended December 31, 1999 and the period January 15, 1998
(Inception) through December 31, 1998.

         NET LOSS. Our net loss increased $22.9 million to $36.0 million for
the year ended December 31, 1999, compared to $13.1 million for the period
January 15, 1998 (Inception) through December 31, 1998. This increase was due
primarily to the increases in expenses described above.

         NET LOSS ATTRIBUTABLE TO COMMON STOCKHOLDERS. Our net loss
attributable to common stockholders increased $24.3 million to $37.6 million
for the year ended December 31, 1999, compared to $13.3 million for the period
January 15, 1998 (Inception) through December 31, 1998. This increase was due
primarily to the increases in expenses described above. The non-cash charges
relating to preferred stock dividends and accretion was $1.7 and $0.2 million
for the year ended December 31, 1999 and the period January 15, 1998
(Inception) through December 31, 1998, respectively.

         EBITDA. Many securities analysts use the measure of earnings before
deducting interest, taxes, depreciation and amortization, also commonly referred
to as "EBITDA," as a way of evaluating our financial performance. EBITDA is not
a measure under generally accepted accounting principles, is not meant to be a
replacement for generally accepted accounting principles and should not be
considered an alternative to net income as a measure of performance or to cash
flows as a measure of liquidity. 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 negative EBITDA increased
$17.0 million to $28.9 million for the year ended December 31, 1999, compared to
$11.9 million for the period January 15, 1998 (Inception) through December 31,
1998.

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 fiber optic communication networks and the
co-location of switches and transmission equipment in incumbent local exchange
carriers' central offices. Although we will continue our capital expenditures
we do not expect 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
and marketing efforts that we have designed to achieve rapid penetration of our
target markets.



                                      32
<PAGE>   35


         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 December 31, 2000, we had an accumulated
deficit of $137.1 million, net operating loss carryforward of $172.0 million,
and $46.7 million in cash and cash equivalents. We have funded these
expenditures primarily through operating revenues, private securities
offerings, a sale-leaseback credit facility, receivables credit facility and an
initial public offering of 6.9 million shares of common stock (including the
underwriters' over-allotment option) that raised net proceeds of $109.1 million
after underwriting discounts and commissions. We intend to continue building
our organization in anticipation of future growth and believe that our
operating expenditures will also continue to increase.

         On February 14, 2000, we paid $14.0 million to extinguish the
outstanding CMB Capital, LLC capital lease obligation and purchase the related
assets. This was the repayment of transactions involving the sale-leaseback of
various furniture and equipment payable over four years from the date of the
transactions. This transaction accounted for a $1.6 million increase in the
carrying value of our assets, resulting from the payments made to terminate the
lease and the carrying value of our capital lease obligation. This $1.6 million
was added to the value of the assets purchased and is depreciated over the
estimated remaining lives in accordance with FASB Interpretation No. 26,
Accounting for Purchase of a Leased Asset by the Lessee during the Term of the
Lease, an interpretation of FASB Statement No. 13.

         On April 14, 2000, we completed the acquisition of Touch 1 for
approximately $9.0 million in cash and 1.1 million shares of our common stock.
The Touch 1 acquisition was accounted for using the purchase method of
accounting. The acquisition of Touch 1 resulted in a total of $67.8 million of
intangible assets, consisting of $9.2 million for customer lists and $58.6
million for goodwill, being amortized over 5 and 20 years, respectively.

         In July 2000, we filed a Certificate of Designation authorizing the
issuance of 5.0 million shares of $.01 par value Series D Convertible Preferred
Stock ("Series D Preferred"). We have received aggregate proceeds of
approximately $56.3 million in connection with the sale of 4,688,247 shares of
Series D Preferred at a price of $12.00. The deal costs associated with the
transaction were approximately $0.4 million. The Series D Preferred is
convertible at a conversion price of $12.00, which price is subject to
adjustment, into common stock at the option of the holder (i.e., initially
convertible on a one-for-one basis); however, there are certain circumstances
that provide for a forced conversion of the stock by us. Series D Preferred is
mandatorily redeemable 8 years from the original issue date, has an 8%
cumulative dividend payable at times in cash and at times with in-




                                      33
<PAGE>   36
kind contributions of additional Series D Preferred and has certain liquidation
preferences and voting rights. Each purchaser of Series D Preferred received a
warrant to purchase a number of shares of our common stock equal to one-half of
the amount of Series D Preferred purchased by such investor. Each warrant is
exercisable at a price of $13.80 per share subject to certain adjustments.

         In July 2000, we entered into an accounts receivable facility 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, with provisions for a commitment of up
to $50.0 million, subject to successful syndication of the receivables sales
program by RFC. We sold $1.4 million of receivables, for net proceeds of $0.8
million, for the year ended December 31, 2000. We recorded a loss of 0.6 million
for the sale of these receivables during 2000. We did not have any other
transactions relating to this facility in 2000.

         In July 2000, we also entered into an agreement with a service firm to
provide various content and new service offerings through the telephone. Under
this agreement we have invested $3.0 million in 2000 and are committed to an
additional $4.0 million in cash payments for future services. This contract
provides for early termination under certain circumstances with adjustments of
the commitments.

         In August 2000, we entered into an agreement with a service firm to
outsource customer provisioning through electronic bonding with incumbent local
exchange carriers. Under this agreement, we paid $0.5 million in 2000 and have
committed to the following minimum cash payments subject to certain adjustments
of $4.0, $7.7, and $9.0 million for the years ended December 31, 2001, 2002 and
2003, respectively. The payment of these fees are subject to the successful
completion by the service firm of certain obligations in the future. This
contract provides for various termination arrangements with related severance
fees.

         In November 2000, we filed a Certificate of Designation authorizing the
issuance of approximately 6.3 million shares of $.01 par value Series E
Convertible Preferred Stock ("Series E Preferred"). We received net proceeds of
approximately $50.0 million in connection with the sale of 4,166,667 shares of
Series E Preferred at a price of $12.00. The purchaser of Series E preferred
received a warrant to purchase a number of shares of our common stock equal to
one-half of the amount of Series E Preferred purchased by such investor. The
purchaser of Series E Preferred has the option, for ninety days after the
initial closing, to purchase (or designate another person who intends to
purchase) an additional 2,083,333 shares of Series E Preferred along with a
warrant to purchase 1,041,667 shares of our common stock, for approximately
$25.0 million, this option expired unexercised in February 2001. Series E
Preferred is convertible at a conversion price of $12.00, which price is
subject to adjustment, into common stock at the option of the holder (i.e.,




                                      34
<PAGE>   37

initially convertible on a one-for-one basis); however, there are certain
circumstances that provide for a forced conversion of the stock by us. Series E
Preferred is mandatorily redeemable 8 years from the original issue date, has
an 8% cumulative dividend payable in cash and has certain liquidation
preferences and voting rights. Each warrant is exercisable at a price of $13.80
per share subject to certain adjustments.

         In December 2000, we sold marketable securities we had purchased for
$0.8 million. This sale resulted in a gain of $2.7 million and provided $3.5
million to support operations.

         We received cash of $0.8 and $2.4 million of notes receivable from
stockholders for common stock and the exercise of stock options, respectively,
for the year ended December 31, 2000.

         The purchase of Touch 1 included the assumption of $38.0 million in
liabilities. We had payments on long-term debt and capital lease obligations
totaling $22.9 million for the year ended December 31, 2000.

         Our capital expenditures for 2000 were $34.2 million, exclusive of $8.9
million to purchase Touch 1. These outlays supported the addition of 300,000
Z-Line Home Edition subscribers during 2000. 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 have experienced an increase in our
capital expenditures consistent with the growth in our operations and staffing.
We expect to make additional investments in technologies and our network
architecture to the extent that we experience growth in the future.

         We have $20.4 million of fixed rate related party debt that is
primarily payable in monthly installments through 2004. We have a $3.0 million
balloon payment due in May 2001 and are in the process of attempting to
re-finance the terms of such debt. We will make investments in sales and
marketing to build our overall "Z" brand and build awareness about our City of
America and lower priced service offerings in an attempt to attract new
customers. We will focus on what we expect to be more efficient marketing
channels such as our on-line agent program and expect to lower acquisition costs
per customer. In the first quarter of 2001 we eliminated approximately 20% of
our workforce through a formal reduction in force, hiring freeze, and normal
attrition. We expect the above and other factors to result in the achievement of
positive EBITDA on a monthly basis during late second quarter or early third
quarter of 2001 and positive cash flow from operations sometime thereafter. We
believe that we have sufficient funding to execute our current business plan;
however, any acceleration or change to the business plan may require additional
equity or debt financing which may not be available on attractive terms, or at
all, or may be dilutive.

NEW ACCOUNTING PRONOUNCEMENTS

         The new accounting pronouncements in footnote one of our Consolidated
Financial Statements are incorporated by reference.

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

         The forward-looking statements in this document are based on the
belief of our management, as well as assumptions made by and information
currently available to our management. Forward-looking




                                      35
<PAGE>   38

statements also may be included in other written and oral statements made or
released by us. You can identify forward-looking statements by the fact that
they do not relate strictly to historical or current facts. The words
"believe," "anticipate," "intend," "expect," "estimate," "project" and similar
expressions are intended to identify forward-looking statements.
Forward-looking statements describe our expectations today of what we believe
is most likely to occur or may be reasonably achievable in the future, but they
do not predict or assure any future occurrence and may turn out to be wrong.
Forward-looking statements are subject to both known and unknown risks and
uncertainties and can be affected by inaccurate assumptions we might make.
Consequently, no forward-looking statement can be guaranteed. Actual future
results may vary materially. We do not undertake any obligation to publicly
update any forward-looking statements to reflect new information or future
events or occurrences. These statements reflect our current views with respect
to future events and are subject to risks and uncertainties about us,
including, among other things:

         o   our ability to market our services successfully to new
             subscribers;

         o   our ability to access markets and finance network developments and
             operations;

         o   our enhancement and expansion, including consumer acceptance of
             new price plans and bundled offerings;

         o   additions or departures of key personnel;

         o   competition, including the introduction of new products or
             services by our competitors;

         o   existing and future regulations affecting our business and our
             ability to comply with these regulations;

         o   our reliance on the Regional Bell operating company's systems and
             provisioning processes;

         o   technological innovations;

         o   general economic and business conditions, both nationally and in
             the regions in which we operate; and

         o   other factors described in this document, including those
             described in more detail below.

         We caution you not to place undue reliance on these forward-looking
statements, which speak only as of the date of this document.

RISKS RELATED TO OUR FINANCIAL CONDITION AND OUR BUSINESS

         LIMITED OPERATING HISTORY. We were formed in January 1998 and began
offering telecommunications services to the public in September 1998. We have
had fewer than three years of actual marketing, sales and operational results.
Our limited operating history and results make it very difficult to evaluate or
predict our ability to, among other things, retain customers, generate and
sustain a revenue base sufficient to cover our operating expenses, and to
achieve profitability. As a result, we believe that our historical financial




                                      36
<PAGE>   39

information is of little or no value in projecting our future results, making
it even more difficult to evaluate our business and prospects.

         UNCERTAIN DEMAND. We initially began to market our products and
services in September 1998. In June 1999, we focused our product offering on
sales of our Z-Line Home Edition service. Our products and services represent
an emerging sector of the telecommunications industry, and the demand for our
services and our ability to retain customers over time are highly uncertain.
Consumer acceptance of our products and services could be limited by:

         o   the willingness of customers to accept Z-Tel as an alternative
             provider of local and long distance telephone services and of
             other enhanced, integrated services;

         o   the presence and attractiveness of other enhanced
             telecommunications service offerings in our target markets;

         o   the perception of complexity in using our services;

         o   the reliability of our technology and network infrastructure;

         o   the quality of our customer service; and

         o   the prices of our services.

         We have determined that substantial marketing effort, time and expense
are required to stimulate initial demand for our products and services. In
addition, we have incurred and will continue to incur substantial operating
expenses, have made, and will continue to make, significant capital investments
and have entered or plan to enter into real property leases, equipment supply
contracts and service arrangements, in each case based upon our expectations as
to the market acceptance of our products and services. We cannot be certain
that substantial markets will develop for our products and services, or, if
such markets develop, that we will be able to attract and maintain a sufficient
revenue-generating customer base to cover our operating expenses. Lack of
acceptance of our services in our target markets would materially and adversely
affect the commercial viability of our business, and as a consequence, the
value of your investment.

         In addition, to maintain our competitive posture, we must be in a
position to reduce the prices for our services in order to meet reductions in
local and long distance rates, if any, offered by others. We cannot be sure
that we will be able to match the reductions made by our competitors and, if we
do, such reductions could have an adverse effect on our business, operating
results and financial condition.

         EXPECTATION OF FUTURE LOSSES. Our product and service offerings are at
an early stage, and we cannot be sure that sales of our products or services
will generate revenues sufficient to cover our operating expenses. Therefore our
operations may not become profitable within the time frame we expect or at all.
Starting up our company and developing our communications technology required
substantial capital and other expenditures and further development of our
business will require significant additional expenditures.



                                      37
<PAGE>   40

         AVAILABILITY AND FAVORABLE PRICING OF UNBUNDLED NETWORK COMPONENTS.
Our business strategy depends on a continued availability of unbundled network
components and on existing and additional states maintaining and adopting
favorable pricing rules for unbundled network components. The public utilities
commissions of certain states have adopted pricing rules for unbundled network
components. As a result of these regulatory initiatives, the Bell operating
companies operating in those states are required to offer to competitive local
exchange carriers such as us, at forward-looking, long-run incremental
cost-based prices, the facilities and equipment and the features, functions and
capabilities of their local exchange network on an unbundled basis. We have
commenced operations in seventeen states using unbundled network components.
However, given that the FCC order permitting unbundled network components is
subject to further appeal, we cannot be certain that unbundled network
components will continue to be available in their present form in those states
or other states or that such other states will ever adopt favorable unbundled
network components pricing. Further regulatory changes may adversely affect
unbundled network components or our Z-Line Home Edition strategy. Our business
model is based, in part, on availability and favorable pricing of the unbundled
network components, and any adverse changes in the unbundled network elements
platform regulatory or competitive environment could have a material adverse
effect on our business, financial condition and results of operations.

         RAPID EXPANSION. We have rapidly expanded our operations since we were
formed. We expect to grow our business rapidly in terms of the number of
services we offer, the number of customers we serve and the regions we serve.
We cannot assure you that we will successfully manage our efforts to:

         o   expand, train, manage and retain our employee base;

         o   expand and improve our customer service and support systems and
             improve the performance of billing systems;

         o   introduce and market new products and services and new pricing
             plans in addition to Z-Line Home Edition and our other service
             offerings;

         o   enhance and upgrade the features of our software;

         o   capitalize on new opportunities in the competitive marketplace;
             and

         o   control our expenses.

         The strains posed by these demands are magnified by the start-up
nature of our operations. If we cannot manage our growth effectively, our
results of operations could be adversely affected.

         DIFFICULTIES IN EXPANDING NETWORK INFRASTRUCTURE. We must continue to
develop, expand and adapt our network infrastructure as the number of our users
and the amount of information they wish to access and transfer increases and as
our customers' demands change. We cannot be sure that we will be able to
develop, expand or adapt the network infrastructure to meet additional demand
or our customers' changing requirements on a timely basis, at a commercially
reasonable cost, or at all. If we fail to expand our network infrastructure on
a timely




                                      38
<PAGE>   41

basis or adapt it to either changing customer requirements or evolving industry
standards, these failures could cause our business to perform poorly.

         ABILITY TO RESELL LONG DISTANCE SERVICES. We offer long distance
telephone services as part of our service packages. We currently have
agreements with various 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. In cases in which we have agreed
to minimum volume commitments and fail to meet them, we will be obligated to
pay underutilization charges. In some instances, if we incur underutilization
charges, our basic rate will increase, which could further adversely affect our
operating results.

         RISK OF SOFTWARE FAILURES AND ERRORS. The software that we use and the
software that we have developed internally and are continuing to develop may
contain undetected errors. Although we have extensively tested our software,
errors may be discovered in the software during the course of its use. Any
errors may result in partial or total failure of our network, loss or
diminution in service delivery performance, additional and unexpected expenses
to fund further product development or to add programming personnel to complete
or correct development, and loss of revenue because of the inability of
customers to use our products or services, which could adversely affect our
business condition.

         PROTECTION OF PROPRIETARY TECHNOLOGY. We currently rely on a
combination of copyright, trademark and trade secret laws and contractual
confidentiality provisions to protect the proprietary information that we have
developed. Our ability to protect our proprietary technology is limited, and we
cannot assure you that our means of protecting our proprietary rights will be
adequate or that our competitors will not independently develop similar
technology. Also, we cannot be certain that the intellectual property that
incumbent local exchange carriers or others claim to hold and that may be
necessary for us to provide our services will be available on commercially
reasonable terms. If we were found to be infringing upon the intellectual
property rights of others, we might be required to enter into royalty or
licensing agreements, which may be costly or not available on commercially
reasonable terms. If successful, a claim of infringement against us and our
inability to license the infringed or similar technology on terms acceptable to
us could adversely affect our business.

         DEPENDENCE ON INFORMATION SYSTEMS. Our billing, customer service and
management information systems are newly developed and we may face unexpected
system difficulties, which would adversely affect our service levels and,
consequently, our business.

         Sophisticated information and processing systems are vital to our
ability to monitor costs, render monthly invoices for services, process
customer orders and achieve operating efficiencies. We rely on internal systems
and third party vendors, some of which have a limited operating history, to
provide our information and processing systems. If our systems fail to perform
in a timely and effective manner and at acceptable costs, or if we fail to
adequately identify all of our information and processing needs or if our
related processing or information systems fail, these failures could have a
material adverse effect on our business.

