<PAGE>

================================================================================
                       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, 2002

                                       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 26, 2003 (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 SmallCap Market as of such date,
was approximately $36,036,434.

         The number of shares of the Registrant's Common Stock outstanding as of
March 26, 2003 was approximately 35,268,253.

                       DOCUMENTS INCORPORATED BY REFERENCE

         Portions of the registrant's proxy statement relating to its 2003
Annual Meeting of Stockholders, to be filed subsequently, are incorporated by
reference into Part III of this Report.
================================================================================


<PAGE>



                                TABLE OF CONTENTS

PART I.
  Item 1.      Business                                                     1
  Item 2.      Properties                                                  20
  Item 3.      Legal Proceedings                                           20
  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       21
               Stockholder Matters
  Item 6.      Selected Consolidated Financial Data                        24
  Item 7.      Management's Discussion and Analysis of Financial           26
               Condition and Results of Operations
  Item 7A.     Quantitative and Qualitative Disclosures about Market
               Risk                                                        52
  Item 8.      Financial Statements and Supplementary Data                F-1
  Item 9.      Changes in and Disagreements with Accountants on
               Accounting and Financial Disclosure                         53
PART III.
  Item 10.     Directors and Executive Officers of the Registrant          53
  Item 11.     Executive Compensation                                      53
  Item 12.     Security Ownership of Certain Beneficial Owners and
               Management                                                  53
  Item 13.     Certain Relationships and Related Transactions              53
  Item 14.     Controls and Procedures                                     53
PART IV.
  Item 15.     Exhibits, Financial Statement Schedules, and Reports        53
               on Form 8-K
Signatures                                                                 58


<PAGE>





ITEM 1.      BUSINESS

GENERAL

         Z-Tel Technologies, Inc. is a communications service provider. We
integrate access to local and long distance telephone networks with our own
advanced features and operational support systems to provide innovative
telecommunications services to consumers, business and other communications
companies.

         We were incorporated in Delaware in 1998. Our first service offering,
launched in the fourth quarter of 1998, was an access card to make long-distance
calls from any phone coupled with enhanced features. We launched our first local
telephone service offering in New York during June of 1999. We acquired Touch 1
Communications, Inc. and its long distance operations in April 2000. We launched
wholesale operations in January 2002.

         At the retail level, our goal is offer distinctive services that give
our customers powerful tools to simplify busy lifestyles. Our principal retail
services are Z-LineHOME(R), Z-LineBUSINESS(R) and Touch 1 Long Distance.
Z-LineHOME, our flagship offering, is residential local and long distance
telephone service, bundled with enhanced services, including the Personal
Communications Center, a suite of our proprietary Internet-accessible and
voice-activated features. The Personal Communications Center includes voicemail,
"Find Me" call forwarding and our recently introduced Personal Voice Assistant,
or "PVA," which utilizes voice-recognition technology so that users can access
and use their own secure, online address books with voice commands. We expect
that eventually all our enhanced features will be accessed and managed via voice
commands so that PVA will supplant the Personal Communications Center.
Z-LineBUSINESS is our local, long distance and enhanced communications service
designed primarily for small businesses. We began offering Z-LineBUSINESS in
January 2002. Touch 1 Long Distance is a residential long distance telephone
service.

         As of March 25, 2003, we offer Z-LineHOME, in every state but Alaska,
Hawaii and Nevada. We have approximately 230,000 Z-LineHOME customers, primarily
in areas served by Regional Bell Operating Companies ("Bell operating
companies"). We currently offer Z-LineBUSINESS in 46 states. We have
approximately 1,500 Z-LineBUSINESS customers, representing approximately 3,000
lines. We offer Touch 1 Long Distance nationwide and have approximately 100,000
Touch 1 Long Distance customers.

         At the wholesale level, we provide telephone and enhanced
communications services and operational support services to other telephone
companies for their use in providing telephone and enhanced communications
services to their own end-user customers. Our principal wholesale customers are
MCI and Sprint. Sprint became a wholesale customer in February 2003.

         Our access to local telephone networks is based upon the
Telecommunications Act of 1996 (the "Telecommunications Act") which requires the
traditional local telephone companies ("incumbent local exchange carriers" or
"ILECs") to provide competing local telephone companies, such as Z-Tel, with
access to the individual components of their networks, called "network
elements." Pursuant to the Telecommunications Act, the Federal Communications
Commission ("FCC") has mandated that incumbent local exchange carriers provide
access to a set of unbundled network elements including, among other elements,
local loops, switching, transport and signaling. This set of elements is
referred to as the "unbundled network element platform" or "UNE-P." Moreover,
the FCC has mandated that ILECs must provide the unbundled network element
platform at rates based on a forward-looking, total long-run incremental cost
methodology. Access to the ILEC network elements at reasonable rates in
combination with our proprietary feature systems and operational and support
systems enables us to provide cost effective packages of communications
services. Our enhanced services platform and our operational support systems,
however, have the capability to integrate with cable, Internet, wireless and
other communications transport networks.

         We have invested heavily in our operational support systems. Our
systems are functionally integrated to support the entire customer life cycle
including price quotation, order entry and processing, ILEC interaction,
customer care, billing and subscriber management. They are scalable vertically
and horizontally and provide us reliable, flexible, low-cost operational
capabilities.

SEGMENT FINANCIAL INFORMATION

         We utilize two segments for internal reporting purposes: consumer
services (for retail services) and wholesale services. Financial information
relating to our consumer services segment and our wholesale segment is set
forth in Item 7, "Management's



                                       1
<PAGE>


Discussion and Analysis of Financial Condition and results of Operations" and
footnote 23 "Segment Reporting" in the "Notes to the Consolidated Financial
Statements."

INDUSTRY BACKGROUND

         The Telecommunications Act was enacted principally to foster
competition in the local telecommunications markets. The Telecommunications Act
imposes a variety of duties upon the incumbent local exchange carriers,
including the duty to provide other communications companies, like us, 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 are allowed
to handle "in-region" long distance calls, that is, calls that originate from
within their telephone service areas and terminate outside their service areas.
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 Z-Tel to use the
unbundled network elements, in an individual or combined fashion, to provide
basic local telephone service. Additionally, the ILECs must price the elements
using a forward-looking, total long-run incremental cost methodology. 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. As discussed
below under "Government Regulation," the FCC recently re-affirmed the
availability of unbundled network elements as part of a scheduled triennial
review.

SERVICES

         We provide telephone services at both the retail and wholesale level.
At the retail level our principal services are Z-LineHOME, Z-LineBUSINESS and
Touch 1 Long Distance. At the wholesale level, we provide services to other
carriers such as MCI and Sprint for their use in providing services to their own
end-user customers.

Z-LINEHOME(R)

         Z-LineHOME is our flagship service. Z-LineHOME is local residential
telephone service bundled with long distance (1+) telephone service, calling
card services and enhanced features, including our own proprietary,
Internet-accessible voicemail, "Find Me," "Notify Me" and voice-activated
services, as well as caller identification, call forwarding, three-way calling,
call waiting and speed calling, all for a single flat monthly price. Bell
operating company customers switching to Z-LineHOME keep their existing phone
numbers. Our "Unlimited Plan" includes unlimited, nationwide, direct-dialed long
distance calling toll-free. Our other lower priced plans include a limited
number of long distance minutes at no additional charge. We currently offer
Z-LineHOME in every state except Alaska, Hawaii and Nevada, in areas served by
Bell operating companies or Sprint and areas formerly served by GTE.