         In addition, our right to use third party systems is dependent upon
license agreements. Some of these agreements are cancelable by the vendor, and
the cancellation or nonrenewal of these agreements




                                      39
<PAGE>   42

could seriously impair our ability to process orders or bill our customers. As
we continue to provide local telephone service, the need for sophisticated
billing and information systems will also increase significantly and we will
have significant additional requirements for data interface with incumbent
local exchange carriers and others. We cannot be certain that we will be able
to meet these additional requirements.

         NETWORK FAILURE. The successful operation of our network will depend
on a continuous supply of electricity at multiple points. Although the system
that carries signals has been designed to operate under extreme weather
conditions (including heavy rain, wind and snow), like all other
telecommunications systems, our network could be adversely affected by such
conditions. Our network, however, is equipped with a back-up power supply and
our existing network operations center is equipped with both a battery backup
and an on-site emergency generator. If a power failure causes an interruption
in our service, the interruption could negatively impact our operations.

         Our network also may be subject to physical damage, sabotage,
tampering or other breaches of security (by computer virus, break-ins or
otherwise) that could impair its functionality. In addition, our network is
subject to unknown capacity limitations that may cause interruptions in service
or reduced capacity for our customers. Any interruptions in service resulting
from physical damage or capacity limitations could cause our systems to fail.

         NETWORK INTERCONNECTION. As a competitive provider of local telephone
service, we must interconnect our network with the networks of incumbent local
exchange carriers. We may not be able to obtain the interconnection we require
at rates and on terms and conditions that permit us to offer services that are
both competitive and profitable. In the event that we experience difficulties
in obtaining high quality, reliable and reasonably priced services from other
carriers, the attractiveness of our services is likely to be significantly
impaired.

         DEPENDENCE ON LOCAL EXCHANGE CARRIERS. We rely on incumbent local
exchange carriers to supply key unbundled components of their network
infrastructure to us on a timely and accurate basis, and in the quantities and
quality demanded by us. We may from time to time experience delays or other
problems in receiving unbundled services or facilities which we request, and
there can be no assurance that we will able to obtain such unbundled elements
on the scale and within the time frames required by us. Any failure to obtain
these components, services or additional capacity on a timely and accurate
basis could adversely affect us.

         ANTICIPATED CAPITAL NEEDS. If we expand more rapidly than currently
anticipated or if our working capital needs exceed our current expectations, we
may need to raise additional capital from debt or equity sources. If we cannot
obtain financing on acceptable terms or at all, we may be required to modify,
delay or abandon our current business plan, which is likely to materially and
adversely affect our business and, as a result, the value of our common stock.

         DEPENDENCE ON THIRD PARTY VENDORS. We currently purchase the majority
of our telecommunications equipment as needed from third party vendors,
including Lucent Technologies, Inc., Sonus Networks, Inc., Dialogic
Communications Corporation, Hewlett-Packard Company, Compaq Computer
Corporation, Sun Microsystems, Inc. and EMC Corporation. In addition, we
currently license our software from third party vendors, including Oracle
Corporation, INPRISE Corporation, Mercator Software, Inc., Microsoft
Corporation, Nuance Communications, Inc., SpeechWorks International, Inc.,
Telution, Inc., AMS, Inc., Netscape Communications, Inc. and Accenture. We
typically do not enter into any




                                      40
<PAGE>   43

long-term agreements with our telecommunications equipment or software
suppliers. Any reduction or interruption in supply from our equipment suppliers
or failure to obtain suitable software licensing terms could have a disruptive
effect on our business and could adversely affect our results of operations.

         DEPENDENCE ON MANAGEMENT AND KEY PERSONNEL. We depend on a limited
number of key personnel who would be difficult to replace. If we lose the
services of some of our key personnel, our business could suffer. We currently
maintain a $5,000,000 key man life insurance policy on the life of Mr. D.
Gregory Smith, our president, chief executive officer and chairman of the
board. We also depend on a limited number of key management, sales, marketing
and product development personnel to manage and operate our business. In
particular, we believe that our success depends to a significant degree upon
our ability to attract and retain highly skilled personnel, including our
engineering and technical staff. If we are unable to attract and retain our key
employees, the value of our common stock could suffer.

RISKS RELATED TO OUR INDUSTRY

         GOVERNMENT REGULATION AND LEGAL UNCERTAINTIES. We are subject to
varying degrees of federal, state, and local regulation. In states where we
will provide intrastate services, we generally will be subject to state
certification or registration and tariff-filing requirements. Delays in
obtaining the required state regulatory approvals may have a material adverse
effect on our business. Challenges to our tariffs by third parties could cause
us to incur substantial legal and administrative expenses.

         We must also comply with various state and federal obligations that
are subject to change, such as the duty to contribute to universal service
subsidies, the impact of which we cannot assess on a going-forward basis as the
rates change periodically. While we do not believe that compliance with federal
and state reporting and regulatory requirements will be burdensome, our failure
to do so may result in fines or other penalties being imposed on us, including
loss of certification to provide services.

         Decisions of the FCC and state regulatory commissions providing
incumbent local exchange carriers with increased flexibility in how they price
their services and with other regulatory relief, could have a material adverse
effect on our business and that of other competitive local exchange carriers.
Future regulatory provisions may be less favorable to competitive local
exchange carriers and more favorable to their competitors. If incumbent local
exchange carriers are allowed by regulators to lower their retail rates, engage
in substantial volume and term discount pricing practices for their end-user
customers, or charge competitive local exchange carriers higher fees for
interconnection to the incumbent local exchange carriers' networks, our
business, operating results and financial condition could be materially
adversely affected. Incumbent local exchange carriers may also seek to delay
competitors through legal or regulatory challenges, or by recalcitrant
responses to requirements that they open their markets through interconnection
and unbundling of network elements. Our legal and administrative expenses may
be increased because of our having to actively participate in rate cases filed
by incumbent local exchange carriers, in which they seek to increase the rates
they can charge for the unbundled network element platform components. Our
profitability may be adversely affected if those carriers prevail in those
cases. Pending court cases, in which certain provisions of the
Telecommunications Act of 1996 will be conclusively interpreted, may result in
an increase in our cost of obtaining unbundled network elements.



                                      41
<PAGE>   44


         We are also subject to federal and state laws and regulations
prohibiting "slamming," which occurs when specific procedures are not followed
when a customer changes telecommunications services. Although we attempt to
diligently comply with all such laws and regulations and have procedures in
place to prevent "slamming," if violations of such laws and regulations occur,
we could become subject to significant fines and penalties, legal fees and
costs, and our business reputation could be harmed.

         COMPETITION. The telecommunications and information services markets
are intensely competitive and rapidly evolving. We expect competition to
increase in the future. Many of our potential competitors have longer operating
histories, greater name recognition, larger customer bases and substantially
greater financial, personnel, marketing, engineering, technical and other
resources than us. We believe the principal competitive factors affecting our
business operations will be price, the desirability of our service offering,
quality and reliability of our services, innovation and customer service. Our
ability to compete effectively will depend upon our ability to maintain high
quality, market-driven services at prices generally equal to or below those
charged by our competitors. Competitor actions and responses to our actions
could, therefore, materially and adversely affect our business, financial
condition and results of operations.

         We face competition from a variety of participants in the
telecommunications market. The largest competitor for local service in each
market in which we compete is the incumbent local exchange carrier serving that
market. Incumbent local exchange carriers have established networks,
long-standing relationships with their customers, strong political and
regulatory influence, and the benefit of state and federal regulations that,
until recently, favored incumbent local exchange carriers. In the local
exchange market, the incumbent local exchange carriers continue to hold
near-monopoly positions. The long distance telecommunications market in which
we compete has numerous entities competing for the same customers and a high
average churn rate as customers frequently change long distance providers in
response to the offering of lower rates or promotional incentives.

         Prices in the long distance market have declined significantly in
recent years and are expected to continue to decline. We will face competition
from large interexchange carriers. Other competitors are likely to include
incumbent local exchange carriers providing out-of-region (and, with the
removal of regulatory barriers, in-region) long distance services, other
incumbent local exchange carriers, other competitive local exchange carriers,
cable television companies, electric utilities, wireless telephone system
operators, microwave and satellite carriers and private networks owned by large
end users.

         The Telecommunications Act of 1996 facilitates such entry by requiring
incumbent local exchange carriers to allow competing providers to acquire local
services at wholesale prices for resale and to purchase unbundled network
elements at cost-based prices. A continuing trend toward combinations and
strategic alliances in the telecommunications industry, including potential
consolidation among incumbent local exchange carriers or competitive local
exchange carriers, or transactions between telephone companies and cable
companies outside of the telephone company's service area, or between
interexchange carriers and competitive local exchange carriers, could give rise
to significant new competitors.

         The enhanced and information services markets are also highly
competitive and we expect that competition will continue to intensify. Our
competitors in these markets will include information service




                                      42
<PAGE>   45
providers, telecommunications companies, on-line service providers and Internet
service providers.

         UNAUTHORIZED TRANSACTIONS; THEFT OF SERVICES. We may be the victim of
fraud or theft of service. From time to time, callers have obtained our
services without rendering payment by unlawfully using our access numbers and
personal identification numbers. We attempt to manage these theft and fraud
risks through our internal controls and our monitoring and blocking systems. If
these efforts are not successful, the theft of our services may cause our
revenue to decline significantly.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

         We currently have instruments sensitive to market risk
relating to exposure to changing interest rates and market prices. 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.


                                      43
<PAGE>   46
ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
                                                                           PAGE
                                                                           ----

Report of Independent Certified Public Accountants                          F-2


Consolidated Financial Statements:

     Consolidated Balance Sheets                                            F-3

     Consolidated Statements of Operations                                  F-4

     Consolidated Statements of Changes in Stockholders' Equity (Deficit)
         and Comprehensive Income                                           F-5

     Consolidated Statements of Cash Flows                                  F-6

Notes to Consolidated Financial Statements                                  F-8





                                      F-1
<PAGE>   47

               REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS


To the Board of Directors and Shareholders of
Z-Tel Technologies, Inc. and Subsidiaries


In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, changes in stockholders' equity (deficit)
and comprehensive income and cash flows present fairly, in all material
respects, the financial position of Z-Tel Technologies, Inc. and its
subsidiaries at December 31, 2000 and 1999, and the results of their operations
and their cash flows for each of the two years in the period ended December 31,
2000 and the period January 15, 1998(Inception) through December 31, 1998 in
conformity with accounting principles generally accepted in the United States of
America. These financial statements are the responsibility of the Company's
management; our responsibility is to express an opinion on these financial
statements based on our audits. We conducted our audits of these statements in
accordance with auditing standards generally accepted in the United States of
America, which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.

/s/ PricewaterhouseCoopers LLP

Tampa, Florida
February 23, 2001, except Note 18,
as to which the date is March 15, 2001



                                      F-2
<PAGE>   48

<TABLE>
<CAPTION>

Z-TEL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2000 AND 1999
(IN THOUSANDS, EXCEPT SHARE DATA)
-----------------------------------------------------------------------------------------------

                                                                           2000          1999
                                                                        ---------     ---------
<S>                                                                     <C>           <C>

ASSETS

Current assets:

    Cash and cash equivalents, including restricted cash of
           $1,267 in 2000                                               $  46,650     $ 101,657
    Accounts receivable, net of allowance for doubtful
        accounts of approximately $9,026 at December 31,
        2000 and $408 at December 31, 1999                                 65,432         4,245
    Prepaid expenses and other current assets                               7,159         2,304
                                                                        ---------     ---------
      Total current assets                                                119,241       108,206

Property and equipment, net                                                59,200        28,549
Intangible assets, net                                                     64,267            --
Other assets                                                                3,753           922
                                                                        ---------     ---------

        Total assets                                                    $ 246,461     $ 137,677
                                                                        =========     =========

LIABILITIES, MANDATORILY REDEEMABLE CONVERTIBLE PREFERRED
      STOCK AND STOCKHOLDERS' EQUITY

Current liabilities:
    Accounts payable and accrued liabilities                            $  44,693     $   8,648
    Deferred revenue                                                        7,666           517
    Current portion of long-term debt
        and capital lease obligations                                       7,637         3,726
                                                                        ---------     ---------
      Total current liabilities                                            59,996        12,891

Long-term debt and capital lease obligations                               12,780        10,408
                                                                        ---------     ---------

        Total liabilities                                                  72,776        23,299
                                                                        ---------     ---------

Mandatorily redeemable convertible preferred stock, $.01 par value;
      50,000,000 shares authorized; 8,854,914 issued and outstanding
      (aggregate liquidation value of approximately $84,585
      at December 31, 2000)                                                84,585            --
                                                                        ---------     ---------

Commitments and contingencies (Notes 8, 12, 17 and 18)

Stockholders' equity:
    Common stock, $.01 par value; 150,000,000
        shares authorized; 34,033,910 and 32,159,911 shares issued;
        33,754,235 and 31,880,236 outstanding, respectively                   340           322
    Notes receivable from stockholders                                       (839)       (1,683)
    Unearned stock compensation                                              (255)       (2,487)
    Additional paid-in capital                                            227,304       167,637
    Accumulated deficit                                                  (137,130)      (49,093)
    Accumulated other comprehensive income                                     (2)           --
    Treasury stock, 279,675 shares at cost                                   (318)         (318)
                                                                        ---------     ---------

      Total stockholders' equity                                           89,100       114,378
                                                                        ---------     ---------

        Total liabilities, mandatorily redeemable convertible
             preferred stock and stockholders' equity                   $ 246,461     $ 137,677
                                                                        =========     =========
</TABLE>

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



                                      F-3
<PAGE>   49

<TABLE>
<CAPTION>

Z-TEL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
-------------------------------------------------------------------------------------------------------------
                                                                                                 Period
                                                                                            January 15, 1998
                                                                    Year Ended            (Inception) through
                                                                    December 31,              December 31,
                                                               2000             1999              1998
                                                           ------------     -----------   -------------------
<S>                                                        <C>              <C>           <C>

Revenues                                                   $    177,668     $      6,615       $       140
                                                           ------------     ------------       -----------

Operating expenses:
   Network operations                                           107,077            6,518               382
   Sales and marketing                                           45,018            8,898             2,201
   Research and development                                       8,276            3,562             4,728
   General and administrative                                    91,330           16,493             4,718
   Depreciation and amortization                                 17,166            4,372             1,283
                                                           ------------     ------------       -----------

     Total operating expenses                                   268,867           39,843            13,312
                                                           ------------     ------------       -----------

     Operating loss                                             (91,199)         (33,228)          (13,172)
                                                           ------------     ------------       -----------

Nonoperating income (expense):
   Interest and other income                                      5,475              608               228
   Interest and other expense                                    (2,313)          (3,351)             (178)
                                                           ------------     ------------       -----------

     Total nonoperating income (expense)                          3,162           (2,743)               50
                                                           ------------     ------------       -----------

     Net loss                                                   (88,037)         (35,971)          (13,122)

     Less mandatorily redeemable convertible
         preferred stock dividends and accretion                 (3,644)          (1,654)             (190)
     Less deemed dividend related to beneficial
         conversion feature                                     (20,027)              --                --
                                                           ------------     ------------       -----------

     Net loss attributable to common stockholders          $   (111,708)    $    (37,625)      $   (13,312)
                                                           ============     ============       ===========

Weighted average common shares outstanding                   33,066,538       15,099,359         6,554,499
                                                           ============     ============       ===========

Basic and diluted net loss per share                       $      (3.38)    $      (2.49)      $     (2.03)
                                                           ============     ============       ===========
</TABLE>

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



                                      F-4
<PAGE>   50

<TABLE>
<CAPTION>

Z-TEL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT) AND COMPREHENSIVE INCOME
(IN THOUSANDS, EXCEPT SHARE DATA)
----------------------------------------------------------------------------------------------
                                                          Notes
                                    Common Stock        Receivable     Unearned    Additional
                                 -------------------       from          Stock       Paid-In
                                   Shares   Par Value  Stockholders  Compensation    Capital
                                 ---------- ---------  ------------  ------------  ----------
<S>                              <C>         <C>       <C>           <C>           <C>

Balances, January 15, 1998
  (Inception)                            --   $    --      $     --    $       --   $       --

Issuance of common stock          9,703,100        97        (3,329)                    10,929
Conversion of note payable
  and accrued interest to
  common stock                    4,708,000        47                                    5,473
Grant of stock options
  below intrinsic value                                                      (281)         281
Vesting of stock options
  granted below intrinsic
  value                                                                        89
Accrued dividend on
  referred stock                                                                          (190)
Net loss
                                 ----------  --------      --------  ------------   ----------

Balances, December 31, 1998      14,411,100       144        (3,329)         (192)      16,493

Issuance of common stock in
  Initial Public Offering,
  net of underwriter
  discount and commissions        6,900,000      69                                    109,020
Cost of issuance of common
  stock in Initial Public
  Offering                                                                              (1,693)
Issuance of common stock
   for exercise of stock
  options                           306,555         3                                      535
Issuance of common stock
   in exchange for
   services rendered                 55,000         1                                      299
Issuance of common stock
  to purchase assets                 11,000                                                 60
Conversion of preferred
  stock to common stock          10,476,256       105                                   39,809
Grant of stock options
   below intrinsic value                                                   (3,225)       4,768
Vesting of stock options
  granted below intrinsic
  value                                                                       930
Treasury stock received
  upon cancellation of
  notes receivable from
  stockholder                      (279,675)                    318
Repayment of stockholders'
  notes                                                       1,222
Forgiveness of stockholder
  note                                                          106
Accrued dividend on
  preferred stock                                                                       (1,654)
Net loss
                                 ----------  --------      --------  ------------   ----------

Balances, December 31, 1999      31,880,236       322        (1,683)       (2,487)     167,637

Issuance of common stock
  for acquisition or Touch 1      1,100,000        11                                   39,275
Issuance of common stock
  for exercise of stock
  options                           773,999         7                                    2,405
Repayment of stockholders'
  notes                                                         844
Vesting of stock options
  granted below intrinsic
  value                                                                     2,232       (2,621)
Warrants extinguished
  with debt                                                                                655
Warrants issued for
  litigation settlement                                                                    611
Mandatorily redeemable
  convertible dividends
  and preferred stock
  accretion                                                                             (3,644)
Warrants issued with
  preferred stock                                                                       22,986