         Z-LineHOME includes unique Z-Line features, all of which can be
accessed and manipulated by telephone or Internet. Our proprietary voicemail
enables Z-LineHOME subscribers to retrieve and listen to their voice-mail
messages via telephone or the Internet. Our voicemail system also enables users
to forward voicemails via e-mail, as attachments. Our "Find-Me" feature forwards
an incoming call to as many as three additional numbers. Our "Notify Me" feature
notifies the subscriber via e-mail, pager or ICQ Internet Chat (instant
messaging) when a new voice mail message arrives. Both Find Me and Notify Me are
accessible via the Internet so that users may easily enable, disable or
otherwise alter the functions. We recently introduced "Personal Voice Assistant"
or "PVA." PVA allows users to store contacts in a virtual address book and then
access and utilize that information by voice from any telephone. Users say
"call" and the contact's name, "call John Doe," for example, and PVA connects
the call. PVA users can also send voice e-mails. Users record a message via
telephone and instruct PVA to deliver the message to a contact. PVA then
attaches the voice message to an e-mail and sends the e-mail to the contact.


                                       2
<PAGE>


Z-LINEBUSINESS(R)

         Z-LineBUSINESS is our complementary service to Z-LineHOME targeted to
small businesses (typically having four or fewer lines). Z-LineBUSINESS, like
Z-LineHOME, is local telephone service bundled with long distance (1+) telephone
service, calling card services and enhanced features, including our proprietary
features. Bell operating company customers switching to Z-LineBUSINESS keep
their existing phone numbers. Because we offer service in nearly every state,
Z-LineBUSINESS is particularly valuable to firms having multiple locations in
various states. With us, they deal with only one telephone company. Our rollout
of Z-LineBUSINESS is in its infancy. We offer Z-LineBUSINESS in 46 states
(excluding Alaska, Connecticut, Hawaii and Nevada) solely in areas served by a
Bell operating company.

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. We acquired
Touch 1 Communications, Inc. (Touch 1) in April 2000.

WHOLESALE SERVICES

         We also offer telephone and enhanced services and operational support
services on a wholesale basis to other carriers for their use in providing
services to their own retail customers. We have the capability to provide our
wholesale customers with a comprehensive package of communications and support
services. Among the wholesale services we offer are local exchange telephone
services, long distance telephone services, our proprietary enhanced features,
enhanced features we acquire from incumbent local exchange carriers,
provisioning (i.e. the process by which a telephone company is established as
the end-user's primary telephone company), inbound sales, fulfillment, billing,
collections and customer care. In most cases we would expect our wholesale
customer to utilize its own long distance services in providing services to its
customers. In some cases, in lieu of providing services, we may license our
technology to other carriers.

         On March 20, 2002, we entered into a four-year contract with MCI
WORLDCOM Communications, Inc. ("MCI") whereby we agreed to provide local
exchange services, enhanced features and operational and support services and
licenses to use certain of our proprietary technology, all for MCI's use in
providing telecommunications services to residential and small business
customers. MCI filed for bankruptcy protection on July 21, 2002. On November 1,
2002, we significantly amended the terms of our agreement to alter the fee
structure and to eliminate certain exclusivity provisions. We expect revenue
from this relationship to decline during 2003.

         On February 4, 2003 we signed a non-exclusive, wholesale services
agreement with the Sprint Communications Company L.P. ("Sprint"). The agreement
will give Sprint access to our telephone exchange services and our
Web-integrated, enhanced communications platform and operational support systems
in connection with Sprint's local residential telephone service.

         We intend to pursue wholesale relationships with, among others,
wireless telephone companies, Internet service providers, cable television
operators, electrical utilities and others who have access to large consumer
bases and in particular those who have the capability to bundle communication
services.

OPERATIONS SUPPORT SYSTEMS

         We have invested substantially in our operations systems and support
platform, which enables integrated customer ordering and provisioning, customer
care and billing functionality throughout the customer lifecycle. Accessing an
incumbent local exchange carrier's network requires us to interact with that
applicable incumbent local exchange carrier. To facilitate this interaction, we
have established, with outside integration and consulting assistance, 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. These
electronic gateways reduce the number of steps required to provision a customer
and consequently reduce the cost and increase the accuracy of our provisioning
process. "Provisioning" is the process by which we (or our wholesale customers)
are established as the customer's primary local exchange and long distance
telephone service provider. In connection with the incumbent local exchange
carriers, our systems also support mediation, network administration and revenue
assurance. We now have electronic gateways operational in every state except
Alaska, Hawaii and Nevada, solely in Bell operating company service areas. We do
not have electronic gateways established in Sprint service areas and areas
formerly served by GTE. Our operational support systems are vertically and
horizontally scalable.



                                       3
<PAGE>


 BUSINESS STRATEGY

         Our basic business strategy is to-

         -        gain and keep new retail customers by offering unique,
                  innovative functionality at competitive prices,

         -        focus our marketing expenditures by targeting markets that
                  have favorable regulatory and pricing environments,

         -        minimize the capital expenditures associated with entering new
                  retail markets and expanding our existing retail markets by
                  use of the unbundled network element platform, and

         -        leverage our existing facilities and infrastructure by
                  establishing wholesale relationships.

CERTAIN ASPECTS UNDERPINNING OUR BUSINESS STRATEGY

         Cost-Effective Bundled Local and Long Distance Telephone Service. We
provide cost-effective bundled packages of local and long distance telephone
services in markets that have favorable regulatory environments for residential
competition. Our service packages include our own enhanced features as well as
typical enhanced telephone features such as call waiting and caller
identification. We typically lease 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 our services without
significant up-front expense.

         Scalable Platform for New Markets. Our use of the unbundled of network
elements platform (i.e. the facilities of the incumbent local exchange carriers)
in providing our services allows us to enter new markets quickly without a
significant investment in equipment, as regulatory authorities in those markets
adopt favorable rules and pricing for unbundled network elements. Moreover,
using our telephone and Internet accessible systems, our 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. Our enhanced
services platform has 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 our platform.

         Advanced Proprietary Technology. We have created an advanced,
integrated and proprietary software and 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 any such
device.

         Our network architecture is designed to interconnect our main
enterprise management center in Tampa, Florida 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.

         We have also developed and enhanced our customer care, billing and
provisioning software into one seamlessly integrated package. This integrated
package provides us with reliable, flexible, low-cost operational capabilities.

         Our network architecture also is designed to accommodate a number of
developing technologies, such as telephone calls over Internet protocol, digital
subscriber lines, asynchronous transfer mode and coaxial cable systems.

RETAIL MARKETING

         We market our retail services to prospective customers primarily
through independent sales representatives (including multi-level marketing
companies), strategic business relationships, direct mail and traditional
advertising media such as billboards, radio and television. We intend to explore
the formation of alliances or ventures with other companies, including Internet
service providers, cable television companies, electrical utilities, 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.




                                       4
<PAGE>


BILLING AND COLLECTION

         We have three primary methods for billing and collecting from our
customers. For our Z-LineHOME customers, we can (1) direct bill by mail and
receive payment through a check or money order by mail; (2) charge a credit card
account or (3) set up an automatic withdrawal from a checking account.
Currently, we bill the majority of our customers by mail and receive payment
through checks delivered by mail. We have a variety of billing arrangements with
our wholesale customers.

INTELLECTUAL PROPERTY AND PROPRIETARY RIGHTS

         We have developed proprietary software that manages the integrated
features of our service offerings and that that allows our network to interface
and interconnect with the systems of the incumbent local exchange carriers and
long-distance carriers. Our network communication facilities are largely
consolidated in our enterprise management center in Tampa, Florida. This
consolidation allows us to maximize the productivity and effective management of
the facilities.

         We have entered into, and will continue to enter into, nondisclosure
agreements with our employees, independent contractors, business customers and
others. These agreements are intended to 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.

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

         For the fiscal years ended December 31, 2002, 2001 and 2000, we
invested approximately $13,157,000, $12,800,000, and $11,361,000, respectively,
in company-sponsored research and development activities.

         We have filed trademark applications for federal registration of
numerous trademarks with the United States Patent and Trademark Office,
including, Z-VOICE MAIL, Z-TECHNOLOGY, Z-MAILBOX, Z-NET, and MYZLINE.COM. We
have received federal registration of the following trademarks: Z-NODE, Z-LINE,
Z-LINEHOME, Z-LINEBUSINESS, WEBDIAL, CLICK & LISTEN, Z-TEL, YOUR PERSONAL
COMMUNICATIONS CENTER, Z-TEL COMMUNICATIONS, INC. and design, Z-LINE COMPANION,
Z-LINE MESSENGER, Z-TEL and design, and Z-TEL TECHNOLOGIES, INC.

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 service packages that include the range of services
and features that 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 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 far 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 in the foreseeable future a significant market share for any of our
services in our markets. 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



                                       5
<PAGE>


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 increased business opportunities for
us. However, such interconnection opportunities have been, and will likely
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 the 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 substantial
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, MCI 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.

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, MCI 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, enhanced services.

         We believe that 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,
BellSouth and SBC Communications, are currently providing both long distance and
local services as well as certain enhanced telephone services that 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 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 telephone service. The World Trade
Organization agreement on basic telecommunications services could increase the
level of competition we face. Under this agreement, the United



                                       6
<PAGE>


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 and competing in 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.

WHOLESALE SERVICES

         We believe we are the sole competitive local exchange carrier offering
local exchange services on a wholesale basis. Our chief competitor on the
wholesale level in each territory is the incumbent local exchange carrier,
usually a Bell operating company. Our competitive advantage is our knowledge and
experience in dealing with incumbent local exchange carriers, our knowledge and
experience in offering local services and our proprietary enhanced features.
Bell operating companies, in general, do not promote and market their ability to
offer wholesale services, preferring to minimize competition in the local
telephone services market. We offer our wholesale customers a full suite of
services for their use in providing telephone services to their customers. We
will face competition from a variety of companies that offer particular services
such as provisioning services, billing services and enhanced services (such as
voicemail) or that offer technologies related to such services.

GOVERNMENT REGULATION

OVERVIEW

         Some of our services are regulated and some are not. In providing our
feature services such as voice mail, "Find-Me" call forwarding and Personal
Voice Assistant, we operate as an unregulated provider of information services,
as that term is defined in the Communications Act of 1934 (the "Communications
Act"), as amended by the Telecommunications Act of 1996 (the "Telecommunications
Act"), and as an enhanced service provider, as that term is defined in the FCC
rules. These non-common carrier operations currently are not regulated by the
FCC or the states in which we operate. In providing Z-LineHOME 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 forty-nine states and the
District of Columbia. We are currently seeking such certification in Alaska.
Z-Tel is certificated as a long-distance reseller in all fifty states.

         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 providing 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 and continue to propose additional rules and policies to
implement this legislation. 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, pursuant to a recent FCC decision in FCC CC Docket No.
01-338 (referred to as the "Triennial Review"), we anticipate that all of the
state commissions in which we do business will be reviewing the availability of
the unbundled network element platform ("UNE-P") within their states. As
described below under "Federal Regulation-FCC Regulation of Common Carrier




                                       7
<PAGE>


Services-Interconnection and Unbundling Requirements," UNE-P is the regulatory
framework under which Z-Tel offers local telecommunications services to our
customers. The details of these proceedings are unknown at this time because the
FCC has not released the complete text of its decision and this decision will
not become legally effective until after that decision is published. However,
according to an FCC news release dated February 20, 2003, state commissions will
be expected during the next 9 months to engage in a detailed and fact-intensive
review of the availability of UNE-P for local telephone services in their
states. The results of these state commission proceedings will impact on our
business, and restriction in the availability of UNE-P could have a material
adverse impact on our business.

         Moreover, pursuant to federal standards state commissions, establish
the prices we pay for access to network elements. State commissions are
continually re-evaluating those prices. As states re-evaluate pricing of network
elements, it is possible that some states could increase or lower rates over
existing levels. The incumbent local exchange carriers, Verizon, BellSouth, SBC
and Qwest, regularly have rate cases pending before state regulatory
commissions. There are ongoing rate cases in Florida, Georgia, Illinois,
Indiana, Michigan, Pennsylvania, Massachusetts, California, and Texas, among
others, and these proceedings could significantly raise or lower the existing
rates for some network elements and network element combinations. Our intent is
to be an active participant in many of 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 and rates proposed by the
incumbents are overstated and do not reflect the true total element long run
incremental costing principles required by the FCC and the Telecommunications
Act. The legality of the FCC-prescribed methodology for calculating unbundled
network element rates was affirmed by the United States Supreme Court in Verizon
v. FCC on May 13, 2002. In the Triennial Review decision announced on February
20, 2003, the FCC noted that it will clarify two aspects of this federal
methodology (referred to as Total Element Long Run Incremental Cost, or TELRIC)
related to cost of capital and depreciation of new, advanced telecommunications
equipment. Since the text of the FCC's Triennial Review decision has not been
released, we cannot analyze the potential impact those clarifications may have
upon current or future rates. While the prevailing trends within the industry
would predict the adoption of lower rates in association with unbundled network
elements and network element combinations, we cannot predict the outcome of any
pending or potential rate case or judicial proceeding. We could face an
additional series of rate cases before state commissions to respond to the FCC's
clarification of its TELRIC rules. Increases or decreases in rate levels charged
by incumbent local exchange carriers can result from regulatory or judicial
review of a rate case or arbitration proceedings, and such changes 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 are unregulated. The FCC exempted enhanced service providers from federal
regulations governing 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 the universal service fund. 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 feature services we provide, including
voice mail, "Find-Me" call forwarding, and Personal Voice Assistant, 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 these 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 Docket No. 01-337, the FCC has proposed rules that would classify
broadband Internet access services offered by wireline telecommunications
providers as "information services" under the Communications Act.

         In general, the FCC does not regulate the rates, services, and market
entry 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 a non-dominant carrier with respect to both our
local and long distance telephone services. Typically, the incumbent local
exchange carrier is the dominant carrier in connection with local services. AT&T
is the traditional dominant carrier in connection with long distance services.



                                       8
<PAGE>


FCC REGULATION OF COMMON CARRIER SERVICES

         We currently are not subject to 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. 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. Our
ability to discontinue interstate services is regulated by Section 214 of the
Communications Act and FCC implementing rules.