Net Loss
Foreign currency
  translation adjustment


Comprehensive Income
                                 ----------  --------      --------  ------------   ----------
Balances, December 31, 2000      33,754,235   $   340      $   (839)   $     (255)  $  227,304
                                 ==========  ========      ========  ============   ==========
</TABLE>

<TABLE>
<CAPTION>

                                               Accumulated
                                                  Other                     Total
                                 Accumulated  Comprehensive  Treasury    Stockholders'
                                   Deficit       Income       Stock    Equity (Deficit)
                                 -----------  -------------  --------  ----------------
<S>                              <C>          <C>            <C>       <C>

Balances, January 15, 1998
  (Inception)                      $      --    $     --        $  --      $     --

Issuance of common stock                                                      7,697
Conversion of note payable
  and accrued interest to
  common stock                                                                5,520
Grant of stock options
  below intrinsic value                                                          --
Vesting of stock options
  granted below intrinsic
  value                                                                          89
Accrued dividend on
  referred stock                                                               (190)
Net loss                             (13,122)                               (13,122)
                                   ----------     -------       ------      ---------

Balances, December 31, 1998          (13,122)         --           --            (6)

Issuance of common stock in
  Initial Public Offering,
  net of underwriter
  discount and commissions                                                  109,089
Cost of issuance of common
  stock in Initial Public
  Offering                                                                   (1,693)
Issuance of common stock
   for exercise of stock
  options                                                                       538
Issuance of common stock
   in exchange for
   services rendered                                                            300
Issuance of common stock
  to purchase assets                                                             60
Conversion of preferred
  stock to common stock                                                      39,914
Grant of stock options
   below intrinsic value                                                      1,543
Vesting of stock options
  granted below intrinsic
  value                                                                         930
Treasury stock received
  upon cancellation of
  notes receivable from
  stockholder                                                    (318)           --
Repayment of stockholders'
  notes                                                                       1,222
Forgiveness of stockholder
  note                                                                          106
Accrued dividend on
  preferred stock                                                            (1,654)
Net loss                             (35,971)                               (35,971)
                                   ----------     -------       ------      ---------

Balances, December 31, 1999          (49,093)         --         (318)      114,378

Issuance of common stock
  for acquisition or Touch 1                                                 39,286
Issuance of common stock
  for exercise of stock
  options                                                                     2,412
Repayment of stockholders'
  notes                                                                         844
Vesting of stock options
  granted below intrinsic
  value                                                                        (389)
Warrants extinguished
  with debt                                                                     655
Warrants issued for
  litigation settlement                                                         611
Mandatorily redeemable
  convertible dividends
  and preferred stock
  accretion                                                                  (3,644)
Warrants issued with
  preferred stock                                                            22,986

Net Loss                             (88,037)                               (88,037)
Foreign currency
  translation adjustment                              (2)                        (2)
                                                                          ---------

Comprehensive Income                                                        (88,039)
                                   ----------     -------       ------    ---------
Balances, December 31, 2000        $(137,130)     $   (2)       $(318)     $ 89,100
                                   ==========     =======       ======    =========
</TABLE>


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



                                      F-5
<PAGE>   51

<TABLE>
<CAPTION>

Z-TEL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
--------------------------------------------------------------------------------------------------------------
                                                                                                  Period
                                                                                            January 15, 1998
                                                                        Year Ended         (Inception) through
                                                                        December 31,           December 31,
                                                                  2000          1999               1998
                                                               ---------     ---------     -------------------
<S>                                                            <C>           <C>           <C>
CASH FLOWS FROM OPERATING ACTIVITIES:

Net loss                                                       $ (88,037)    $ (35,971)          $(13,122)
                                                               ---------     ---------           --------
Adjustments to reconcile net loss to net cash used in
      operating activities:

    Depreciation and amortization                                 17,166         4,372              1,283
    Interest expense on capital lease obligation discount             --         2,192                 --
    Provision for bad debts                                       17,804           958                 54
    Expense charged for granting of stock options                   (389)          387                 89
    Expense charged for granting of stock for services                --           300                 --
    Interest expense converted to common stock                                      --                170
    Expense charged for issuance of warrants for litigation
      settlement                                                     611            --                 --
    Expense charged for issuance of warrants to extinguish
      debt                                                           655            --                 --
    Gain on sale of assets                                        (2,124)           --                 --
    Change in operating assets and liabilities:
      Increase in accounts receivable                            (71,581)       (5,188)               (69)
      Increase in prepaid expenses and other current assets       (5,592)       (1,881)              (423)
      Increase in other assets                                      (995)         (769)              (153)
      Increase in accounts payable and accrued liabilities        28,473         2,402              4,402
      Increase in deferred revenue                                 7,149           517                 --
                                                               ---------     ---------           --------
        Total adjustments                                         (8,823)        3,290              5,353
                                                               ---------     ---------           --------
        Net cash used in operating activities                    (96,860)      (32,681)            (7,769)
                                                               ---------     ---------           --------

CASH FLOWS FROM INVESTING ACTIVITIES:

    Proceeds from sale and leaseback transaction                      --        15,969                 --
    Proceeds from sale of receivables                                766            --                 --
    Proceeds from sale of marketable securities                    3,486            --                 --
    Purchases of property and equipment                          (34,849)      (21,151)           (11,393)
    Purchase of securities                                        (1,050)           --                 --
    Purchase of Touch 1, net of cash acquired                     (8,955)           --                 --
                                                               ---------     ---------           --------
        Net cash used in investing activities                    (40,602)       (5,182)           (11,393)
                                                               ---------     ---------           --------

CASH FLOWS FROM FINANCING ACTIVITIES:

    Proceeds from issuance of notes payable                           --            --              5,350
    Proceeds from issuance of mandatorily redeemable
        convertible preferred stock                              106,260        24,950             14,964
    Proceeds from issuance of initial public offering,
        net underwriter discount and commissions                      --       109,089                 --
    Payment of issuance cost for initial public offering              --        (1,693)                --
    Payment of issuance cost for mandatory redeemable
        preferred stock                                           (1,464)           --                 --
    Proceeds from exercise of stock options                        2,412           538              7,697
    Proceeds from notes receivable                                   844         1,222                 --
    Payments on long-term debt obligations                        (8,853)         (565)              (852)
    Payments on capital lease obligations                        (14,031)       (1,994)               (24)
    Payments of preferred stock dividends                         (2,713)           --                 --
                                                               ---------     ---------           --------
        Net cash provided by financing activities                 82,455       131,547             27,135
                                                               ---------     ---------           --------

Net increase in cash and cash equivalents                        (55,007)       93,684              7,973
Cash and cash equivalents, beginning of period                   101,657         7,973
                                                               ---------     ---------           --------

Cash and cash equivalents, end of period                       $  46,650     $ 101,657           $  7,973
                                                               =========     =========           ========
</TABLE>

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



                                      F-6
<PAGE>   52

<TABLE>
<CAPTION>

Z-TEL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
----------------------------------------------------------------------------------------------------------------------------
                                                                                                     Period
                                                                                                  January 15, 1998
                                                                                 Year Ended     (Inception) through
                                                                                 December 31,       December 31,
                                                                                     2000              1999            1998
                                                                                   -------           --------         ------
<S>                                                                                <C>               <C>              <C>

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
    Cash paid for interest                                                         $ 1,592           $  1,130         $    8
                                                                                   =======           ========         ======
NON-CASH INVESTING AND FINANCING ACTIVITIES:
    Property and equipment acquired under capital lease obligations                $    --           $ 15,944         $   95
    Property and equipment acquired with long-term debt                            $    --           $     --         $1,505
    Conversion of note payable and accrued interest to common stock                $    --           $     --         $5,520
    Increase in additional paid-in capital for stock options granted               $ 2,405           $  5,064         $  281
    Net increase in unearned stock compensation for stock options granted $          2,232           $  2,295         $  192
    Accrued dividends and accretion on preferred stock                             $ 3,644           $  1,654         $  190
    Notes receivable issued for common stock                                       $    --           $     --         $3,329
    Forgiveness of note receivable issued for common stock                         $    --           $   (106)        $   --
    Common stock issued for purchase of assets                                     $    --           $     60         $   --
    Treasury stock received upon cancellation of note receivable
        for common stock                                                           $    --           $   (318)        $   --
    Conversion of preferred stock to common stock                                  $    --           $ 39,914         $   --
    Beneficial conversion associated with preferred stock issuance                 $20,027           $     --         $   --
    Warrants extinguished with satisfaction of debt                                $   655           $     --         $   --
    Warrants issued in litigation settlement                                       $   611           $     --         $   --
    Acquisition of Touch 1
      Assets acquired, net of cash                                                 $85,967           $     --         $   --
      Liabilities assumed                                                          $37,979           $     --         $   --
      Assets acquired in exchange for common stock                                 $40,201           $     --         $   --
</TABLE>

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



                                      F-7
<PAGE>   53
Z-TEL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
-------------------------------------------------------------------------------

1.       NATURE OF BUSINESS

         DESCRIPTION OF BUSINESS

         Z-Tel Technologies, Inc. and subsidiaries ("Z-Tel" or the "Company")
         incorporated in Delaware on January 15, 1998 as Olympus
         Telecommunications Group, Inc. In March 1998, Olympus
         Telecommunications Group, Inc. changed its name to Z-Tel Technologies,
         Inc. Z-Tel Technologies, Inc. is the parent Company and has no other
         operations. The Company has eight wholly owned subsidiaries: Z-Tel
         Communications, Inc., Z-Tel Business Networks, Inc., Z-Tel Holdings,
         Inc., Z-Tel Communications of Virginia, Inc., Z-Tel, Inc., Z-Tel
         Network Services, Inc., Z-Tel Investments, Inc., and Touch 1
         Communications, Inc. and subsidiaries.

         Z-Tel is an emerging provider of advanced, integrated
         telecommunications services targeted to residential subscribers. Z-Tel
         offers local and long distance telephone services in combination with
         enhanced communication features accessible through the telephone the
         Internet and certain personal digital assistants. Z-Tel offers its
         Z-Line Home Edition service, at least on an initial marketing basis,
         in seventeen states. Z-Tel also provides long-distance
         telecommunications services to customers nationally.

         INITIAL PUBLIC OFFERING

         On December 15, 1999, the Company filed its initial public offering
         (IPO) of 6,900,000 shares (including the underwriters' over-allotment
         option) of its common stock at $17.00 per share. Net proceeds to the
         Company aggregated approximately $109.1 million after underwriter
         discount and commissions. All of the mandatorily redeemable convertible
         preferred stock outstanding at the date of the IPO was converted into
         10,476,256 shares of common stock as of the closing date of the
         offering.

2.       SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

         PRINCIPLES OF CONSOLIDATION

         The consolidated financial statements include the accounts of the
         Company and its wholly owned subsidiaries. All intercompany accounts
         and transactions have been eliminated.

         CASH AND CASH EQUIVALENTS

         The Company considers all highly liquid investments with original
         maturity dates of three months or less to be cash equivalents.

         RESTRICTED CASH

         In December 2000, approximately $1.3 million was segregated to
         guarantee three employees' margin loans. See footnote thirteen,
         related party transactions for further details. The guarantee is
         classified as restricted cash on the balance sheet at December 31,
         2000.

         PREPAID EXPENSES AND OTHER CURRENT ASSETS

         Prepaid expenses and other current assets consist primarily of prepaid
         maintenance and support contracts and advances to suppliers.

         PROPERTY AND EQUIPMENT

         Property and equipment are recorded at historical cost. Maintenance
         and repairs are expensed as incurred, while renewals and betterments
         are capitalized. Upon the sale or other disposition of property, the
         cost and related accumulated depreciation are removed from the




                                      F-8
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
-------------------------------------------------------------------------------

         accounts and any gain or loss is recognized in operations. Depreciation
         and amortization is provided on a straight-line basis. Effective
         January 1, 1999, the Company adopted Statement of Position ("SOP")
         98-1, "Accounting for the Cost of Computer Software Developed or
         Obtained for Internal Use." SOP 98-1 requires computer software costs
         related to internal software that is incurred in the preliminary
         project stage to be expensed as incurred. When the capitalization
         criteria of SOP 98-1 have been met, costs of developing or obtaining
         internal-use computer software are capitalized. The Company capitalized
         approximately $3.1 and $0.5 million of employee salary and related
         costs for internally developed software for the years ended December
         31, 2000 and 1999, respectively. Internal use software is included as a
         component of property and equipment on the consolidated balance sheet.

         LONG-LIVED ASSETS

         The Company reviews long-lived assets for impairment whenever events
         or changes in circumstances indicate that the carrying amount of an
         asset may not be recoverable. Recoverability of assets to be held and
         used is measured by a comparison of the carrying amount of an asset to
         future net undiscounted cash flows expected to be generated by the
         asset. If such assets are considered to be impaired, the impairment to
         be recognized is measured by the amount by which the carrying amount
         of the assets exceeds the discounted cash flows. The Company has
         recognized no impairment losses.

         INTANGIBLE ASSETS

         Intangible assets consist of customer lists and goodwill resulting from
         our acquisition in 2000, see footnote three. The customer lists and
         goodwill are amortized over five and twenty years, respectively, using
         the straight-line method and the intangibles are reviewed for
         impairment as outlined in our long-lived assets policy above.

         INVESTMENTS

         Included in investments are available for sale securities and
         investments accounted for utilizing the cost method of accounting, for
         those investments without a readily identifiable market. In accordance
         with Statement of Financial Accounting Standards ("SFAS") No. 115,
         "Accounting for Certain Investments in Debt and Equity Securities"
         securities that are available for sale are reported at fair value, if a
         readily identifiable market exists, with changes in the fair value from
         period to period included as a separate component of comprehensive
         income in equity. At December 31, 2000 the Company had approximately
         $0.4 million in investments, included in other assets, accounted for at
         cost since no readily identifiable market existed for these
         investments. Z-Tel received gross proceeds of approximately $3.5
         million and recognized a gain on available for sale securities in the
         amount of approximately $2.7 million for the year ended December 31,
         2000. The Company had no investments at December 31, 1999 and no sales
         of investments for the year ended December 31, 1999 and the period
         January 15, 1998 (Inception) through December 31, 1998.



                                      F-9
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
-------------------------------------------------------------------------------

         INCOME TAXES

         The Company utilizes the asset and liability method of accounting for
         income taxes. Under this method, deferred income taxes are recorded to
         reflect the tax consequences on future years of differences between
         the tax basis of assets and liabilities and their financial reported
         amounts at each year-end based on enacted laws and statutory rates
         applicable to the periods in which differences are expected to affect
         taxable income. A valuation allowance is provided against the future
         benefits of deferred tax assets if it is determined that it is more
         likely than not that the future tax benefits associated with the
         deferred tax asset will not be realized.

         STOCK-BASED COMPENSATION

         The Company applies the provisions of Accounting Principles Board
         ("APB") Opinion No. 25 and consequently recognizes 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. For stock options granted to non-employees,
         the Financial Accounting Standards Board ("FASB") issued 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. The Company also provides the required pro forma net income
         and earnings per share disclosures for grants made as if the fair value
         method defined in SFAS No. 123 had been applied.

         REVENUE RECOGNITION

         Revenues are recognized when earned. Revenues related to long distance
         and carrier access service charges are billed monthly in arrears, and
         the associated revenues are recognized in the month of service. In June
         1999, the Company began offering its local service, Z-Line Home
         Edition, to consumers. Charges for Z-Line Home Edition service are
         billed monthly in advance and the Company recognizes revenues for this
         service ratably over the service period, which management believes
         approximates the actual provision of services.

         ADVERTISING

         Advertising costs are expensed as incurred. Included in sales and
         marketing expenses are advertising costs of approximately $9.3, $7.1
         and $0.6 million for the years ended December 31, 2000 and 1999 and
         the period January 15, 1998 (Inception) through December 31, 1998,
         respectively.

         COSTS OF START-UP ACTIVITIES

         The Company expenses the costs of start-up activities as incurred.

         FOREIGN CURRENCY TRANSLATION

         The assets and liabilities of the Company's foreign subsidiary, whose
         functional currency is other than the U.S. Dollar, are translated at
         the exchange rates in effect on the reporting date, and income and
         expenses are translated at the weighted average exchange rate during
         the period. The net effect of translation gains and losses is not
         included in determining net




                                      F-10
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
-------------------------------------------------------------------------------

         income but is included in accumulated other comprehensive income,
         which is reflected as a separate component of shareholder's equity.
         Foreign currency translation gains and losses are included in
         determining net income. Such gains and losses are not material for any
         period presented.

         CONCENTRATIONS

         Financial instruments that potentially subject the Company to
         concentrations of credit risk consist principally of cash and cash
         equivalents and accounts receivable. The Company places its cash and
         cash equivalents in financial institutions considered by management to
         be high quality. The Company maintains cash balances at financial
         institutions in excess of the $100,000 insured by the Federal Deposit
         Insurance Corporation (FDIC). The Company had approximately $42.9 and
         $99.0 million invested in interest bearing money market and short-term
         fixed income investments that are not insured by the FDIC at December
         31, 2000 and 1999, respectively. The Company has not experienced any
         losses in these accounts and believes it is not exposed to any
         significant credit risk on cash balances.

         During the normal course of business, the Company extends credit to
         residential customers residing in the United States. The Company's
         services were introduced first into the states of New York and Texas,
         which has resulted in a concentration of credit to residential
         customers in these states. The Company believes its credit policies,
         collection procedures and allowance for doubtful accounts eliminate the
         exposure to significant credit risk of accounts receivable balances.

         The Company relies upon the Regional Bell Operating Companies
         ("RBOCs"), for provisioning of customers and the RBOCs are the primary
         suppliers of local central office switching and local telephone lines.
         Global Crossing Ltd is the primary supplier for the Company's
         long-distance calling.