         Comprehensive amendments to the Communications Act were made by the
Telecommunications Act, which was signed into law on February 8, 1996. The
Telecommunications Act effected changes in regulation at both the federal and
state levels that impact 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 effects of the Telecommunications Act, it is already
clear that the legislation provides us with new opportunities and challenges.

         Interconnection and Unbundling Requirements. The Telecommunications Act
greatly expands the interconnection requirements applicable to the incumbent
local exchange carriers, i.e., generally, those existing local telephone
companies that, in the past, enjoyed virtual or legal monopoly status.
(Conversely, new entrants to the local telephone market, like Z-Tel, are
referred to as "competitive local exchange carriers.") The Telecommunications
Act requires the incumbent local exchange carriers to-

         -        provide physical collocation, that is allow competitive local
                  exchange carriers to install and maintain their own network
                  termination equipment in incumbent local exchange carrier
                  central offices, or, if requested or if physical collocation
                  is demonstrated to be technically infeasible, provide virtual
                  collocation;

         -        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

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

         In addition, all local exchange carriers must -

         -        interconnect with the facilities of other carriers;

         -        establish number portability, that is allow customers to
                  retain their existing phone numbers if they switch from the
                  local exchange carrier to another local service provider;

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

         -        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 implementing certain portions of the
Telecommunications Act, including the unbundling and interconnection
requirements, upon which Z-Tel relies to provide local telephone services. The
FCC issued its first unbundling and interconnection order on August 8, 1996,
referred to as the 1996 Local Competition Order. Among other rules, the 1996
Local Competition Order 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
(TELRIC).

         Those rules have been the subject of considerable litigation. Two
Supreme Court decisions have resolved some of these issues, but many others,
including the identification of network elements that must be unbundled, remain
in dispute.

         In the May 13, 2002 decision in Verizon v. FCC, the Supreme Court
affirmed the particular pricing methodology adopted by the FCC in the 1996 Local
Competition Order for unbundled network elements, known as TELRIC. That decision
ensures that unbundled elements must be priced according to forward-looking
costs, at least until the FCC changes its pricing methodology. On



                                       9
<PAGE>


February 20, 2003, an FCC news release indicates that a future FCC order will
clarify two aspects of this pricing methodology with regard to cost of capital
and depreciation and new network investment. The text of that "clarification"
has not been released; however, we anticipate that this clarification may result
in reassessment of unbundling rates by many states, which could impact our
business. In addition, the FCC's Calendar Year 2003 Strategic Plan notes that it
is considering a complete review of its TELRIC rules. The FCC has not released
any proposals to modify those rules, but implementation of a different or
modified pricing standard for unbundled network elements could significantly
impact our business.

         On January 25, 1999, in AT&T v. Iowa Utilities Board, the Supreme Court
held 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 1997
Supreme Court decision reversed a July 18, 1997 decision by the United States
Court of Appeals for the Eighth Circuit on many grounds.

         In part of this 1999 AT&T decision, the Supreme Court remanded the list
of unbundled network elements identified in the 1996 Local Competition Order to
the FCC for further consideration of the necessity of each one under the
Telecommunications Act's statutory standard for unbundling. In response to this
Supreme Court decision, on November 5, 1999, the FCC released an order (the
"1999 Unbundling Order") that largely retained the existing list of unbundled
network elements, but eliminated the requirement that incumbent local exchange
carriers provide unbundled access to operator services and directory assistance
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 provide 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 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 requires Bell operating companies to provide
nondiscriminatory access to these services. The 1999 Unbundling Order required
that Bell operating companies must continue to provide these services to
competitors; however, it allowed them to charge different rates for these
offerings.

         On May 24, 2002, the D.C. Circuit Court of Appeals in USTA v. FCC,
reversed and remanded the 1999 Unbundling Order. A subsequent decision by the
D.C. Circuit in Competitive Telecommunications Ass'n v. FCC (October 25, 2002)
indicated that the FCC may limit required unbundling by means of carrier and
service-specific restrictions. In the USTA decision, the D.C. Circuit court
decided that the FCC had not adequately examined in specific detail local
competitive market conditions, alternative sources of supply, and the impact
those local conditions should have on the availability of unbundled network
elements. The D.C. Circuit stated that since the FCC had implemented unbundling
requirements of "unvarying scope" those rules must be reversed and remanded. In
the same decision D.C. Circuit also reversed and vacated the FCC's 1999 Line
Sharing and 2000 Line Splitting Orders on similar grounds. (Line Sharing and
Line Splitting are discussed below.) Several competitive carriers have requested
a Supreme Court review of the USTA decision, noting in part that the decision is
inconsistent with the Supreme Court's rationale in Verizon v. FCC and other
grounds. As of March 26, 2003, the Supreme Court has not decided whether to hear
that appeal.

         On February 20, 2003, the FCC announced its decision in the Triennial
Review docket, CC 01-338, a proceeding that it began on December 20, 2001. The
final text of this decision has not been released; as a result, we cannot fully
determine the impact the decision will have upon our business. However, an FCC
press release issued on February 20, 2003 indicates that in this decision the
FCC attempted to address the concerns expressed by the D.C. Circuit in the USTA
decision. (The effective date of the D.C. Circuit's mandate in USTA was extended
to February 20, 2003, which was the date upon which the FCC announced its
Triennial Review decision.) In particular, the FCC release states that in order
to provide the fact-based, local-market condition requirements imposed by USTA,
the FCC decided to request that state commissions undertake an important
fact-finding role with regard to



                                       10
<PAGE>


unbundled local switching and dedicated transport. According to the FCC release,
with regard unbundled switching in particular (a key component of UNE-P) the FCC
established "presumptions" of availability based upon customer characteristics.
Parties may attempt to rebut those presumptions before state commissions by
arguing with regard to operational or economic factors surrounding the
availability of switching from non-incumbent sources in that state for that
particular market. With regard to the services Z-Tel seeks to offer, the FCC
news release states that the FCC has established a presumption in favor of
statewide availability; such presumption may be rebutted in state proceedings
that are to last nine months. The FCC rejected arguments that unbundled loops,
switching, transport, and signaling at TELRIC rates are required by Section 271
of the Telecommunications Act.

         As a result of the Triennial Review proceeding, we anticipate that
virtually all states in which we do business will, after the effective date of
the to-be-released final FCC Order, commence in the next several months'
proceedings about the availability of UNE-P in their jurisdictions. We will
participate in many of theses state proceedings, either individually or through
coalitions of other similarly situated competitive carriers. We devoted
substantial resources in 2001-2002 to building the substantive case that we
intend to use in these state proceedings; however, it is impossible to predict
the outcome of these proceedings. It is possible that in many states, our
ability to utilize UNE-P to serve our customers will be significantly or
substantially curtailed. Such a result could significantly, adversely, and
materially harm our business. It is also possible that as a result of these
cases, our access to UNE-P could be expanded, such as lifting of the 3-line rule
in the 1999 Unbundling Order that limits our entry in one or many states. Such a
result could assist our small business and wholesale product lines in those
states.

         The Triennial Review release also indicates that the FCC will
significantly loosen its unbundling requirements for "advanced"
telecommunications network elements, such as packet-switching technology and
other new investment by incumbents. In addition, the FCC eliminated the
requirement that incumbents line-share with competitive DSL providers. However,
the FCC does appear to have preserved line-splitting, which would allow a Z-Tel
customer to obtain competitive DSL service from a non-incumbent suppliers. Once
again, the details of these regulatory changes remain in flux; as a result, it
is difficult for us to say how they will impact our business. Many of these
changes could substantially harm potential wholesale competitive carrier
customers of Z-Tel and therefore could harm our wholesale business. Substantial
relaxation of broadband regulations on our incumbent competitors like SBC,
Verizon, Qwest and BellSouth could make competition more difficult; for example,
incumbents may be able to bundle now-deregulated advanced services with local
telephone service, and Z-Tel may not be able to match because we cannot obtain
unbundled access to those advanced services. Such a result, among others, could
substantially harm our business. In addition, restrictions on unbundled access
may limit our business opportunities or ability to expand the services we offer
to customers.

         We emphasize that the final text of the FCC's Triennial Review decision
has not been released as of this writing. As a result, it is impossible to fully
gauge the impact the FCC's final Order will have upon Z-Tel's business. Several
incumbent local exchange carriers have stated publicly that they intend to
appeal that order, and even possibly seek a stay of its implementation. The
impact of such a stay upon Z-Tel's business is unclear. If a stay is granted,
incumbents may utilize the situation that since the USTA court decision became
effective on February 20, 2003, there are no federal rules requiring the
unbundling of any network element. Such a result would significantly and
substantially harm our business. While we disagree and would certainly litigate
that issue, we believe that our current interconnection agreements and contracts
with incumbent local telephone companies generally require them to continue to
provide us access until new rules are implemented. However, we cannot be certain
that our interpretation of our agreements would be accepted by all regulatory or
judicial bodies. There are likely to be several other appeals of the FCC's
Triennial Review Order which are likely to take at least one to two years to
resolve.

         The FCC is also considering other changes to other competition rules
that could impact our business. On December 20, 2001, the FCC issued a Notice of
Proposed Rulemaking in CC Docket No. 01-337 in which the FCC sought comment on
regulatory requirements for incumbent local exchange carrier provision of
broadband telecommunications services. In this proceeding, the FCC is
considering whether it should remove regulatory safeguards and common carrier
obligations, including unbundling regulations, on incumbent local exchange
carrier broadband networks. An FCC decision limiting unbundling or deregulating
incumbent local exchange carrier broadband networks could have a significant and
material adverse impact on our business. For example, incumbent local exchange
carriers may be able to offer consumers deregulated broadband network packages
of local exchange, information services and broadband service (such as DSL) that
Z-Tel would not be able to offer because Z-Tel would not have unbundled access
to that broadband network. In addition, because the incumbent local exchange
carrier "broadband network" in most instances utilizes the same network
facilities as the current incumbent local exchange dial tone network,
limitations on unbundling or deregulation of that "broadband network" could
inexorably make it difficult, more costly, or even impossible, for Z-Tel to
provide its current telecommunications and information services to consumers.

         On February 14, 2002, the FCC adopted a Notice of Proposed Rulemaking
in CC Docket No. 02-42 that proposed to classify incumbent local exchange
carrier provision of wireline broadband Internet access services as an
"information service" and regulate the



                                       11
<PAGE>


provision of such services pursuant to Title I of the Communications Act of
1934. In addition, the FCC sought comment on whether its Computer II/Computer
III rules, which govern access to incumbent networks by third parties to provide
information services. The proposed rules could, if adopted without adequate
assurances for competitive access, limit the ability of new entrants to access
and utilize the networks of incumbent local exchange carriers to provide
advanced, broadband Internet access and could therefore harm Z-Tel's ability to
provide services to its customers.

         These and other FCC determinations are likely to be the subject of
further appeals or reconsideration. Thus, while the Supreme Court has 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 and their impact on our
business.

         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-LineHOME. Z-Tel operates from interconnection agreements in the
following SBC states: California, Texas, Arkansas, Missouri, Kansas, Oklahoma,
Illinois, Indiana, and Ohio. SBC and Z-Tel have signed interconnection
agreements in Michigan and Wisconsin and are awaiting approval from those state
commissions. Meanwhile, Z-Tel continues to purchase required network elements
from SBC Ameritech's state tariffs in Michigan and Wisconsin. (Z-Tel does not
currently operate in SBC's territory in Connecticut and Nevada.) Z-Tel has
effective interconnection agreements, approved by the relevant state
commissions, in all the states where in which Verizon, Qwest and BellSouth are
an incumbent local exchange carrier. In addition, Z-Tel has effective
interconnection agreements, approved by the relevant state commissions, with
Sprint in Florida and Nevada.

         To ensure that it obtains interconnection and unbundled access at the
best-available terms, Z-Tel reviews available contracts, or amendments, and
negotiates new arrangements in a number of states. Section 252(i) of the 1996
Act gives Z-Tel the legal right to "pick-and-choose" interconnection and
unbundling terms and conditions in this manner. However, in a February 20, 2003
release, the FCC proposed to eliminate many, if not all, of these
"pick-and-choose" requirements. The text of this FCC proposal has not yet been
released, so we cannot say how implementation of the proposal may have on our
business. However, limitations on our ability to pick-and-choose interconnection
and unbundling terms and conditions could have a significant adverse impact on
our business, by increasing our costs in reaching interconnection agreements and
possibly having less-favorable arrangements than our competitors. In addition,
at any point in time our interconnection agreement may not contain the
best-available terms offered to our competitors, a situation that could
adversely affect our ability to compete in the market.

         If we cannot reach a voluntary interconnection agreement with an
incumbent local exchange carrier on acceptable terms, either side may petition
the applicable state commission to arbitrate remaining disagreements. These
arbitration proceedings can last for a substantial period of time and can
require substantial resources to litigate. 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. The incentive of the incumbent local exchange carrier
to negotiate fair or proper interconnection agreement terms is a function of the
willingness and authority of state commissions and the FCC to enforce rules and
policies promulgated under the Telecommunications Act. The potential cost in
resources and delay from this interconnection agreement negotiation and
arbitration 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.

         The ability of a new entrant like Z-Tel to enforce interconnection
agreements and state tariffs with incumbent local exchange carriers or appeal
state commission arbitrations regarding interconnection agreements is currently
subject to considerable legal uncertainty. In May 20, 2002, the United States
Supreme Court in Verizon v. Maryland PSC decided that it was appropriate for
carriers to appeal state commission determinations to enforce interconnection
agreements in federal district court. State commissions had argued that the
Eleventh Amendment precludes appeal of these decisions and determinations to
federal district court, and the Supreme Court's decision resolved many such
questions. Nevertheless, the relationship the interconnection and unbundling
implementation provisions of the 1996 Act and state law remain subject to
considerable litigation. A January 2002 decision by the United States Circuit
Court for the Eleventh Circuit ruled that the Georgia state commission did not
have authority to enforce interconnection agreements between incumbent local
exchange carriers and new entrants. This decision is in apparent conflict with
decisions by other United States Circuit Courts. As a result of this decision,
litigating enforcement of interconnection agreements in state or federal courts
in the Eleventh Circuit and elsewhere could substantially increase the cost of
such litigation. In addition, two recent decisions by the United States Circuit
Court of Appeals for the Sixth Circuit indicate that the authority of the
Michigan state commission to require incumbent local telephone companies to file
unbundling and interconnection tariffs may be limited or even



                                       12
<PAGE>


preempted by the 1996 Act interconnection agreement process. In Michigan and
other states, Z-Tel has utilized rights under state tariff regimes to provide
service; limitations on our ability to utilize Michigan or other state tariffs
in this way could increase our costs of doing business significantly. Moreover,
limitations on the ability to resort to state laws, regulations, policies, or
procedures could made entry into local markets more costly, time-consuming, and
difficult.