         The Company relies upon two separate service providers for
         provisioning and billing services essential to support the Company's
         operations.

         SEGMENT REPORTING

         SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
         Information," requires that the Company report financial and
         descriptive information about reportable segments, and how these
         segments were determined. The Company determines the allocation and
         performance of resources based on total operations. Based on these
         factors, management has determined that the Company operates as one
         segment as defined by SFAS No. 131 during all periods presented.

         FINANCIAL INSTRUMENTS

         The recorded amounts of cash and cash equivalents approximate fair
         value due to the short-term nature of these instruments. The Company
         has determined that due to the interest rates and short-term nature of
         the capital lease obligation, the fair value approximates the value
         recorded. The Company has determined that the long-term debt assumed
         through acquisition is recorded at fair value. The interest rates were
         adjusted to the current market rate for purchase accounting treatment
         and the Company believes the debt is properly recorded at fair value.



                                     F-11

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
-------------------------------------------------------------------------------

         MANAGEMENT'S USE OF ESTIMATES

         The preparation of financial statements in conformity with generally
         accepted accounting principles requires management to make estimates
         and assumptions that affect the reported amounts of assets and
         liabilities and disclosure of contingent assets and liabilities at the
         date of the financial statements. Estimates also affect the reported
         amounts of revenues and expenses during the reporting period. Actual
         results could differ from those estimates.

         NEW ACCOUNTING PRONOUNCEMENTS

         In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
         Instruments and Hedging Activities", that would have been effective
         January 1, 2000. In June, 1999, the FASB issued SFAS No. 137,
         "Accounting for Derivatives Instruments and Hedging Activities --
         Deferral of the Effective Date of SFAS No. 133" postponing the
         effective date for implementing SFAS No. 133 to fiscal years beginning
         after June 15, 2000. In June 2000, the FASB issued SFAS No. 138,
         "Accounting for Certain Derivative Instruments and Certain Hedging
         Activities." SFAS No. 138 addresses certain issues related to the
         implementation of SFAS No. 133, but does not change the basic model of
         SFAS No. 133 or further delay the implementation of SFAS No. 133. The
         Company believes that the adoption of SFAS No. 133, 137 and 138 did not
         have a material impact on the Company's consolidated financial
         statements.

         In December 1999, the SEC issued Staff Accounting Bulletin No. 101
         ("SAB 101"), "Revenue Recognition in Financial Statements." While not
         intended to change current literature related to revenue recognition,
         SAB 101 provides additional guidance on revenue recognition policies
         and procedures. The Company believes that its current accounting
         policies and procedures related to revenue recognition comply with SAB
         101. SAB 101 did not have a material impact on the consolidated
         financial statements.

         In March 2000, the FASB released Financial Interpretation ("FIN")
         No. 44, "Accounting for Certain Transactions involving Stock
         Compensation, an interpretation of APB Opinion No. 25," which provides
         clarification of Opinion 25 for certain issues such as the
         determination of an employee, the criteria for determining whether a
         plan qualifies as a non-compensatory plan, the accounting consequences
         of various modifications to the terms of a previously fixed stock
         option or award, and the accounting for an exchange of stock
         compensation awards in a business combination. The Company believes
         that its practices are in conformity with this guidance, and therefore
         FIN 44 did not have a material impact on the Company's consolidated
         financial statements.

         In September 2000, the FASB issued SFAS No. 140, "Accounting for
         Transfers and Servicing of Financial Assets and Extinguishments of
         Liabilities", replacing SFAS No. 125, "Accounting for Transfers and
         Servicing of Financial Assets and Extinguishments of Liabilities."
         SFAS No. 140 revises criteria for accounting for securitizations,
         other financial asset transfers and collateral, and introduces new
         disclosures. SFAS No. 140 is effective for fiscal 2000 with respect to
         the new disclosure requirements and amendments of the collateral
         provisions originally presented in SFAS No. 125. All other provisions
         are effective for transfers of financial assets and extinguishments of
         liabilities occurring after March 31, 2001. The provisions are to be
         applied prospectively with certain exceptions. The Company has made
         all the necessary disclosures and does not expect SFAS No. 140 to have
         a material impact on the Company's consolidated financial statements.

         RECLASSIFICATION

         Certain amounts in the December 31, 1999 and 1998 financial statements
         have been reclassified to conform to the December 31, 2000
         presentation.



                                     F-12
<PAGE>   58

Z-TEL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
-------------------------------------------------------------------------------

3.       ACQUISITION OF TOUCH 1

         The Company completed the acquisition of Touch 1 Communications, Inc.
         ("Touch 1"), a reseller of long distance service to subscribers
         throughout the United States, on April 14, 2000. The purchase price for
         Touch 1 consisted of 1.1 million shares of the Company's common stock
         at a price of $35.71 per share, approximately $9.0 million in cash, and
         approximately $1.0 million in transaction and related fees. The
         acquisition of Touch 1 was accounted for using the purchase method of
         accounting and, accordingly, the results of operations of Touch 1 for
         the period from April 1, 2000 (the closing date for accounting
         purposes) are included in the accompanying condensed consolidated
         financial statements. The acquisition of Touch 1 resulted in
         approximately $67.8 million of intangible assets. The intangible assets
         are comprised of approximately $9.2 million for customer lists and
         approximately $58.6 million for goodwill, being amortized, on the
         straight line basis, over periods of five and twenty years,
         respectively. The Company recorded approximately $3.6 million of
         amortization of the intangible assets for the year ended December 31,
         2000.

         The following unaudited pro forma information presents a summary of
         our consolidated results of operations as if the acquisition had
         occurred at the beginning of the periods presented.

                                                                 UNAUDITED
         In thousands, except per share data:               2000          1999
         --------------------------------------------    ---------     --------

         Revenues                                        $ 192,307     $ 71,580
         Net loss                                          (87,741)     (40,337)
         Net loss attributable to common stockholders     (111,412)     (41,991)
         Loss per share                                      (3.34)       (2.59)


         The pro forma condensed consolidated financial information is not
         necessarily indicative of what Z-Tel's results of operations would
         have been had the acquisition been completed at the beginning of the
         periods presented or the future results of the Company's operations.

         Touch 1 and its wholly owned subsidiary, direcTEL, filed a voluntary
         petition for relief under Chapter 11 of the Bankruptcy Code on June
         29, 1999 and July 9, 1999, respectively, in the United States
         Bankruptcy Court for the Southern District of Alabama (the "Bankruptcy
         Court"). The Bankruptcy Court entered an order confirming the join
         plan of reorganization of Touch 1 and direcTEL on August 6, 1999 and
         entered final decrees closing the direcTEL case on October 5, 2000 and
         the Touch 1 case on October 30, 2000.

4.       ACCOUNTS RECEIVABLE AGREEMENT

         In July 2000, the Company entered into an accounts receivable
         agreement with RFC Capital Corporation, a division of Textron,
         Inc.("RFC"), providing for the sale of certain of the Company's
         accounts receivable to RFC. RFC has agreed to purchase up to $25.0
         million of the Company's accounts receivable, with provisions for a
         commitment of up to $50.0 million, subject to successful syndication
         of the receivable sales program by RFC. Z-Tel has




                                     F-13
<PAGE>   59

Z-TEL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
-------------------------------------------------------------------------------

         sold approximately $1.4 million of receivables to RFC, for net proceeds
         of approximately $0.8 million, for the year ended December 31, 2000.
         Z-Tel is responsible for the continued servicing of the receivables
         sold. The Company recorded a loss of approximately $0.7 million for the
         year ended December 31, 2000.

5.       PROPERTY AND EQUIPMENT

         At the respective dates, property and equipment consist of the
         following:
<TABLE>
<CAPTION>

                                                       DEPRECIABLE
                                                          LIVES         2000       1999
                                                       (In Years)
                                                       -----------    -------    -------
         <S>                                           <C>            <C>        <C>

         Switching equipment                               5-10       $15,635    $11,018
         Computer equipment                                5-10        25,068      9,237
         Software                                             3        23,832     10,820
         Furniture and office equipment                    5-10         9,174      1,078
         Leasehold improvements                            3-15         4,186        235
         Land and building                                20-30         4,123         --
         Construction-in-progress                                       2,371      1,815
                                                                      -------    -------
                                                                       84,389     34,203
         Less accumulated depreciation and amortization                25,189      5,654
                                                                      -------    -------
                                                                      $59,200    $28,549
                                                                      =======    =======
</TABLE>

         Depreciation expense related to property and equipment amounted to
         approximately $8.2, $2.0, and $0.6 million for the years ended December
         31, 2000 and 1999 and the period January 15 (Inception) through
         December 31, 1998, respectively. Amortization expense related to
         software amounted to approximately $5.4, $2.4 and $0.7 million for the
         years ended December 31, 2000 and 1999 and the period January 15
         (Inception) through December 31, 1998.

         At the respective dates, assets acquired under capital leases,
         included in property and equipment, consist of the following:

<TABLE>
<CAPTION>
                                                                        2000       1999
                                                                      -------    -------
         <S>                                                          <C>        <C>
         Switching equipment                                          $    --    $10,778
         Computer equipment                                                --      4,868
         Furniture and office equipment                                    95        298
                                                                      -------    -------
                                                                           95     15,944
         Less accumulated depreciation and amortization                    27      3,070
                                                                      -------    -------
                                                                      $    68    $12,874
                                                                      =======    =======
</TABLE>


         In March 1999, the Company entered into an agreement with CMB Capital,
         LLC (a wholly owned entity of a shareholder of the Company) to sell and
         lease-back certain equipment. This agreement allowed for a sale and
         lease-back of up to approximately $35.2 million of certain equipment
         with revolving terms of 48 months and an approximate effective interest
         rate ranging from 10.0% to 19.5%. Included in this agreement was a
         stock warrant to purchase 521,832 shares of common stock at $3.37 per
         share. The warrant expires in March 2009. The Company accounted for the
         warrant granted in accordance with SFAS No. 123, recognizing costs
         associated with the grant equal to the fair value of the warrant. The
         Company has recorded



                                     F-14
<PAGE>   60

Z-TEL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
-------------------------------------------------------------------------------

         the fair value of the warrant as a commitment fee associated with the
         capital lease obligation and included it as part of minimum lease
         payments.

         For the year ended December 31, 1999, the Company sold and leased-back
         certain equipment, receiving proceeds under this agreement of
         approximately $16.0 million. No gain or loss was recognized on the
         sale of these assets.

         In November 1999, the Company entered into an agreement with CMB
         Capital, LLC to restructure the terms of the leasing facility to allow
         for the early payment of the facility. The Company granted warrants for
         115,500 shares of common stock at $7.27 per share, the warrant expires
         in November 2009. At December 31, 1999, the Company had approximately
         $19.2 million available under this agreement for future sale and
         leaseback transactions. The assets of the Company collateralized these
         leases. In February 14, 2000, the Company paid approximately $14.0
         million in fulfillment of the capital lease obligations outstanding.

6.       OTHER ASSETS

         At the respective dates, other assets consist of the following:


                                                        2000      1999
                                                       ------     ----

         Deposits                                      $2,656     $217
         Certificates of deposit, restricted              573      500
         Interest receivable from stockholders            111      205
         Other                                            413       --
                                                       ------     ----
                                                       $3,753     $922
                                                       ======     ====

         The certificates of deposit are pledged as collateral on outstanding
         letters of credit in the amount of approximately $0.6 and $0.5 million
         at December 31, 2000 and 1999, respectively, related to lease
         obligations on two of the Company's office spaces.

7.       ACCOUNTS PAYABLE AND ACCRUED LIABILITIES

         At the respective dates, accounts payable and accrued liabilities
         consist of the following:

                                                         2000      1999
                                                       -------    ------

         Trade accounts payable                        $32,679    $5,177
         Accrued payroll and related liabilities         3,982       744
         Dividend payable to preferred shareholders         --     1,844
         Accrued taxes payable                           2,239       100
         Accrued rent                                    1,218       441
         Other accrued liabilities                       4,575       342
                                                       -------    ------
                                                       $44,693    $8,648
                                                       =======    ======



                                     F-15
<PAGE>   61

Z-TEL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
-------------------------------------------------------------------------------

8.       LONG-TERM DEBT

         Long-term debt consists of the following:

<TABLE>
<CAPTION>

                                                                                             2000        1999
                                                                                           --------     ------
         <S>                                                                               <C>          <C>
         RELATED PARTIES:

         Note payable to Corman Elegre Capital L.L.C ("Corman Elegre"),
              customer base pledged as collateral, balloon payment due May 2001,
              interest rate at prime plus one and one-half percent, which was 11%
              at December 31, 2000                                                         $  3,000     $   --

         Note payable to Corman Elegre, customer base pledged as collateral, payable
              in monthly installments through September, 2004, interest rate at 6%            9,868         --

         Note payable to First Revocable Trust of W. F. Corman, unsecured
               payable in monthly installments through September 2004, interest rate at 6%      612         --

         Note payable to James F. Corman, unsecured, payable in monthly
               installments through September 2004, interest rate at 6%                         211         --

         UNRELATED PARTIES:

         Note  payable to Franklin Investment Funds, unsecured, payable in monthly
               installments, through September 2004, interest rate of 6%                      4,250         --

         Note payable to First National Bank of Atmore, unsecured, personally
               guaranteed by James F. Corman, payable in monthly installments,
               through September 2004, interest rate at 6%                                      570         --

         Notes payable to pre-petition creditors (trade vendors), unsecured,
               payable in monthly installments, through September 2004, interest rate
               at 6%                                                                          1,475         --

         Notes payable to pre-petition creditors (trade vendors), priority unsecured,
               payable in monthly installments, through September 2005, interest rate
               at 6%                                                                            417         --
                                                                                           --------     ------
                                                                                             20,403         --

         Less:  Current portion                                                              (7,623)        --
                                                                                           --------     ------
                                                                                           $ 12,780     $   --
                                                                                           ========     ======
</TABLE>

         OPERATING LEASES

         The Company has entered into various non-cancelable operating leases
         for equipment and office space with monthly payments through the year
         2005. Included in general and administrative expense is rental
         expense relating to operating leases of approximately $1.7, $1.6 and
         $0.2 million for the years ended December 31, 2000 and 1999, and the
         period January 15, 1998 (Inception) through December 31, 1998,
         respectively. Sales and marketing




                                     F-16
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Z-TEL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
-------------------------------------------------------------------------------

         expense includes $0.6 million of rental expense relating to operating
         leases for the year ended December 31, 2000.

         CAPITAL LEASES

         The Company entered into various capital lease obligations during 1999
         that had effective interest rates ranging from 10.0% to 19.5%, with
         one capital lease remaining with payments through 2001.

         Future minimum lease payments under non-cancelable operating and
         capital leases and long-term debt as of December 31, 2001 are as
         follows:

<TABLE>
<CAPTION>

                                                                                                        Capital
                                                                                        Operating        Lease       Long-Term
   Year Ending December 31,                                                               Leases      Obligations       Debt
   ------------------------                                                             ---------     -----------    ---------
<S>                                                                                     <C>           <C>            <C>

           2001                                                                            3,519          $19         $ 6,976
           2002                                                                            3,877                        4,390
           2003                                                                            3,845                        4,893
           2004                                                                            3,877                        4,063
           2005                                                                            2,706           --              81
           Thereafter                                                                      5,256
                                                                                          -------         ---         -------
           Net minimum payments                                                           23,080           19         $20,403
                                                                                                                      =======
                  Less amount representing interest on obligations under capital lease                     (5)
                                                                                                          ---

                  Present value of minimum lease and long-term debt payments                              $14
                                                                                                          ===
</TABLE>


9.       MANDATORILY REDEEMABLE CONVERTIBLE PREFERRED STOCK

         During 1998, the Company amended its articles of incorporation to
         authorize the issuance of up to 5,930,749 shares of Series A
         mandatorily redeemable convertible preferred stock ("Series A
         Preferred") and 1,338,208 shares of Series B mandatorily redeemable
         convertible preferred stock ("Series B Preferred"), both with a $.01
         par value.

         In November 1998, the Company closed a private placement of 2,695,795
         shares of Series A Preferred and 1,338,208 shares of Series B
         Preferred, receiving aggregate net proceeds of approximately $15
         million.

         During 1999, the Company amended its articles of incorporation to
         reduce the authorized




                                      F-17
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Z-TEL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
-------------------------------------------------------------------------------

         shares of its Series A Preferred from 5,930,749 to 2,695,795 and
         increase the authorized shares of its Series B Preferred from 1,338,208
         to 4,034,003. In September 1999, the Company closed a private placement
         of 2,695,795 shares of Series B mandatorily redeemable convertible
         preferred stock. The Company received aggregate net proceeds of
         approximately $10 million from this placement.

         In October 1999, the Company amended its articles of incorporation to
         authorize the issuance of up to 2,794,800 shares of its Series C
         mandatorily redeemable convertible stock (Series C Preferred). The
         Company closed a private placement of 2,794,800 shares of Series C
         Preferred stock. The Company received aggregate net proceeds of
         approximately $15 million from this placement.

         The preferred stock issues yielded 8% cumulative dividends, which
         amounted to approximately $1.7 and $0.2 million at December 31, 1999
         and 1998, respectively. In December 1999, in connection with the
         closing of the Company's IPO, all of the mandatorily redeemable
         convertible preferred stock outstanding was converted into 10,476,256
         shares of common stock.

         In January 2000, the Company paid $1.4, $0.2, and $0.2 million to
         the Series A, B, and C Preferred shareholders in satisfaction of the
         8% cumulative dividend as all shares were converted to common stock.

         In July 2000, the Company filed a Certificate of Designation
         authorizing the issuance of 5.0 million shares of $.01 par value
         Series D Convertible Preferred Stock ("Series D Preferred"). The
         Company has received aggregate proceeds of approximately $56.3 million
         in connection with the sale of 4,688,247 shares of Series D Preferred
         at a price of $12.00. The deal costs associated with the transaction
         were approximately $0.4 million. The Series D Preferred is convertible
         at a conversion price of $12.00, which price is subject to adjustment,
         into common stock at the option of the holder (i.e., initially
         convertible on a one-for-one basis); however, there are certain
         circumstances that provide for a forced conversion of the stock by the
         Company. Series D Preferred is mandatorily redeemable 8 years from the
         original issue date, has an 8% cumulative dividend payable at times in
         cash and at times in-kind with additional Series D Preferred and has
         certain liquidation preferences and voting rights. Each purchaser of
         Series D Preferred received a warrant to purchase a number of shares
         of Z-Tel common stock equal to one-half of the amount of Series D
         Preferred purchased by such investor. Each warrant is exercisable at a
         price of $13.80 per share subject to certain adjustments.

         In October 2000, the Company paid $0.9 million to the Series D
         Preferred shareholders in satisfaction of the 8% cumulative dividend.



                                     F-18
<PAGE>   64

Z-TEL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
-------------------------------------------------------------------------------

         In November 2000, the Company filed a Certificate of Designation
         authorizing the issuance of approximately 6.3 million shares of $.01
         par value Series E Convertible Preferred Stock ("Series E Preferred").
         The Company received proceeds of approximately $50.0 million in
         connection with the sale of 4,166,667 shares of Series E Preferred at
         a price of $12.00. The purchaser of Series E Preferred received a
         warrant to purchase a number of shares of Z-Tel common stock equal to
         one-half of the amount of Series E Preferred purchased by such
         investor exercisable at a price of $13.80 per share subject to certain
         adjustments. The purchaser of Series E Preferred had the option, for
         ninety days from November 13, 2000 (initial closing), to purchase (or
         designate another person who intends to purchase) an additional
         2,083,333 shares of Series E Preferred along with a warrant to purchase
         1,041,667 shares of Z-Tel common stock, for approximately $25.0
         million. This option expired unexercised in February 2001. Series E
         Preferred is convertible at a conversion price of $12.00, which price
         is subject to adjustment, into common stock at the option of the
         holder (i.e., initially convertible on a one-for-one basis); however,
         there are certain circumstances that provide for a forced conversion
         of the stock by the Company. Series E Preferred is mandatorily
         redeemable 8 years from the original issue date, has an 8% cumulative
         dividend payable in cash and has certain liquidation preferences and
         voting rights.

         In accordance with Emerging Issues Task Force 98-5, "Accounting for
         Convertible Securities with Beneficial Conversion Features or
         Contingently Adjustable Conversion Ratios," ("EITF 98-5") APB Opinion
         No. 14, "Accounting for Convertible Debt and Debt Issued with Stock
         Purchase Warrants," and SFAS No. 128 "Earnings Per Share" the Company
         has recorded non-cash charges relating to a beneficial conversion,
         cumulative dividends and preferred stock accretion of approximately
         $20.0, $1.1, and $2.5 million and approximately $0.0, $0.0, and $1.7
         million, for the years ended December 31, 2000, 1999 and the period
         January 15, 1998 (Inception) through December 31, 1998, respectively.
         During the year ended December 31, 2000 Z-Tel used the "stated
         conversion price" method, included in EITF 98-5, for the original
         calculation of a beneficial conversion of approximately $7.4 million
         during the third quarter of 2000. The beneficial conversion related to
         the issuance of Series D Preferred. EITF 98-5 allowed for the usage of
         the "stated conversion price" method for the purpose of calculating
         beneficial conversions until the fourth quarter of 2000. In November
         2000, the Emerging Issues Task Force 00-27, "Application of Issue No.
         98-5 to Certain Convertible Instruments" required that all beneficial
         conversions be calculated using the "accounting conversion price"
         method. Z-Tel recorded a cumulative catch-up adjustment of
         approximately $12.6 million in the fourth quarter of 2000 since the SEC
         required retroactive application of this method. The Company has
         restated the third quarter earnings per share to reflect the change in
         footnote nineteen.

         The recording of the beneficial conversion feature and the resulting
         preferred stock accretion is the result of calculating the accounting
         conversion price through a fair value allocation of the net proceeds
         received in the preferred stock offerings in 2000 between the preferred
         stock and the warrants issued. This required the use of the
         Black-Scholes valuation model to calculate the fair value on a per
         share or warrant basis for both the Series D Preferred and Series E
         Preferred. The beneficial conversion and resulting preferred stock
         accretion and the cumulative dividend are included in the calculations
         of the net loss attributable to common stockholders and the Company's
         net loss per share calculation.



                                     F-19
<PAGE>   65

Z-TEL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
-------------------------------------------------------------------------------

10.      COMMON STOCK

         In connection with the closing of the IPO, the Company amended its
         Articles of Incorporation to provide the authority to issue
         150,000,000 shares of common stock and 50,000,000 shares of preferred
         stock, both with a $.01 par value.

         No dividends on common stock have been declared by the board of
         directors since January 15, 1998 (Inception).

         On November 19, 1999, the Company's Board of Directors authorized an
         11 for 10 stock split, which was affected in the form of a 10% stock
         dividend. All common share amounts have been adjusted to give effect
         to this split.

         On February 19, 2001, the Board of Directors of the Company adopted a
         Stockholders Rights Agreement (the "Plan") designed to deter coercive
         takeover tactics and prevent an acquirer from gaining control of the
         Company without engaging in negotiation with the Board of Directors of
         the Company.

         Under the terms of the plan, preferred stock purchase rights were
         distributed as a dividend at the rate of one right for each share of
         common stock, par value $0.01 per share, of the Company (and a
         corresponding number of rights for each outstanding share of the
         Company's Series D Preferred and Series E Preferred Stock) outstanding
         at the close of business on March 7, 2001. Until the rights become
         exercisable, additional common stock or Series D Preferred or Series E
         Preferred issued by the Company will also have one right attached.

         The rights will become exercisable only upon certain triggering events
         whereby certain persons or groups of persons have or have expressed
         the intent to acquire at least 15% or more of the voting power of the
         outstanding common shares.

         Upon the occurrence of a triggering event, each right will entitle
         holders to buy one one-thousandth of a share of Series F Junior
         Participating Preferred Stock of the Company, par value $0.001 per
         share, at an exercise price of $45 per one-thousandth of a share,
         subject to adjustment. Each holder of a right will thereafter have the
         right to receive, in lieu of Series F Junior Participating Preferred
         Stock and upon payment of the exercise price, common stock (or in
         certain circumstances, cash, property or other securities of the
         Company) having a value equal to two times the exercise price of the
         right. The Company, except as otherwise provided in the plan, will
         generally be able to redeem the rights at $0.001 per right at any time
         on or prior to a triggering event. The rights will expire on February
         19, 2011, unless earlier redeemed by the Board of Directors.

11.      INCOME TAXES

         The Company accounts for income taxes under SFAS No. 109, "Accounting
         for Income Taxes." Deferred income tax assets and liabilities are
         determined based upon differences between financial reporting and tax
         basis of assets and liabilities and are measured using the enacted tax
         rates and laws that will be in effect when the differences are
         expected to reverse.



                                     F-20
<PAGE>   66

Z-TEL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
-------------------------------------------------------------------------------

         A reconciliation of the difference between the effective income tax
         rate and the statutory federal tax rate follows:

                                                  2000         1999
                                                --------     --------

         Tax at U.S. statutory rate             $(30,813)    $(12,590)
         State taxes, net of federal benefit      (2,565)      (1,045)
         Goodwill amortization                       768           --
         Change in valuation allowance            32,218       13,635
         Other                                       392           --
                                                --------     --------
                                                $     --     $     --
                                                ========     ========


         Significant components of the Company's deferred tax assets and
         liabilities are as follows:

                                                   2000         1999
                                                 --------     --------

         Current deferred tax assets:
             Accounts receivable                 $  3,430     $    155
             Other                                    214           --

         Noncurrent deferred tax assets:
             Net operating loss carryforward       65,358       18,742
             Deferred compensation                    468          295
             Other                                    505          292
                                                 --------     --------
         Gross deferred tax assets                 69,975       19,484
         Less:  Valuation allowance               (63,659)     (18,608)
                                                 --------     --------
                                                    6,316          876
         Noncurrent deferred tax liabilities:
         Property and equipment                    (3,362)        (876)
         Intangible assets                         (2,954)          --
                                                 --------     --------
         Net deferred tax asset                  $     --     $     --
                                                 ========     ========

         Generally accepted accounting principles require a valuation allowance
         to reduce the deferred tax assets reported if, based on the weight of
         the evidence, it is more likely than not that some portion or all of
         the deferred tax assets will not be realized. After consideration of
         all of the evidence, both positive and negative, management has
         determined that a valuation allowance of approximately $63.7 and $18.6
         million is necessary at December 31, 2000 and 1999, respectively.

         At December 31, 2000 and 1999, the Company's net operating loss
         carryforward for federal income tax purposes is approximately $172.0
         and $49.3 million, expiring in various amounts from 2011 through 2020.
         The net operating loss carryforwards are subject to certain tax law
         provisions that limit the utilization of net operating losses following
         a change in ownership.



                                     F-21
<PAGE>   67

Z-TEL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
-------------------------------------------------------------------------------

12.      COMMITMENTS AND CONTINGENCIES

         The Company has disputed billings and access charges to and from
         certain inter-exchange carriers (IXCs) and incumbent local exchange
         carriers (ILECs). The Company contends the invoicing and billings of
         access charges are not in accordance with the interconnection, service
         level, or tariff agreements entered between the Company and certain
         IXCs and ILECs. The Company has not paid for a portion of these
         disputes and management believes that the Company will prevail in these
         disputes. At December 31, 2000 and 1999, the disputed amounts
         were approximately $9.1 and $2.3 million, respectively.

         In July 2000, the Company entered into an agreement with a service firm
         to provide various content and new service offerings through the
         telephone. Under this agreement, Z-Tel has invested $3.0 million in
         2000, included in prepaid assets, and is committed to an additional
         $4.0 million in cash payments for future services. This contract
         provides for early termination under certain circumstances with
         adjustments of the commitments.

         In August 2000, the Company entered into an agreement with a service
         firm to outsource customer provisioning through electronic bonding with
         incumbent local exchange carriers. Under this agreement, the Company is
         committed to the following minimum cash payments, subject to certain
         adjustments of approximately $4.0, $7.7, and $9.0 million for the years
         ended December 2001, 2002, and 2003, respectively. The payment of these
         fees are subject to the successful completion by the service firm of
         certain obligations in the future. This contract provides for various
         termination arrangements with related severance fees.

         As of December 31, 2000 the Company is obligated to monthly minimum
         cash payments to an outside service provider for network maintenance up
         to $0.8 million. The Company expects this to be completed by 2002.

13.      RELATED PARTY TRANSACTIONS

         During 1998, various executives of the Company issued full recourse
         promissory notes, totaling approximately $3.3 million to the Company in
         connection with the purchase of 2,929,575 shares of common stock. The
         accompanying consolidated financial statements include the notes as a
         decrease in stockholders' equity. The outstanding notes receivable at
         December 31, 2000 and 1999 are approximately $0.9 and $1.7 million
         respectively. The Company received payments of approximately, $0.8 and
         $1.2 million in 2000 and 1999, respectively. The principal balance of
         the notes and the related accrued interest (8% per annum) are due
         December 31, 2001. The notes are collateralized by the shares of common
         stock acquired with the notes, and those shares are held in escrow by
         the Company. Interest income on these notes receivable was $0.1, $0.3,
         and $0.1 million for the years ended December 31, 2000, 1999 and the
         period January 15, 1998 (Inception) through December 31, 1999,
         respectively.



                                     F-22
<PAGE>   68

Z-TEL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
-------------------------------------------------------------------------------

         During 1998, an executive loaned the Company approximately $5.4 million
         with interest at a rate of 8% per year until paid. In August 1998, the
         Company issued 4,708,000 shares of common stock to the executive in
         satisfaction of the debt and accrued interest payable of approximately
         $1.7 million.

         In September 1999, the Company cancelled approximately $0.3 million of
         notes receivable and reacquired 279,675 shares of common stock at
         $1.14 per share from an employee. At December 31, 2000 and 1999, these
         shares are presented as treasury shares, at cost.

         In May 2000, as a result of a change of control provision that was
         triggered by the acquisition of Touch 1, Touch 1 purchased a building
         used to house its technology infrastructure from its lessor,
         Brookwood, L.L.C., for approximately $3.5 million from a limited
         liability company of which an executive of Z-Tel is a significant
         shareholder.

         During 2000, the Company made total payments of approximately $5.6
         million, exclusive of approximately $3.5 million to purchase a building
         as described in the above paragraph, to an executive and several
         entities affiliated with this executive pursuant to debt and lease
         agreements. The entities and the various debt terms are outlined in
         footnote eight, under related party, with the total amounts owed to
         each of the entities for each of the years ended December 31, 2000
         and 1999.

         During 2000, a member of the Board of Directors of the Company received
         approximately $0.2 million from Breckenridge Securities Corporation
         ("BSC"), which fee was paid from amounts paid by the Company to BSC in
         connection with services provided in conjunction with the issuances of
         Series D and Series E Preferred. The member of the Board of Directors
         entered into this agreement prior to being appointed to the Board.

         During 2000, the Company made payments of $0.1 million in rental
         payments to Olympus Management Group, Inc., an entity 100% owned by
         a Company executive.

         In December 2000, the Company agreed to a guarantee of three employees'
         margin loans. This required the Company to segregate the guarantee
         amount of approximately $1.3 million into a restricted cash account.
         Each employee executed an agreement with the Company in which each
         pledges to the Company a security interest in all shares of the
         Company's common stock they own as well as in all of their other
         tangible and intangible property. In addition, each employee entered
         into a Secured Promissory Note providing that, should any amounts be
         drawn on the Company guarantee by the creditor who made the margin loan
         to these employees, such amounts would be considered advances under a
         secured promissory note and would bear interest until paid.

14.      EMPLOYEE BENEFIT PLAN

         In 1999, the Company established a 401(k) plan covering defined
         employees who meet established eligibility requirements. Under the
         original plan provisions, the company did not make matching
         contributions. Effective September 15, 2000, the Company merged the
         plans of Touch 1 and Z-Tel and established a matching contribution for
         the 401(k) plan to 50% of participating contributions to a maximum
         matching amount of 5% of a participant's compensation. The Company
         contribution was approximately $0.2 million for the year ended December
         31, 2000.



                                     F-23
<PAGE>   69

Z-TEL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
-------------------------------------------------------------------------------

15.      STOCK-BASED COMPENSATION

         Effective October 30, 1998, the Company adopted the 1998 Equity
         Participation Plan ("1998 Plan"), for the grant to eligible employees
         and eligible participants of options to purchase up to 1,261,000
         shares of the Company's common stock. During September and November
         1999, the Board of Directors (the "Board") increased the shares
         available for grant under the 1998 Plan to 6.0 and 7.5 million shares,
         respectively.

         Effective April 20, 2000, the Company adopted the 2000 Equity
         Participation Plan ("2000 Plan"), this plan allows for the grant to
         eligible employees and eligible participants of options to purchase up
         to 2.0 million shares of the Company's common stock. The 2000 Plan
         automatically increases the number of shares available for grant on
         the first day of the company's fiscal year beginning in 2001 equal to
         the lesser of (i) 3.0 million shares, (ii) 6% of the outstanding
         shares on such date, or (iii) a lesser amount determined by the Board.

         The Plan is administered by a committee appointed by the Board, or by
         the Board. The Board or the appointed committee shall administer the
         2000 Plan, select the eligible employees and eligible participants to
         whom options will be granted, the price to be paid, the exercise
         period and the number of shares subject to any such options and
         interpret, construe and implement the provisions of the 2000 Plan.

         During the years ended December 31, 2000 and 1999 and the period
         January 15, 1998 (Inception) through December 31, 1998, respectively,
         the Company awarded options under the 1998 and 2000 Plan for the right
         to purchase 3,305,540, 3,187,225 and 201,050, shares of common stock,
         respectively, at a weighted average option price per share of $18.28,
         $5.79 and $3.64, respectively. Stock option grants approximate the
         fair market value at the date of grant. The vesting periods on these
         options range from immediately to four years and have a maximum
         contractual life of ten years.

         Prior to the adoption of the 1998 Plan, the Board awarded options (the
         "Initial Plan") for the right to purchase 3,868,800 shares of common
         stock at a weighted average option price per share of $2.83. The
         vesting periods on these options range from immediately to four years,
         and have a maximum contractual life of ten years.

         A summary of the stock option activity for the years ended December
         31, 2000, 1999 and the period January 15, 1998 (Inception) through
         December 31, 1998 is presented below:



                                     F-24
<PAGE>   70

Z-TEL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
-------------------------------------------------------------------------------

<TABLE>
<CAPTION>

                                                                 1998 Equity             2000 Equity
                                          Initial Plan        Participation Plan      Participation Plan              Total
                                      -------------------    ---------------------    --------------------    ---------------------
                                                  Weighted                Weighted                 Weighted                Weighted
                                                  Average                 Average                  Average                 Average
                                      Number of   Exercise   Number of    Exercise    Number of    Exercise   Number of    Exercise
                                      Shares       Price       Shares      Price       Shares       Price       Shares      Price
                                      ---------   --------   ---------    --------    ---------    --------   ---------    --------
    <S>                               <C>         <C>        <C>          <C>         <C>          <C>        <C>          <C>
    OUTSTANDING, JANUARY 15, 1998
         (INCEPTION)                         --    $   --           --    $     --           --    $    --           --    $    --
       Granted                        3,868,800      2.83      201,050        3.64           --         --    4,069,850       2.87
       Forfeited                        (69,500)     2.42           --          --           --         --      (69,500)      2.42
                                     ----------             ----------               ----------    -------   ----------

    OUTSTANDING, DECEMBER 31, 1998    3,799,300      2.83      201,050        3.64           --         --    4,000,350       2.88

       Granted                               --        --    3,187,225        5.79           --         --    3,187,225       5.79
       Exercised                       (305,094)     1.73       (1,466)       3.64           --         --     (306,560)      1.74
       Forfeited                       (301,073)     3.49      (57,745)       3.69           --         --     (358,818)      3.53
                                     ----------              ---------               ----------    -------   ----------

    OUTSTANDING, DECEMBER 31, 1999    3,193,133      2.88    3,329,064        5.69           --         --    6,522,197       4.32

       Granted                               --        --    1,423,100       27.33    1,882,440      11.43    3,305,540      18.28
       Exercised                       (387,384)     2.47     (386,611)       3.77           --         --     (773,995)      3.12
       Forfeited                        (32,981)     2.62     (530,229)      14.71     (111,550)     12.38     (674,760)     13.74
                                     ----------              ---------               ----------    -------   ----------

    OUTSTANDING, DECEMBER 31, 2000    2,772,768    $ 2.94    3,835,324    $  12.67    1,770,890    $ 11.37    8,378,982    $  9.18
                                      =========              =========                =========    =======    =========
</TABLE>

         Had compensation cost for the Company's stock options granted been
         determined based on the fair value at the date of grant, consistent
         with the provisions of SFAS No. 123, the Company's net loss and loss
         per share of common stock for the years ended December 31, 2000, 1999
         and the period January 15, 1998 (Inception) through December 31, 1998,
         respectively, would have been increased to the pro forma amounts shown
         below.