         Collocation. The FCC has adopted rules designed to make it easier and
less expensive for competitive local exchange carriers to collocate equipment 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. Restrictions and
impediments to collocation could harm our business as they make it more
difficult if not impossible for us to obtain alternatives to unbundled network
elements we purchase from incumbent local exchange carriers.

         As outlined in our previous annual reports, the FCC's collocation rules
have been subject to a number of legal challenges by incumbent local telephone
companies. On June 18, 2002, the D.C. Circuit affirmed the legality of the FCC's
collocation rules in Verizon Telephone Companies v. FCC. In the process of these
court challenges, the FCC's new rules could increase the cost and time for
competitors to collocate equipment in incumbent local exchange carrier central
offices and could have a substantial and material impact on Z-Tel's future
business prospects.

         Line Sharing and Line Splitting. In November 1999, the FCC adopted an
order that required incumbent local exchange carriers to provide line sharing,
which is a method in which a competitive provider can provide data services over
the same line that the incumbent provides voice services (the 1999 Line Sharing
Order). In an order on reconsideration, the FCC stated that incumbents must also
permit competitive carriers to engage in "line-splitting" arrangements in which
one competitive provider may offer voice services and another competitive
provider may offer data services (e.g., DSL) on one of the incumbent's local
loops (the 2000 Line Splitting Order). In USTA, the D.C. Circuit reversed,
remanded and vacated the 1999 Line Sharing Order and 2000 Line Splitting Order.

         On February 20, 2003, as part of its Triennial Review decision
discussed above, the FCC announced that it will eliminate the requirement that
line-sharing be provided as an unbundled network element, subject to a
transition period. Z-Tel does not utilize line-sharing to provide DSL services
to our customers, so we believe that the FCC February 20, 2003 announcement that
its Triennial Review Order will eliminate line-sharing as an unbundled network
element has no immediate impact on our retail business. However, since the text
of that Order had not been released, we cannot now predict how that decision
could impact future prospects of our business, the on-going viability of our
wholesale or potential wholesale customers that may utilize line-sharing. The
FCC's Triennial Review release does indicate that the FCC has kept in place
requirements for "line-splitting," which is the method in which a Z-Tel voice
customer may be able to order DSL service from a non-incumbent competitor. Once
again, since the text of the FCC decision has not been released, we cannot at
this time make any judgment as to the impact that decision would have on our
business.

         While we expect that the preservation of line-splitting could be
beneficial to competitive local exchange carriers like Z-Tel, we cannot be
certain that these rules will be implemented by the incumbent local exchange
carrier in a timely or favorable manner. As a result, Z-Tel's ability to offer
its customers DSL service and voice service by use of line-splitting and the
unbundled network element platform combination is restricted significantly by
incumbent local exchange carriers. That restriction could harm our business and
our ability to match the service packages and bundles offered by our
competitors, including the incumbents. In addition, the FCC's apparent
elimination of line-sharing could make existing and potential wholesale
competitive carrier customers less-financially viable, which could harm our
business.

         Bell Operating Company Entry into the Long Distance Market. The
Telecommunications Act permitted the Bell operating companies (Verizon, SBC,
Qwest, and BellSouth) to provide long distance services outside their local
service regions immediately, and permits them to provide in-region long distance
service upon demonstrating to the FCC that they have adhered to the
Telecommunication Act's Section 271 14-point competitive checklist. The FCC must
also find that granting the application would be in the "public interest."

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



                                       13
<PAGE>


         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. However, since December 1999, the FCC has not rejected a Section
271 application submitted by any Bell operating company, although several
applications have been withdrawn after being submitted. In late December 1999,
the FCC approved Verizon's Section 271 application for the state of New York.
Since that time, the FCC has approved Bell operating company applications in 36
other states and the District of Columbia. Section 271 authority has been
granted in Currently pending before the FCC are applications for Michigan (SBC),
Nevada (SBC), New Mexico (Qwest), Oregon (Qwest), and South Dakota (Qwest). In
addition to those pending applications, Bell operating companies do not have
Section 271 authority in Illinois, Indiana, Ohio, Wisconsin, Minnesota, and
Arizona.

         Several state public utility commissions (including Illinois and
Minnesota) 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, we expect Bell operating
companies to file applications for long distance authority in most of the
remaining states in 2003 and that the FCC will grant many, if not most, of those
applications, despite the objections of competitive carriers and the Department
of Justice.

         It is generally expected that competition for Z-Tel's long-distance
services will increase as the Bell operating companies enter the market. Section
271 entry permits the Bell operating company to offer a bundle of local,
long-distance and enhanced services comparable to Z-Tel's services and therefore
could increase competition and harm our business, especially if we cannot obtain
adequate access to unbundled network elements from that same Bell operating
company.

         The Section 271 process also provides an important incentive for Bell
operating companies to comply with the unbundling and interconnection
requirements of the Telecommunications Act. Z-Tel relies upon obtaining
unbundled access and interconnection with Bell operating companies to provide
its services to its customers; as a result, Z-Tel has a direct business interest
in ensuring that the Bell operating companies comply with the law. Granting a
Bell operating company long-distance authority pursuant to Section 271 in a
state where the Bell operating company has not fully-complied with the law could
have a significant and material adverse impact on Z-Tel's business, as it would
diminish the incentive of Bell operating companies to comply with the law
nationwide. Z-Tel has in many cases documented discriminatory behavior by the
Bell operating company. For example, on September 19, 2001, the FCC granted
Verizon's Section 271 application for Pennsylvania, despite the strong
objections of Z-Tel and other competitors that Verizon's operational systems in
that state were discriminatory. In October 2001, Z-Tel appealed that FCC
decision before the United States Circuit Court for the District of Columbia.
That appeal was heard by the D.C. Circuit in February 2003 and a decision is
pending. If Z-Tel is not successful in this litigation, the incentive of Bell
operating companies to comply with their interconnection and unbundling
obligations fully could be significantly diminished, which could have a material
adverse impact on our business.

         The D.C. Circuit has recently reversed FCC 271 grants on the basis that
the FCC did not consider all the evidence and arguments before it. In December
28, 2001, the United States Circuit Court for the District of Columbia remanded
the FCC's decision to grant SBC long-distance authority in Kansas and Oklahoma.
On October 22, 2002, the D.C. Circuit reversed the FCC's Massachusetts 271 Order
in WorldCom v. FCC. In both decisions, the court ruled that the FCC had not
fully considered whether granting such authority was in the public interest,
given the alleged potential for a "price squeeze" between regulated retail and
wholesale rates for local service. These proceedings have been remanded to the
FCC. It is unclear how and when the FCC will decide this issue on remand. If the
FCC continues to reject arguments raised by competitors, the ability for
entrants to utilize the section 271 process as a method of achieving lawful
wholesale rates or compliance with the 1996 Act could be substantially
diminished.