<TABLE>
<CAPTION>
                                                                                             Period
                                                                                        January 15, 1998
                                                               Year Ended             (Inception) through
                                                               December 31,               December 31,
                                                           2000           1999               1998
                                                        ----------     ----------     -------------------
         <S>                                            <C>            <C>                <C>

         Net Loss
            As presented                                $  (88,037)    $  (35,971)        $  (13,122)
            As adjusted                                    (99,174)       (36,477)           (13,161)

         BASIC AND DILUTED NET LOSS PER COMMON SHARE
            As presented                                $    (3.38)    $    (2.49)        $    (2.03)
            As adjusted                                      (3.72)         (2.53)             (2.04)

</TABLE>



                                     F-25
<PAGE>   71

Z-TEL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
-------------------------------------------------------------------------------


         These adjusted amounts were determined using the Black-Scholes
         valuation model with the following key assumptions: (a) a discount rate
         of approximately 6.5%, 5.7% and 4.7% for each of the years ended
         December 31, 2000 and 1999, and the period January 15, 1998 (Inception)
         through December 31, 1998, (b) a volatility factor of approximately
         123%, 81%, and 64% for each of the years ending December 31, 2000 and
         1999, and the period January 15, 1998 (Inception) through December 31,
         1998 respectively; (c) an average expected option life of 5 years; (d)
         there have been no options that have expired; and (e) no payment of
         dividends on common stock.

         During 2000, 1999 and 1998, respectively, included in the options
         granted by the Company, are 0, 695,082 and 113,300 options granted to
         non-employees. The Company recorded expense for the same periods,
         respectively, of approximately $0.1, $0.3 and $0.1 million,
         respectively, related to these non-employee options in accordance with
         the provisions of SFAS No. 123.

         The following table summarizes information about stock options
         outstanding at December 31, 2000:

                                             Weighted Average
                                                 Remaining
                                                Contractual
                                 Number             Life            Number
         Exercise Prices      Outstanding        (In Years)       Exercisable
         --------------        ---------     ----------------     -----------

         $1.14 - $3.64         4,027,712                7.6        2,946,249
         $5.45 - $7.27         1,280,805                9.1          378,796
         $8.00 - $13.00        2,025,515                9.4           90,870
         $14.00 - 47.00        1,044,950                9.2           59,904
                               ---------                           ---------
                               8,378,982                           3,475,819
                               =========                           =========

16.      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 are not included in the calculation of net loss per share
         as the inclusion of such equivalents would be anti-dilutive.



                                     F-26
<PAGE>   72

Z-TEL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
-------------------------------------------------------------------------------

         Net loss per share is calculated as follows:

<TABLE>
<CAPTION>

                                                                                                                   PERIOD
                                                                                                              JANUARY 15, 1998
                                                                                YEAR ENDED                       (INCEPTION)
                                                                                DECEMBER 31,                THROUGH DECEMBER 31,
                                                                           2000              1999                   1998
                                                                      ------------       ------------       --------------------
         <S>                                                          <C>                <C>                <C>

         BASIC AND DILUTED NET LOSS PER SHARE:
             Loss attributable to common stockholders:

               Net loss                                               $    (88,037)      $    (35,971)       $   (13,122)
               Less mandatorily redeemable convertible preferred
                    stock dividends                                         (3,644)            (1,654)              (190)
               Less beneficial conversion feature                          (20,027)                --                 --
                                                                      ------------       ------------        -----------

                 Loss attributable to common stockholders             $   (111,708)      $    (37,625)       $   (13,312)
                                                                      ============       ============        ===========

             Weighted average common shares outstanding                 33,066,538         15,099,359          6,554,499
                                                                      ============       ============        ===========

             Basic and diluted net loss per share                     $      (3.38)      $      (2.49)       $     (2.03)
                                                                      ============       ============        ===========
</TABLE>


         For each of the periods presented, basic and diluted net loss per
         share are the same. Unexercised options to purchase 8,378,982,
         6,522,197 and 4,000,350 shares of common stock, unexercised warrants
         to purchase 4,602,457, 637,332, and 0 shares of common stock,
         mandatorily redeemable convertible preferred stock convertible into
         9,174,605, 0 and 4,437,403 shares of common stock for the years ended
         December 31, 2000 and 1999 and the period January 15, 1998 (Inception)
         through December 31, 1998, respectively, which could potentially
         dilute basic earnings per share in the future were not included in the
         computation of diluted net loss per share for these periods because to
         do so would have been anti-dilutive in each case.

17.      LEGAL AND REGULATORY PROCEEDINGS

         On June 9, 2000, PTEK Holdings, Inc. and Premiere Communications, Inc.
         (collectively, "PTEK") filed a lawsuit against the Company, Z-Tel
         Communications, Inc., David Gregory Smith, Z-Tel's Chairman, Chief
         Executive Officer and President, Eduard Mayer, one of Z-Tel's
         directors and James Kitchen, a Senior Vice President of Z-Tel (the
         "Lawsuit").

         On November 14, 2000, the parties to the Lawsuit agreed to resolve in
         full all claims asserted by each party against the other. In
         connection with the settlement, the Company agreed to issue a warrant
         to PTEK Holdings, Inc. to purchase 175,000 shares of the Company's
         common stock at an exercise price of $12.00, which price is subject to
         certain adjustments. The warrant is fully vested and non-forfeitable
         but is not exercisable until two years after the issue date of the
         warrant. As a result of the issuance of the warrant and the accrual of
         legal fees related to the Lawsuit, the Company has recognized an
         expense of approximately $1.0 million for the year ended December 31,
         2000.




                                     F-27
<PAGE>   73

Z-TEL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
-------------------------------------------------------------------------------

         In the ordinary course of business, the Company is involved in legal
         proceedings that are generally incidental to its operations. In
         addition, from time to time, the Company is the subject of customer
         complaints filed with the state utility commissions of the states in
         which it operates or the FCC. 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, the Company does not believe their
         disposition will have a material adverse effect on the Company's
         consolidated results of operations or financial position.

18.      SUBSEQUENT EVENTS

         On March 7, 2001, in accordance with the Stockholders Rights
         Agreement, the Company distributed preferred stock purchase rights as
         a dividend. See footnote ten.

         On March 15, 2001, the Company filed a lawsuit against AT&T Corp.
         (AT&T). The Company alleged that AT&T has received originating and
         terminating access service from the Company and has unlawfully
         withheld access charges for such services. We seek damages from AT&T
         in the current amount of approximately $7.0 million, and have alleged
         we are entitled to late fees and interest on such amount and any
         future amounts, consequential damages, punitive damages, attorney's
         fees and costs. We also have asked the Court to enter an order
         directing AT&T to pay access charges to us in the future if AT&T
         continues to use our service.

19.      QUARTERLY OPERATING RESULTS (UNAUDITED)

         The following table presents unaudited quarterly operating results for
         each of the last eight quarters. This information has been prepared by
         the Company on a basis consistent with the Company's consolidated
         financial statement statements and includes all adjustments,
         consisting only of normal recurring accruals, in accordance with
         generally accepted accounting principles. Such quarterly results are
         not necessarily indicative of future operating results.

<TABLE>
<CAPTION>
                                                                 QUARTER ENDED
                                      ---------------------------------------------------------------------
                                        MARCH 31,          JUNE 30,         SEPTEMBER 30,      DECEMBER 31,
                                          1999               1999               1999               1999
                                      ------------       ------------       ------------       ------------
         <S>                          <C>                <C>                <C>                <C>

         Sales                        $        664       $        761       $        745       $      4,445
         Operating loss                     (5,843)            (4,488)           (10,849)           (12,048)
         Net loss                           (5,939)            (5,611)           (12,097)           (12,324)
         Net loss per share(1)        $      (0.43)      $      (0.42)      $      (0.87)      $      (0.75)
         Weighted average shares
            outstanding                 14,411,100         14,411,100         14,328,120         17,257,893


                                                                 QUARTER ENDED
                                      ---------------------------------------------------------------------
                                        MARCH 31,          JUNE 30,         SEPTEMBER 30,      DECEMBER 31,
                                          2000               2000               2000               2000
                                      ------------       ------------       ------------       ------------

         Sales                        $     13,976       $     40,157       $     54,415       $     69,120
         Operating loss                    (16,521)           (22,687)           (22,228)           (29,763)
         Net loss                          (15,476)           (23,055)           (23,109)           (26,397)
         Net loss per share(1)        $      (0.48)      $      (0.71)      $      (1.32)(2)   $      (0.85)
         Weighted average shares
            outstanding                 31,941,964         33,042,008         33,536,724         33,717,824
</TABLE>


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

(1)  Earnings per share were calculated for each three month and twelve month
     period on a stand-alone basis

(2)  Included in this calculation is approximately $12.7 million for a
     cumulative catch adjustment required by EITF 00-27 as discussed in
     footnote nine.

                                     F-28
<PAGE>   74
ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
         FINANCIAL DISCLOSURE

         NONE.

                                    PART III


ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

DIRECTORS AND EXECUTIVE OFFICERS

The following sets forth certain information regarding our directors and
executive officers as of March 22, 2001:

Name                        Age                           Position

D. Gregory Smith            42      President, Chief Executive Officer and
                                        Chairman of the Board and Director
James F. Corman             48      President-Touch 1 Communications, Inc.
J. Bryan Bunting            54      Senior Vice President-Engineering and
                                        Technical Services
Robert A. Curtis            33      Senior Vice President-Strategic Planning
                                        and President, Z-Tel Network
                                        Services, Inc.
Horace J. Davis, III        33      Senior Vice President-Budgeting and
                                        Financial Planning
N. Dumas Garrett            40      Senior Vice President-Finance &
                                        Administration
John M. Hutchens            53      Senior Vice President-Chief Financial
                                        Officer
James A. Kitchen            41      Senior Vice President-Chief Architect
Charles W. McDonough        49      Senior Vice President-Chief Technology
                                        Officer and Director
Douglas W. Jackson          35      Vice President-Marketing
Eduard J. Mayer             48      Vice President-Strategic Alliances
                                        and Director
Mark H. Johnson             44      Secretary and Treasurer
Jeffrey H. Kupor            32      General Counsel
Jeffrey A. Bowden           54      Director
Mark S. Feighner            52      Director
Laurence S. Grafstein       40      Director
Charles D. Hyman            42      Director
Buford H. Ortale            39      Director
Lawrence C. Tucker          58      Director


         D. Gregory Smith, a founder of Z-Tel, has served as chairman of the
board and chief executive officer of Z-Tel since inception. Mr. Smith was a
director of Premiere Technologies, Inc. from 1991 to 1997, executive vice
president from 1994 to 1997 and vice president from 1991 to 1994. From 1987 to
1991, Mr. Smith was a management and financial consultant with Olympus
Telecommunications, Inc. and Olympus Partners, Inc., companies that he founded.
Mr. Smith has also held positions with NationsBank of Florida, N.A. and Chase
Bank of Florida. Mr. Smith received his B.S. in Commerce from the University of
Virginia.

         James F. Corman has served as President of Touch 1 Communications,
Inc., a wholly-owned subsidiary of Z-Tel doing business as Z-Tel Consumer
Services, from 1989 through the present. Z-Tel acquired Touch 1 Communications,
Inc. effective April 14, 2000. See page 2, "Bankruptcy of Touch 1 and
Directel, Inc.," for information regarding a chapter 11 bankruptcy proceeding
involving Touch 1 Communications, Inc. From 1987 through 1989, he was Senior
Vice President of Telecom USA, after holding several positions within Southland
Communications and its subsidiaries from 1969 to 1987, including service as
President from 1981 through 1987. Mr. Corman received a B.S. in Finance from
Auburn University and an M.B.A. from the University of Texas.

         J. Bryan Bunting has served as senior vice president-engineering and
technical services since January 1999 and was senior vice president-Z-Tel
Business Networks from August 1998 to January 1999. From 1968 through 1998, he
was an officer of NationsBank, serving most recently as senior vice president
of direct banking. Mr. Bunting attended Old Dominion University.

         Robert A. Curtis has served as senior vice president-strategic
planning since July 1999 and as President, Z-Tel Network Services, Inc., a
wholly owned subsidiary, since January 2001. From May 1998 to June 1999, Mr.
Curtis was vice president-business development and legal affairs at Z-Tel. From
September 1995 to April 1998, Mr. Curtis was an attorney at the Houston office
of Fulbright & Jaworski LLP, where he specialized in antitrust and complex
federal litigation. Mr. Curtis graduated from the Duke University School of Law
in 1995. Mr. Curtis received his B.A. in Philosophy from Trinity University and
his Doctor of Philosophy (D. Phil) from the University of Oxford (England).

         Horace J. Davis, III has served as senior vice president-budgeting and
financial planning since January 2001. Mr. Davis has been Chief Financial
Officer and Vice President-Planning for Touch 1 Communications, Inc. since
1995. See page 2, "Bankruptcy of Touch 1 and Directel, Inc.," for
information regarding a Chapter 11 bankruptcy proceeding involving Touch 1
Communications, Inc. Mr. Davis received a B.B.A and an M.B.A from Millsaps
College.



                                       44
<PAGE>   75


         N. Dumas Garrett has served as senior vice president-finance &
administration of Z-Tel since April 2000. From December 1999 through April
2000, he was senior vice president-business development. From 1987 through
1999, he was an officer of Stephens Inc., serving most recently as managing
director and senior vice president and head of the technology and
telecommunications group. Mr. Garrett has a B.S. in Industrial Engineering from
the University of Arkansas and an M.B.A. from the University of Virginia.

         John M. Hutchens has served as senior vice president-chief financial
officer since September 1999. From 1982 through 1999 he was an employee and
then a partner at Arthur Andersen LLP. Mr. Hutchens received a B.S. in
Accountancy from the University of Illinois, and a Masters of Health
Administration from the Ohio State University. Mr. Hutchens is a Certified
Public Accountant licensed in Florida.

         James A. Kitchen, a founder of Z-Tel, has served as senior vice
president-chief architect of Z-Tel since January 1999. He served as vice
president, engineering from January 1998 to December 1998 and was a chief
architect and developer of Premiere Communications, Inc. from 1992 to 1997. Mr.
Kitchen received his B.S. in Engineering from Georgia Institute of Technology.

         Charles W. McDonough has served as senior vice president-chief
technology officer since August 1998 and as a director since November 2000.
From 1975 through 1998, he was an employee and then a partner at Andersen
Consulting LLP. Mr. McDonough received a B.A. in Industrial Engineering and a
M.S. in Industrial Administration from Carnegie Mellon University.

         Doug W. Jackson has served as vice president-marketing of Z-Tel since
June 1999. From 1996 through 1999 he held the position of senior brand manager
for the Coca-Cola Company and prior to that from 1992 to 1996 he was an
associate product manager for Kraft General Foods Corp. Mr. Jackson received
his B.A. from University of Virginia and his M.B.A. from University of
Michigan.

         Eduard J. Mayer has been a director of Z-Tel since July 1998 and vice
president-strategic alliances since July 1999. Mr. Mayer holds a Bachelor's
degree in Commerce from the University of Windsor and a M.B.A. from New York
University.

         Mark H. Johnson has served as secretary and treasurer of Z-Tel since
August 1999. From May 1998 until his arrival at Z-Tel, Mr. Johnson was an
employee of Olympus Management, a venture firm. From November 1991 until May
1998, Mr. Johnson was an employee of First Union National Bank. Mr. Johnson
holds a B.A. from the University of Virginia.

         Jeffrey H. Kupor has served as General Counsel of Z-Tel since November
1999. From September 1993 until January 1998, Mr. Kupor was an attorney with
the Houston office of Fulbright & Jaworski LLP, specializing in complex
commercial and securities litigation. From January 1998 until November 1999,
Mr. Kupor was a Staff Attorney and later Counsel at AIM Management Group, Inc.,
an investment adviser to a group of registered investment companies, where his
responsibilities included securities registration, corporate and fund
litigation, and labor and employment-related legal issues. Mr. Kupor has a B.S.
in Economics from the University of Pennsylvania and a J.D. from the Boalt Hall
School of Law at the University of California at Berkeley.

         Jeffrey A. Bowden, a founder of Z-Tel, has served as a director of
Z-Tel since July 1998. Mr. Bowden has been Executive Vice President-Corporate
Strategy since September 2000 and director since December 2000 of Pacific
Century Cyberworks, Limited. Mr. Bowden is also a director of Softnet Systems,
Inc. Mr. Bowden was a director of The Boston Consulting Group, Inc. from 1998 to
September 2000. Mr. Bowden was vice president of Bell Atlantic Corporation from
1997 to 1998. Mr. Bowden was a vice president of The Nynex Corporation from 1994
to 1997 and vice president and a director of The Boston Consulting Group, Inc.
from 1988 to 1994. Mr. Bowden received his B.S. from the University of Michigan
and his M.B.A. from the Harvard Graduate School of Business.