         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. Our share of the
payments into these subsidy funds is 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, and 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, in Texas Office of Public Utility Counsel v. FCC, 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. The Fifth Circuit ruled
that the FCC's could not require that incumbent local exchange carriers recover
universal service costs via access charges paid by interstate carriers, as such
a result would create an implicit subsidy prohibited by section 253 of the 1996
Act. In October 1999, on remand from this decision, the FCC issued new universal
service



                                       14
<PAGE>


rules. The FCC decided that if a carrier derives less than 8 percent of its
revenue from interstate services, its international revenues will not be used in
calculating the contribution. For those carriers receiving 8 percent or more of
their revenues from interstate services, the FCC will include their
international revenue in the base for determining their contributions. The
Commission also permitted, rather than require, ILECs to recover their universal
service costs through access charges to interstate carriers. These or other
changes to the universal service program could affect our costs by increasing
charges for interstate access or requiring higher assessments on interstate
revenues. On May 20, 2001, the Fifth Circuit once again reversed the FCC's
rules, deciding, in Comsat Corp. v. FCC, that the FCC cannot permit local
exchange carriers to recover universal service charges through access charges,
as such an arrangement would create an implicit subsidy.

         On December 13, 2002, the FCC announced that it will modify on an
interim basis the method in which carriers are required to make payments to the
fund. Among other changes, the FCC announced that carriers will be required to
contribute based upon projected, collected end-user interstate revenues, instead
of historical, gross-billed revenues. Competitive carriers will be prohibited
from marking-up USF contributions for administrative fees if carriers recover
USF contributions through phone bill line items. These interim measures impact
the manner in which we make contributions into the federal fund and could impact
our business. The FCC also proposed further changes to its contribution
methodology.

         The outcome of this litigation and subsequent and forthcoming FCC and
state determinations could adversely impact or delay our ability to obtain
universal service funding for our services, the sums we pay into universal
service funds, the price for access, and our ability to compete with carriers
that do obtain such funding. Changes to the federal or state support programs
could adversely affect our costs, our ability to separately-list these charges
on end-user bills, and our ability to collect these fees from our customers.

         Interstate Tariffs and Rates. Beginning July 31, 2001, interstate
domestic long distance companies were no longer allowed to file interstate
long-distance end-user tariffs with the FCC. This regulatory change requires
that Z-Tel must make its long-distance service information directly available to
customers pursuant to private contracts. In March 1999, the FCC adopted rules
that require interexchange carriers like Z-Tel to make specific disclosures on
their web sites of their rates, terms and conditions for domestic interstate
services. These detariffing and disclosure requirements could increase our costs
in providing interstate long-distance services to our subscribers.

         On April 27, 2001, the FCC limited the ability of nondominant,
competitive local exchange carriers, including Z-Tel, to file tariffs for
interstate switched access services. In doing so, the FCC effectively regulates
the rates Z-Tel charges long-distance companies for interstate switched access
services. Local exchange carriers (like Z-Tel) provide interstate switched
access services to interexchange long-distance companies (like AT&T, MCI, and
Sprint) when a state-to-state long distance call is made to or placed by a local
telephone customer. Given the large number of interstate long-distance
companies, these interstate switched access services are provided generally
through FCC interstate tariffs. Prior to this April 27, 2001 decision, the FCC
had refrained from any price regulation of the interstate access rates of
competitive local exchange companies like Z-Tel. With the April 27, 2001 Report
and Order in CC Docket No. 96-262, the FCC ruled that it would not accept for
filing any interstate switched access tariff filing by a competitive local
exchange carriers if the per-minute rate exceeded an FCC benchmark. The FCC
benchmark varies by metropolitan statistical area. In metropolitan statistical
areas ("MSAs") that a competitive local exchange carrier began to provide
service after June 20, 2001 (the effective date of the Order), the FCC benchmark
rate is the interstate switched access rate for the "competing" incumbent local
exchange carrier, which is established pursuant to publicly-filed tariffs before
the FCC. For MSAs in which a carrier was providing local service in as of June
20, 2001, the FCC benchmark rate from June 20, 2001 through June 19, 2002 is 2.5
cents per minute or the competing incumbent local exchange carrier rate,
whichever is higher. For those same MSAs, the FCC benchmark rate from June 20,
2002 through June 19, 2003 is 1.8 cents per minute or the competing incumbent
local exchange carrier rate, whichever is higher. For those same MSAs, the FCC
benchmark rate from June 20, 2003 through June 19, 2004 is 1.2 cents per minute
or the competing incumbent local exchange carrier rate, whichever is higher.
Beginning on June 20, 2004, the FCC benchmark rate for those MSAs will be the
switched access rate of the competing incumbent local exchange carrier. As of
June 20, 2001, Z-Tel was providing local service in most of the MSAs in its
current footprint; as a result, the FCC benchmark rates for Z-Tel's interstate
switched access charges in those MSAs will, through June 20, 2004, be
considerably higher than the FCC benchmark rate for Z-Tel's competitors that
begin to provide service in those MSAs after June 20, 2001.

         AT&T and Sprint have appealed the FCC's April 2001 CLEC Access Charge
Order before the United States Circuit Court for the District of Columbia,
arguing that the FCC's benchmark rates are too high and that competitive local
exchange carriers like Z-Tel should be required to provide interstate switched
access services at the competing incumbent local exchange carrier rate
immediately. Z-Tel has intervened in that court proceeding against those
long-distance companies. Two competitive local exchange carriers have also
appealed the FCC decision, and several competitive carriers have sought
reconsideration or clarification of the FCC's decision. In addition, Z-Tel has
sought a waiver of FCC rules requiring it to tariff interstate switched access
services at the competing incumbent


                                       15
<PAGE>


local exchange carrier rate for several dozen smaller MSAs that Z-Tel did not
have any local subscribers in as of June 20, 2001, arguing to the FCC that the
cost to Z-Tel to provide interstate switched access services at two different
rate levels in the same state would impose unnecessary costs on Z-Tel that is
inconsistent with the public interest. These appeals, reconsiderations, and the
waiver request are all pending. The outcome of any of these determinations could
have a significant and material impact on Z-Tel's business. In particular, if
AT&T and Sprint are successful in requiring Z-Tel and other entrants to charge
the competing incumbent local exchange carrier rate for interstate switched
access services immediately, it would have a substantial and material adverse
effect on Z-Tel's business and competitive advantage.

         In 2001, Z-Tel settled pending litigation with AT&T and Sprint over
their nonpayment of access charges to Z-Tel. Z-Tel provides interstate and
intrastate switched access services to both of those long-distance carriers
pursuant to switched access service agreements. Based on history of nonpayment
of both of these long-distance carriers to Z-Tel, there is a risk that either or
both of these long-distance companies could fail to pay Z-Tel for switched
access services. While Z-Tel has in the past and will in the future adamantly
litigate and defend its position against these carriers, nonpayment could have a
substantial and material adverse impact 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 were based on end-user telecommunications
revenues and have been 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 in CC Dockets No.
96-98 and 99-200 that proposed adoption of a "market-based" approach for
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 and possibly make it more difficult for us
to obtain telephone numbers for our customers.