         Mark S. Feighner has been a director of Z-Tel since November 2000. Mr.
Feighner was President of GTE Wireless (formerly GTE Mobilnet) from 1995 until
his retirement in February 2000. Mr. Feighner has over 28 years experience in
the telecommunications industry. Mr. Feigner received a B.S. from Indiana
University.

         Laurence S. Grafstein has been a director of Z-Tel since October 1999.
Mr. Grafstein is a co-founder of Gramercy Communications Partners, a private
equity fund based in New York specializing in telecommunications investments.
Previously, he was head of the global telecommunications practice at Credit
Suisse First Boston. He is currently a member of the Executive Committee of the
Wall Street Division of the United Jewish Appeal and a member of the




                                       45
<PAGE>   76

boards of the Arts Connection and the Jerusalem Foundation. Mr. Grafstein
received his B.A. from Harvard University, his M. Phil from Balliol College of
Oxford University and an LL.B from the University of Toronto Faculty of Law.

         Charles D. Hyman has been a director of Z-Tel since November 2000.
Since 1993, Mr. Hyman has been President of Charles D. Hyman and Company, a
private investment advisory firm he founded. Mr. Hyman received a B.A. from the
University of Virginia and an M.B.A. from the University of Florida.

         Buford H. Ortale has been a director of Z-Tel since July 1998. Since
1996 Mr. Ortale has been the president of Sewanee Ventures, LLC, a private
investment firm. From 1993 to 1996 Mr. Ortale was a director and then a
managing director of NationsBanc Capital Markets Inc. He is a member of the
board of directors of Digital Medical Systems. Mr. Ortale received his B.A.
degree from The University of the South and a M.B.A. from Vanderbilt
University.

         Lawrence C. Tucker has been a director of Z-Tel since November 2000.
Mr. Tucker has been with Brown Brothers Harriman & Co., a private investment
banking and advisory firm, for 33 years, and was named a General Partner of the
firm in 1979. Mr. Tucker received a B.S. from the Georgia Institute of
Technology and an M.B.A. from the Wharton School of the University of
Pennsylvania.


Section 16(a) Beneficial Ownership Reporting Compliance

         Based solely upon a review of Forms 3, 4, and 5 furnished to us during
or with respect to our most recently completed fiscal year, we believe that all
of our directors, officers, and 10% beneficial owners complied with all Section
16(a) filing requirements applicable to them.

ITEM 11. EXECUTIVE COMPENSATION

SUMMARY COMPENSATION TABLE

         The following table provides summary information concerning
compensation paid or accrued by us to, or on behalf of, our "Named Executive
Officers," which are our Chief Executive Officer and our five most highly
compensated executive officers serving as executive officers at December 31,
2000. The aggregate amount of perquisites and other personal benefits,
securities or property received by each of the Named Executive Officers was
less than either $50,000 or 10% of the total annual salary and bonus reported
for that Named Executive Officer:

<TABLE>
<CAPTION>

                                                                                     Long Term
                                                       Annual Compensation         Compensation
                                                  ------------------------------      Awards
                                                                                   ------------
                                                                                      Shares        All Other
                                                  Year      Salary        Bonus     Underlying     Compensation
 Name and Principal Position                                  ($)          ($)        Options         ($)(1)
                                                  ----      -------   ----------    ----------     ------------
 <S>                                              <C>       <C>       <C>           <C>            <C>

 D. Gregory Smith                                 2000      162,000           --      100,000          471
      President, Chief Executive Officer and      1999      162,000           --        1,100          471
      Chairman

 James A. Kitchen                                 2000      162,000           --           --           --
      Senior Vice President-Chief Architect       1999      162,000           --       27,500           --

 J. Bryan Bunting                                 2000      162,000           --       75,000         1146
      Senior Vice President-Engineering and       1999      162,000           --       27,500         1146
      Technical Services

 Charles W. McDonough                             2000      162,000           --       75,000          777
      Senior Vice President-Chief Technology      1999      162,000           --       27,500          777
      Officer

 N. Dumas Garrett                                 2000      150,000           --       75,000           --
      Senior Vice President- Finance &            1999        6,250           --      275,000           --
      Administration

 John M. Hutchens                                 2000      150,000           --           --           --
      Senior Vice President-Chief Financial       1999       42,500           --      242,000           --
      Officer
</TABLE>

---------------
(1)  Amounts shown reflect premiums paid on behalf of the Named Executive
     Officer for term life insurance.



                                       46
<PAGE>   77

OPTION GRANTS IN LAST FISCAL YEAR

         The following table contains information concerning the stock option
grants made to each of the Named Executive Officers during the fiscal year
ended December 31, 2000, subject to the following:

         The options described below were granted pursuant to the Company's
1998 Equity Participation Plan. The options vest over a three-year period
commencing on the grant date and expire ten years thereafter (unless the
employee at the time of the grant owned more than 10% of the total combined
voting power of all classes of stock, in which case they expire over five
years).

         The 5% and 10% assumed annual rates of compounded stock price
appreciation are mandated by the rules of the Securities and Exchange
Commission. We cannot be certain that the actual stock price appreciation over
the ten-year option term will be at the assumed 5% and 10% levels or at any
other defined level. Unless the market price of the common stock appreciates
over the option term, no value will be realized from the option grants. The
potential realizable value is calculated by assuming that the fair market value
of the common stock as determined by the Board of Directors on the date of
grant of the options appreciates at the indicated rate of the entire term of
the option and that the option is exercised at the exercise price and sold on
the last day at the appreciated price.

<TABLE>
<CAPTION>

                                                     Individual Grants

                                                                   Weighted
                         Number of Shares       % of Total          Average                        Potential Realizable
                         of Common Stock     Options Granted       Exercise                          Value at Assumed
                            Underlying         to Employees          Price       Expiration    Annual Rates of Stock Price
         Name            Options Granted       in 2000 (%)          ($/sh)          Date       Appreciation for Option Term
         ----            ----------------   ------------------     --------      ----------    ----------------------------
                                                                                                   5% ($)      10% ($)
                                                                                                   ------      -------
<S>                      <C>                <C>                    <C>           <C>           <C>             <C>

D. Gregory Smith             100,000               3.03              15.00        5/25/2005         414,422         915,765

James A. Kitchen                  --                 --                 --               --              --              --

J. Bryan Bunting              75,000               2.27              13.00        5/25/2010         613,172       1,553,899

Charles W. McDonough          75,000               2.27              13.00        5/25/2010         613,172       1,553,899

N. Dumas Garrett              75,000               2.27              13.00        5/25/2010         613,172       1,553,899

John M. Hutchens                  --                 --                 --               --              --              --
</TABLE>


AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND YEAR-END OPTION VALUE TABLE

         The following table shows information concerning stock option
exercises during 2000 and stock option values as of the year ending December
31, 2000 by each of the Named Executive Officers. The value of unexercised
in-the-money options is determined by subtracting the exercise price from the
fair market value of the common stock based on $5.1875, the closing price of
Z-Tel common stock as of December 29, 2000, multiplied by the number of shares
underlying the options.

<TABLE>
<CAPTION>
                          Shares                Number of Securities Underlying         Value of Unexercised
                         Acquired                Unexercised Options at Fiscal     In-the-Money Options at Fiscal
                            on         Value             Year-End (#)                       Year-End ($)
                         Exercise    Realized    ----------------------------      ----------------------------
         Name               (#)         ($)      Exercisable    Unexercisable      Exercisable    Unexercisable
--------------------     --------    --------    -----------    -------------      -----------    -------------
<S>                      <C>         <C>         <C>            <C>                <C>            <C>

D. Gregory Smith              --           --      550,489         100,611            851,882            946
James A. Kitchen          27,473      205,635      517,944          32,083            784,968         23,642
J. Bryan Bunting              --           --      222,222         145,728            327,339         82,748
Charles W. McDonough          --           --      155,427         114,583            495,155        334,644
N. Dumas Garrett              --           --       91,667         258,333                 --             --
John M. Hutchens          55,000      277,613       48,278         138,722             28,371        141,854
</TABLE>



                                       47

<PAGE>   78



COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION

         The members of the compensation committee of the Board of Directors
during the year ended December 31, 2000 were Messrs. Bowden and Ortale, both of
whom are non-employee directors. The compensation committee is responsible for
all decisions concerning executive officer compensation, including decisions
regarding grants of stock options.

DIRECTOR COMPENSATION

         Directors do not currently receive any cash compensation for services
rendered to Z-Tel in their capacities as directors. Pursuant to the terms of
the 2000 Equity Participation Plan of Z-Tel Technologies, Inc., upon initial
election to the Board of Directors each outside director receives options to
purchase 1,100 shares of Z-Tel's common stock. Each outside director also
receives options to purchase an additional 1,100 shares of Z-Tel's common stock
at the time of each annual meeting of stockholders at which such director is
reelected or is continuing as a member of the Board of Directors.



                                       48
<PAGE>   79

EXECUTIVE EMPLOYMENT AGREEMENTS, TERMINATION OF EMPLOYMENT AND
CHANGE-IN-CONTROL ARRANGEMENTS

         We have entered into the following employment agreements:

<TABLE>
<CAPTION>
                                                          Annual
          Officer                    Term                 Salary                      Position
          -------                    ----                 ------                      --------
<S>                     <C>                             <C>          <C>

D. Gregory Smith        July 1998 - July 2001           $162,000     President, Chief Executive Officer and
                                                                     Chairman

Charles W. McDonough    August 1998 - August 2001       $162,000     Senior Vice President - Chief Technology
                                                                     Officer

J. Bryan Bunting        August 1998 - August 2001       $162,000     Senior Vice President - Engineering and
                                                                     Technical Services

James A. Kitchen        July 1998 - July 2001           $162,000     Senior Vice President - Chief Architect

John M. Hutchens        October 1999 - October 2001     $150,000     Senior Vice President - Chief Financial
                                                                     Officer
</TABLE>



         The employment agreements with Messrs. Smith, McDonough, Bunting,
Kitchen, and Hutchens also provide for:

         o   automatic renewal for subsequent one year terms unless either
             party elects not to renew prior to 90 days from the end of the
             then current term of the agreement, except that Mr. Hutchens'
             agreement does not provide for automatic renewal;

         o   a bonus or other incentive compensation in an amount to be
             determined by our compensation committee;

         o   the payment of his base salary and any other benefits to which he
             would have been entitled for the term of the agreement if he is
             terminated without cause (as defined in the agreements);

         o   generally, if a change of control occurs, the payment of two and
             nine-tenths (2.9) times his base salary and any incentive or bonus
             paid in the prior year if, within three years of the occurrence of
             a change of control, specified events occur, except that Mr.
             Hutchens' agreement does not contain these "change-of-control"
             provisions;

         o   his obligation to keep our nonpublic information confidential; and

         o   his obligation not to compete with us in the United States and not
             to solicit our employees.



                                       49
<PAGE>   80

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

         The following table sets forth, as of March 23, 2001 (unless
otherwise stated), the number of shares of our common stock, our Series D
Preferred Stock, and our Series E Preferred Stock beneficially owned by:

         o   each person who we know to be a beneficial owner of 5% or more of
             that class or series of stock;

         o   each of our directors;

         o   each of our Named Executive Officers; and

         o   all executive officers and directors as a group.

<TABLE>
<CAPTION>

                                              Shares Beneficially Owned and Percentage of Class(1)
                                        --------------------------------------------------------------
                                                              Series D               Series E             Percentage
                                                              Preferred              Preferred             of Total
          Beneficial Owner              Common Stock    %       Stock         %        Stock        %    Voting Power
          ----------------              ------------   ----   ---------      ---     ---------     ---   ------------
<S>                                     <C>            <C>    <C>            <C>     <C>           <C>   <C>

D. Gregory Smith(2)(3)  . . . . . . .      7,896,442   23.0       *           *          *          *        18.3
Carol Jane Smith(2)(3)  . . . . . . .      5,500,000   16.3       *           *          *          *        12.9
G/CJ Investments, L.P.(3) . . . . . .      5,500,000   16.3       *           *          *          *        12.9
J. Bryan Bunting(4) . . . . . . . . .        486,597    1.4       *           *          *          *         1.1
James A. Kitchen(5) . . . . . . . . .      1,839,514    5.4       *           *          *          *         4.3
Charles W. McDonough(6) . . . . . . .        967,847    2.8       *           *          *          *         2.3
N. Dumas Garrett(7) . . . . . . . . .        179,861    *         *           *          *          *          *
John M. Hutchens(8) . . . . . . . . .        135,181    *         *           *          *          *          *
Mark S. Feighner  . . . . . . . . . .          9,000    *         *           *          *          *          *
Laurence S. Grafstein(9)  . . . . . .            275    *         *           *          *          *          *
Charles D. Hyman  . . . . . . . . . .         48,117    *         *           *          *          *          *
Eduard J. Mayer(10) . . . . . . . . .            275    *         *           *          *          *          *
Buford H. Ortale(11)  . . . . . . . .      3,785,986   10.6   1,304,250       27.8       *          *         8.5
Jeffrey A. Bowden(12) . . . . . . . .        451,161    1.3       *           *          *          *         1.1
Lawrence C. Tucker (13) . . . . . . .      6,250,000   15.6       *           *      4,166,667     100       12.8
Brown Brothers Harriman & Co.(13) . .      6,250,000   15.6       *           *      4,166,667     100       12.8
Fulmead Ventures Limited(14)  . . . .      2,723,520    8.0     250,000       5.3        *          *         6.3
BA Capital Company, L.P.(15)  . . . .      1,780,325    5.3       *           *          *          *         4.2
Gramercy Z-Tel, L.P.(16)  . . . . . .      4,636,779   13.1   1,041,666      22.2        *          *        10.5
Sewanee Z-Tel Partners, L.P.(11). . .      1,956,375    5.5   1,304,250      27.8        *          *         4.4
Richland Ventures III, L.P.(17) . . .      1,875,000    5.3   1,250,000      26.7        *          *         4.2
Falcon Global Fund, L.P.(18)  . . . .        500,000    1.5     333,333       7.1        *          *         1.2
All directors and officers as . . . .     23,242,490   52.4   1,304,250      27.8    4,166,667     100       43.7
group (19 persons)
</TABLE>

--------
 *   Less than 1%.

(1)  Beneficial ownership is determined in accordance with the rules of the
     Securities and Exchange Commission. In computing the aggregate number of
     shares beneficially owned by the individual stockholders and groups of
     stockholders described above and the percentage ownership of such
     individuals and groups, shares of common stock subject to options or
     warrants that are currently exercisable or exercisable within 60 days of
     the date of this report are deemed outstanding. Such shares, however, are
     not deemed outstanding for the purposes of computing the percentage
     ownership of the other stockholders or groups of stockholders.

(2)  The address for each of Mr. and Mrs. Smith is c/o Z-Tel Technologies,
     Inc., 601 South Harbour Island Boulevard, Suite 220, Tampa, Florida 33602.

(3)  D. Gregory Smith and Carol Jane Smith are husband and wife. The number of
     shares shown for D. Gregory Smith and for Carol Jane Smith each includes
     all of the shares held by G/CJ Investments, L.P., a Delaware limited
     partnership. G/CJ Investments, Inc., a Delaware corporation established
     and controlled by Mr. and Mrs. Smith, is the sole general partner of G/CJ



                                       50
<PAGE>   81

     Investments, L.P. The share amount also includes 550,642 shares for Mr.
     Smith that are deemed to be beneficially owned by him by virtue of certain
     stock options that are currently exercisable or become exercisable within
     60 days. The address of G/CJ Investments, L.P. is 300 Delaware Avenue,
     Suite 900, Wilmington, DE 19801.

(4)  Includes 256,597 shares deemed to be beneficially owned by Mr. Bunting by
     virtue of certain stock options that are currently exercisable or which
     become exercisable within 60 days.

(5)  Includes 537,041 shares deemed to be beneficially owned by Mr. Kitchen by
     virtue of certain stock options that are currently exercisable or which
     become exercisable within 60 days.

(6)  Includes 220,357 shares deemed to be beneficially owned by Mr. McDonough
     by virtue of certain stock options that are currently exercisable or which
     become exercisable within 60 days.

(7)  Includes 129,861 shares deemed to be beneficially owned by Mr. Garrett by
     virtue of certain stock options that are currently exercisable or which
     become exercisable within 60 days.

(8)  Includes 83,139 shares deemed to be beneficially owned by Mr. Hutchens by
     virtue of certain stock options that are currently exercisable or which
     become exercisable within 60 days.

(9)  Excludes 4,636,779 shares of Common Stock and 1,041,666 shares of Series D
     Preferred Stock deemed to be beneficially owned by Gramercy Z-Tel L.P., of
     which Mr. Grafstein is a senior officer. Mr. Grafstein disclaims
     beneficial ownership of the shares owned by Gramercy Z-Tel L.P. Also
     includes 275 shares deemed to be beneficially owned by Mr. Grafstein by
     virtue of certain stock options that are currently exercisable or which
     become exercisable within 60 days.

(10) Includes 275 shares deemed to be beneficially owned by Mr. Mayer by virtue
     of certain stock options that are currently exercisable or which become
     exercisable within 60 days. Does not include 2,348,520 shares of Common
     Stock owned directly by Fulmead Ventures Limited, which is beneficially
     owned by The Mayer Trust. Mr. Mayer is a principal beneficiary of The
     Mayer Trust. Mr. Mayer disclaims beneficial ownership of these shares as
     he does not have voting or dispositive power with respect to these shares.

(11) The number of shares of Common Stock shown for Mr. Ortale and Sewanee
     Z-Tel Partners, L.P. includes (a) 1,304,250 shares of Series D preferred
     stock presently convertible into shares of our Common Stock owned by
     Sewanee Z-Tel Partners, L.P., the general partner of which is a limited
     liability company of which Mr. Ortale is the principal member, and (b)
     652,125 shares deemed to be beneficially owned by virtue of warrants
     presently convertible by Sewanee Z-Tel Partners, L.P. into shares of our
     Common Stock. In addition, the number of shares shown for Mr. Ortale
     includes 158,036 shares held by a general partnership with which Mr.
     Ortale is affiliated 68,622 shares held by a trust of which Mr. Ortale is
     a trustee, and 550 shares deemed to be beneficially owned by Mr. Ortale by
     virtue of certain stock options that are currently exercisable or which
     become exercisable within 60 days.

(12) Includes 331,161 shares deemed to be beneficially owned by Mr. Bowden by
     virtue of stock options that are currently exercisable or which become
     exercisable within 60 days.

(13) Mr. Tucker does not own any shares directly. The number of shares shown
     for Mr. Tucker and Brown Brothers Harriman & Co. is derived from a
     Schedule 13D filed November 20, 2000 filed jointly by Brown Brothers
     Harriman & Co., The 1818 Fund III, L.P., T. Michael Long and Lawrence C.
     Tucker. Each of these parties is shown to have shared voting and
     dispositive power with respect to all of the shares shown. Of the shares
     of Common Stock shown for Mr. Tucker and Brown Brothers Harriman & Co.,
     4,166,667 shares are deemed to be beneficially owned by virtue of shares
     of Series E preferred stock presently convertible into shares of our
     Common Stock, and 2,083,333 shares are deemed to be beneficially owned by
     virtue of warrants presently convertible into shares of our Common Stock.
     The address of Brown Brothers Harriman & Co. is 59 Wall Street, New York,
     New York 10005.

(14) This information is derived from a Schedule 13D dated February 4, 2000
     filed jointly by The Mayer Trust, Eduard J. Mayer, Mutual Risk Management
     Ltd., Mutual Risk Management (Holdings) Limited, Hemisphere Trust (Jersey)
     Limited, Hemisphere Trustees Limited, Hemisphere Nominees Limited,
     Hemisphere Investments Limited, and Fulmead Ventures Limited. Each of
     these parties is shown to have shared voting and dispositive power with
     respect to all of the shares shown. Eduard J. Mayer disclaims beneficial
     ownership of the shares shown. The address of Fulmead Ventures Limited is
     Akara Bldg., 24 Castro Street, Wickhams Cay I, Road Town, Tortola, British
     Virgin Islands.

(15) This information is derived from a Schedule 13D dated February 14, 2000
     filed jointly by BA Capital Company, L.P., BA SBIC Management, LLC, BA
     Equity Management, L.P., BA Equity Management GP, LLC, Walter W. Walker,
     Jr., and Bank of America Corporation. Each of these parties is shown to
     have sole voting and dispositive power with respect to all of the shares
     shown. The address of BA Capital Company, L.P., is 901 Main Street, 22nd
     Floor, Dallas, TX 75202-3714.

(16) This information is derived from a Schedule 13G dated September 8, 2000
     filed jointly by Gramercy Z-Tel L.P., Gramercy Z-Tel LLC and
     Communicapital Partners (Cayman), L.P. Each of these



                                       51
<PAGE>   82

     parties is shown to have shared voting and dispositive power with respect
     to all of the shares shown. Of the shares of Common Stock shown, 1,041,666
     shares are deemed to be beneficially owned by virtue of shares of Series D
     preferred stock presently convertible into shares of our Common Stock, and
     520,833 shares are deemed to be beneficially owned by virtue of warrants
     presently convertible into shares of our Common Stock. The address of
     Gramercy Z-Tel L.P. is 712 Fifth Avenue, New York, NY 10019.

(17) Of the shares of Common Stock shown, 1,250,000 shares are deemed to be
     beneficially owned by virtue of shares of Series D preferred stock
     presently convertible into shares of our Common Stock, and 625,000 shares
     are deemed to be beneficially owned by virtue of warrants presently
     convertible into shares of our Common Stock. The address of Richland
     Ventures III, L.P. is 200 31st Avenue North, Suite 200, Nashville, TN
     37203.

(18) Of the shares of Common Stock shown, 333,333 shares are deemed to be
     beneficially owned by virtue of shares of Series D preferred stock
     presently convertible into shares of our Common Stock, and 166,667 shares
     are deemed to be beneficially owned by virtue of warrants presently
     convertible into shares of our Common Stock. The address of Falcon Global
     Fund, L.P. is c/o KFAED Investment Department, Box 2921, Safat 13030,
     Kuwait.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

PURCHASES OF COMMON STOCK

         In agreements dated September 1, 1998, each of James A. Kitchen,
Charles W. McDonough and J. Bryan Bunting, together referred to as the officer
investors, purchased, in the aggregate, 2,310,000 shares of our common stock
for an aggregate purchase price of $2.63 million. In connection with the
purchase of these shares, we loaned: (1) $750,000 to Mr. Kitchen for the
purchase price of 660,000 of his shares; (2) $468,750 to Mr. McDonough for the
purchase price of 550,000 of his shares and (3) $187,500 to Mr. Bunting for the
purchase price of 220,000 of his shares. These loans, which bear interest at an
8% annual rate and mature on December 31, 2001, are secured by a pledge to us
of the common stock. The largest amount of indebtedness under the notes during
2000 was $500,000; $468,750; and $187,500, respectively and the outstanding
note balances as of March 23, 2001 were $0; $468,750; and $0, respectively.

         These agreements permit Messrs. Smith and Kitchen, first, and us,
second, to purchase from the officer investors a portion of their shares in the
event of a termination (as defined in the agreements) of the officer's
employment with us. This purchase option must be exercised within 30 days after
the termination of the respective officer's employment with us. In addition,
the purchase option lapses automatically if we are involved in a corporate
transaction (as defined in the agreements).

         The officer investors have a right, subject to quantity limitations we
determine, or determined by underwriters, if applicable, to request that we
register their common stock that is no longer subject to the purchase option.

Purchase of Series D Preferred Stock

         In August 2000, we raised funds through the private placement of
4,688,247 shares of Series D Preferred Stock at a price of $12.00 per share.
Each purchaser of Series D Preferred Stock also received warrants to purchase
one share of Z-Tel's common stock for every two shares of Series D Preferred
Stock purchased. Certain of our 5% shareholders invested in this private
placement, on the same terms as other investors in the August 2000 private
placement, as follows: Gramercy Z-Tel L.P. - 1,041,666 shares and 520,833
warrants; Sewanee Z-Tel Partners, L.P., with which Buford H. Ortale is
affiliated - 1,304,250 shares and 652,125 warrants; Richland Ventures III, L.P.
- 1,250,000 shares and 625,000 warrants; Fulmead Ventures Limited, with which
Eduard J. Mayer is affiliated - 250,000 shares and 125,000 warrants; and Falcon
Global Fund, L.P. - 333,333 shares and 166,667 warrants.

Purchase of Series E Preferred Stock

         In November 2000, The 1818 Fund III, L.P., purchased 4,166,667 shares
of Series E Preferred Stock and a warrant to purchase up to 2,083,333 shares of
Z-Tel's common stock, for an aggregate purchase price of approximately $50
million.



                                       52
<PAGE>   83

Transactions involving Breckenridge Securities Corporation

         During the period covered by this report, based on an agreement
entered into by Mr. Hyman before he became one of our directors, Mr. Hyman
received a total of $167,625 from Breckenridge Securities Corporation (BSC),
which fee was paid from amounts paid by us to BSC in connection with its
involvement in our issuances of Series D and Series E Convertible Preferred
Stock.

Transactions with Olympus Management Group, Inc.

         Since January 1, 2000, Z-Tel Communications, Inc., one of our wholly
owned subsidiaries, has sub-sub leased, on a month-to-month basis, three pieces
of real property from Olympus Management Group, Inc., an entity of which Mr.
Smith is a 100% shareholder. The rental obligation under these sub-sub leases
is $11,900 per month. The sub-sub leases are terminable by either party at any
time.

Guarantee of Margin Loan of James Kitchen

         In December 2000, we agreed to guarantee Mr. Kitchen's margin loan,
which is secured by certain shares of our common stock owned by Mr. Kitchen, in
the principal amount of approximately $900,000. In connection with that
guarantee, Mr. Kitchen executed a Pledge and Security Agreement in which Mr.
Kitchen granted to us a security interest in all shares of our common stock
owned by Mr. Kitchen as well as in all of his other tangible and intangible
property. In addition, Mr. Kitchen entered into a Secured Promissory Note
providing that, should any amounts be drawn on our guarantee by the creditor
who made the margin loan to Mr. Kitchen, such amounts would be considered
advances under the Secured Promissory Note and would bear interest until paid.

Transactions involving James Corman

         In May 2000, as a result of a change of control provision that was
triggered by our acquisition of Touch 1, Touch 1 purchased a building used to
house its technology infrastructure from its lessor, Brookwood, L.L.C., a
limited liability company of which Mr. Corman is a significant shareholder, for
$3.53 million.

         During the period covered by this report, Touch 1 made total interest
payments in the amounts of $67,342, $199,367 and $3,213,112 on notes payable to
Mr. Corman, a trust of which Mr. Corman is a co-trustee and a beneficiary and a
limited liability company with which Mr. Corman is associated, respectively.



                                       53
<PAGE>   84

                                    PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

1.       The following financial statements of Z-Tel Technologies,  Inc. and
the report thereon of PricewaterhouseCoopers LLP dated February 23, 2001 are
filed as part of this report:

         Report of Independent Certified Public Accountants.

         Consolidated Balance Sheets, December 31, 2000, and December 31, 1999.

         Consolidated Statements of Operations for the years ended December 31,
2000, December 31, 1999 and the period January 15, 1998 (Inception) through
December 31, 1998.

         Consolidated Statements of Changes in Stockholders' Equity (Deficit)
for the years ended December 31, 2000, December 31, 1999 and the period January
15, 1998 (Inception) through December 31, 1998.

         Consolidated Statements of Cash Flows for the years ended December 31,
2000, December 31, 1999 and the period January 15, 1998 (Inception) through
December 31, 1998.


         Notes to Financial Statements.

2.       The following Financial Statement Schedules are included herein:

         Schedules are not submitted because they are not applicable or not
required or because the required information is included in the financial
statements or the notes thereto.

3.       The following exhibits are filed as part of this report (exhibits
marked with an asterisk have been previously filed with the Commission as
indicated, and are incorporated herein by this reference):

Exhibit
Number           Description
------           -----------

2.1               Agreement and Plan of Merger dated April 10, 2000 by and
                  among Z-Tel Technologies, Inc., Tiger Acquisition Subsidiary,
                  Inc., Touch 1 Communications, Inc., and certain shareholders
                  of Touch 1 Communications, Inc.(A)

3.1               Amended and Restated Certificate of Incorporation of Z-Tel,
                  as amended(B)

3.2               Amended and Restated Bylaws of Z-Tel(C)

4.1               Form of Common Stock Certificate(C)

4.2               See Exhibits 3.1 and 3.2 of this Form 10-K for
                  provisions of the Amended and Restated Certificate of
                  Incorporation, as amended, and the Bylaws of Z-Tel defining
                  rights of security holders

4.3               Stock Purchase Agreement, dated July 6, 2000, by and between
                  the Registrant and the various purchasers of the Registrant's
                  Series D Convertible Preferred Stock(D)

4.4               Certificate of Designations, Preferences and Relative Rights,
                  Qualifications, Limitations and Restrictions relating to the
                  Registrant's Series D Convertible Preferred Stock(D)

4.5               Form of Registration Rights Agreement by and between the
                  Registrant and each of the purchasers of the Registrant's
                  Series D Convertible Preferred Stock(D)

4.6               Form of Warrant for the purchase of shares of common stock of
                  the Registrant by each of the purchasers of the Registrant's
                  Series D Convertible Preferred Stock(D)

4.7               Stock and Warrant Purchase Agreement, dated October 19, 2000,
                  by and among the Registrant and The 1818 Fund III, L.P.(E)

4.8               Certificate of Designation of 8% Convertible Preferred Stock,
                  Series E, Setting Forth the Powers, Preferences, Rights,
                  Qualifications, Limitations and Restrictions of Such Series
                  of Preferred Stock(E)

4.9               Registration Rights Agreement between and among the
                  Registrant and The 1818 Fund III, L.P.(E)



                                       54
<PAGE>   85


4.10              Warrant for the purchase of shares of common stock of the
                  Registrant by The 1818 Fund III, L.P.(E)

4.11              Certificate of Designations of Series F Junior Participating
                  Preferred Stock

4.12              Rights Agreement dated as of February 19, 2001 between Z-Tel
                  Technologies, Inc. and American Stock Transfer & Trust
                  Company, as Rights Agent(F)



                                       55
<PAGE>   86


10.1.1            Stockholders' Agreement dated October 8, 1999, between and
                  among the Company, BA Capital Corporation, Sewanee Partners
                  II, L.P., Gramercy Z-Tel LLC and the other parties set forth
                  therein(C)

10.1.2            Employment Agreement dated July 1998 between the Company and
                  D. Gregory Smith(C)

10.1.3            Employment Agreement dated September 1999 between the Company
                  and John Hutchens(C)

10.1.4            Employment Agreement dated August 1998 between the Company
                  and Charles W. McDonough(C)

10.1.5            Employment Agreement dated August 1998 between the Company
                  and J. Bryan Bunting(C)

10.1.6            Employment Agreement dated July 1998 between the Company and
                  James A. Kitchen(C)

10.1.7            Investment Agreement dated March 15, 1999 between the Company
                  and CMB Capital LLC(C)

10.2.1            1998 Equity Participation Plan(C)

10.2.2            2000 Equity Participation Plan(G)

10.3              Form of Employment Agreement for certain key Touch 1
                  employees, including James F. Corman, President of Touch 1(A)

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.(D)

10.5              Form of Indemnification Agreement for executive officers and
                  directors of the Company

10.6              Loan and Guaranty Agreement dated January 11, 2001 between the
                  Company and James A. Kitchen

10.7              Secured Promissory Note dated January 11, 2001 delivered by
                  James A. Kitchen to the Company

10.8              Pledge and Security Agreement dated January 11, 2001 between
                  James A. Kitchen and the Company

10.9              Promissory Note, dated September 10, 1999, between Touch 1
                  Communications, Inc. and Corman Elegre Capital

10.10             Promissory Note, dated May 11, 1999, between Touch 1
                  Communications, Inc. and Corman Elegre Capital

10.11             Promissory Note, dated September 10, 1999, from Touch 1
                  Communications, Inc. and William F. Corman (First
                  Revocable Trust)

10.12             Promissory Note, dated September 10, 1999, from Touch 1
                  Communications, Inc. and James F. Corman

21                List of Subsidiaries

23                Consent of PricewaterhouseCoopers LLP

--------------
(A)       Incorporated by reference to the correspondingly numbered exhibit to
          the Registrant's Current Report on Form 8-K filed April 28, 2000.

(B)       Incorporated by reference to Exhibit 4.1 to the Registrant's
          Registration Statement on Form S-8, filed on July 18, 2000.

(C)       Incorporated by reference to the correspondingly numbered exhibit to
          the Registrant's Registration Statement on Form S-1 (File No.
          333-89063), originally filed October 14, 1999, as amended and as
          effective December 14, 1999.

(D)       Incorporated by reference to the correspondingly numbered exhibits to
          the Registrant's Quarterly Report on Form 10-Q for the quarterly
          period ending June 30, 2000, filed on August 14, 2000.

(E)       Incorporated by reference to the correspondingly numbered exhibits to
          the Registrant's Quarterly Report on Form 10-Q for the quarterly
          period ending September 30, 2000, filed on November 14, 2000.

(F)       Incorporated by reference to Exhibit 4.1 to the Registrant's Form 8-A
          Registration Statement filed February 21, 2001.

(G)       Incorporated by reference to Appendix B to the Registrant's
          Preliminary Proxy Statement filed on April 14, 2000.

(b)       The Company did not file any reports on Form 8-K during the last
          quarter of the year ended December 31, 2000.

                                       56
<PAGE>   87

                                   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 30th day
of March, 2001.

                                          Z-TEL TECHNOLOGIES, INC.

                                          By: /s/ D. Gregory Smith
                                             ----------------------------------
                                                  D. Gregory Smith, President
                                                  and Chief Executive Officer

         Pursuant to the requirements of the Securities Exchange Act of 1934,
this Report has been signed below by the following persons on behalf of the
Registrant in the capacities and on the dates indicated.



                                       57
<PAGE>   88

SIGNATURE                            TITLE                          DATE
------------------------------------------------------------------------------

/s/ D.  Gregory Smith
------------------------     President, CEO, Chairman         March 30, 2001
D.  Gregory Smith            of the Board and Director
                             (Principal Executive Officer)

/s/ N. Dumas Garrett
------------------------     Senior Vice President --         March 30, 2001
N. Dumas Garrett             Finance and Administration
                             (Principal Financial and
                             Accounting Officer)

/s/ Charles W. McDonough
-------------------------    Senior Vice President-           March 26, 2001
Charles W. McDonough         Chief Technology Officer,
                             and Director

/s/ Jeffrey A.  Bowden
-------------------------    Director                         March 25, 2001
Jeffrey A.  Bowden

/s/ Charles D. Hyman
-------------------------    Director                         March 26, 2001
Charles D. Hyman

/s/ Eduard J.  Mayer
-------------------------    Director                         March 29, 2001
Eduard J.  Mayer

/s/ Buford H.  Ortale
-------------------------    Director                         March 26, 2001
Buford H.  Ortale

/s/ Laurence S. Grafstein
-------------------------    Director                         March 26, 2001
Laurence S. Grafstein

/s/ Mark S. Feighner
-----------------------      Director                         March 26, 2001
Mark S. Feighner

/s/ Lawrence C. Tucker
-----------------------      Director                         March 26, 2001
Lawrence C. Tucker



                                     58