         Restrictions on Bundling. On March 30, 2001, in CC Dockets Nos. 96-61
and 98-183, the FCC eliminated a rule that prohibited all carriers from bundling
customer premises equipment and telecommunications services. FCC rules also
require that nondominant carriers that own common carrier transmission
facilities and provide enhanced services may bundle basic telecommunications and
enhanced services in packages to customers, but such carriers must make the
underlying transmission capacity for the enhanced service available to other
enhanced service providers under nondiscriminatory terms and conditions under
which they provide such services to their own enhanced service operations.

         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



                                       16
<PAGE>


covered only long distance) to local service as well. Z-Tel is also subject to
state rules and regulations regarding slamming, cramming, and other consumer
protection regulation.

         Network Information. Section 222 of 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. The FCC's original rules prevented a
carrier from using CPNI acquired through one of its offerings of a
telecommunications service to market certain other services without approval of
the affected customer. The United States Court of Appeals for the Tenth Circuit
overturned a portion of the FCC's rules established in CC Docket No. 96-115
regarding the use and protection of CPNI.

         In response to the Tenth Circuit decision, in October 2001, in CC
Docket No. 96-115, the FCC clarified that the Tenth Circuit reversal was limited
and that most of the FCC's CPNI rules remained in effect. The FCC sought further
comment on what method of customer consent offered by a carrier (either an
"opt-in" or "opt-out" approach) would serve the governmental interest in Section
222 and be consistent with the First Amendment. The final determination of this
issue and other FCC rules regarding handling of CPNI could result in significant
administrative expense to Z-Tel in modifying internal customer systems to meet
these requirements.

         Intercarrier Compensation (Interstate Access Charges and Reciprocal
Compensation). Because Z-Tel, as a competitive local exchange carrier, passes
and receives local and toll calls to and from other local exchange carriers and
long-distance companies, the rates for "intercarrier compensation" for these
calls has a significant and substantial impact on the profitability of Z-Tel's
business. In addition, the rates that Z-Tel's competitors, especially the
incumbent local exchange carriers, are permitted to charge end-users, other
local exchange carriers, and long-distance companies for originating,
transmitting, and terminating telecommunications traffic can have a substantial
impact on Z-Tel's ability to offer services in competition with those carriers.

         The current regulatory (and intercarrier compensation) status of
dial-up calls to Internet service providers is in dispute and litigation. 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.

         Since passage of the Telecommunications Act of 1996, the FCC has
fundamentally restructured the "access charges" that incumbent local exchange
carriers charge to interexchange carriers and end-user customers to connect to
the incumbent local exchange carrier's network. The FCC revised access charges
for the largest incumbent local exchange carriers 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 incumbent local exchange carriers 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. The CALLS plan also attempted to remove implicit
universal service subsidies paid for by long-distance companies in interstate
access rates and place those funds into the federal universal service support
system, where they would be recovered from all interstate carriers. Most of the
reductions in the CALLS plan resulted from shifting access costs away from
interexchange carriers onto end-user customers. Last year, the Fifth Circuit
reversed and remanded portions of the CALLS plan back to the FCC for further
consideration of the issue as to the size of the subsidy for universal service
should be removed from the interstate access charges and placed into the federal
interstate universal service support system. The outcome of this litigation
could impact the contributions Z-Tel, as an interstate carrier, must pay to
support the federal universal service support system.

         In addition, as discussed above, the rates that Z-Tel and other
competitive local exchange carriers may charge for interstate switched access
services are regulated pursuant to the FCC's April 2001 CLEC Access Charge
Order.



                                       17
<PAGE>


         In April 2001, the FCC released a Notice of Proposed Rulemaking in CC
Docket No. 01-92 in which it proposed a "fundamental re-examination of all
currently regulated forms of intercarrier compensation." The FCC proposed that
carriers transport and terminate local traffic on a bill-and-keep basis, rather
than per-minute reciprocal compensation charges. The FCC regards the CALLS Order
and the CLEC Access Charge Order as well as its reciprocal compensation rules to
be 3-year "transitional intercarrier compensation regimes". After completion of
that three-year transition, a new interstate intercarrier compensation regime
based upon bill-and-keep or another alternative may be in place. In addition,
AT&T and Pulver.com have both filed before the FCC petitions for declaratory
rulings that "IP telephony" services offered by them are, in different ways, not
subject to the FCC's access charge regime. Because Z-Tel both makes payments to
and receives payments from other carriers for exchange of local and
long-distance calls, at this time we cannot predict the effect that the FCC's
determination in CC Docket No. 01-92 or these IP telephony petitions may have
upon our business.

         Potential Adverse Federal Legislation. In the past, federal lawmakers
have considered bills that would alter the pro-competitive regulatory structure
of the 1996 Telecommunications Act and similar state statutes. For example, on
February 27, 2002, the U.S. House of Representatives passed H.R. 1542, (the
"Tauzin-Dingell" bill). Had that bill been enacted into law, a substantial
portion of the Telecommunications Act, including several of the unbundling
requirements, would have been overturned. The possibility of similar or other
adverse federal legislation being introduced and passed is significant and could
have a material, harmful impact on our business. Similar efforts are pending
before state legislatures, which are discussed below. Such legislative actions
can have a significant and material adverse impact on our business. Other
changes to the market-opening and enforcement provisions of the Communications
Act could adversely affect our ability to provide competitive services and could
harm our business.

         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

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

         -        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.

         -        The FCC has adopted new rules designed to make it easier for
                  customers to understand the bills of telecommunications
                  carriers. These Truth-in-Billing 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.

         -        The FTC is considering applying national "do not call" lists
                  to telephone companies that utilize telemarketing. Z-Tel has
                  utilized telemarketing strategies and such regulation could
                  increase the cost and decrease the effectiveness of
                  telemarketing.

         -        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.

         -        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, legislative bodies, or state
or local governments.

STATE REGULATION

         To the extent that we provide telecommunications services that
originate and terminate within 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 services and
may become increasingly subject to state regulation. The Telecommunications Act
preserves 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,



                                       18
<PAGE>


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 forty-nine states. Z-Tel has sought such authority
also in Alaska. No assurance can be made that the Alaska state regulatory
authority 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. Changes in those rates for unbundled network elements could
have a substantial and material impact on our business. Our ability to appeal
State commission determinations in federal court is subject to considerable
legal uncertainty (see "Interconnection Agreements" above).

         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.

         We are also subject to state laws and regulations regarding slamming,
cramming, and other consumer protection and disclosure regulations. These rules
could substantially increase the cost of doing business in any one particular
state. State commissions have issued or proposed several substantial fines
against competitive local exchange companies for slamming or cramming. 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 before a state commission could cause extensive litigation expenses
for us. In addition, state law enforcement authorities may utilize their powers
under state consumer protection laws against us in the event legal requirements
in that state are not met. In addition, our wholesale business raises particular
risks that could make Z-Tel liable for slamming, cramming or other consumer
protection and disclosure violations undertaken by our wholesale customers and
sales agents. While we try and ensure that our contracts with our wholesale
customers and sales agents provide for indemnification to Z-Tel of such
liability, there is substantial risk that Z-Tel may be held liable regardless
and that the wholesale customer or agent may not have the financial ability to
indemnify Z-Tel fully.

         Z-Tel's rates for intrastate switched access services, which Z-Tel
provides to long-distance companies to originate and terminate in-state toll
calls, are subject to the jurisdiction of the state commissions in which the
call originated and terminated. State commissions may, like Texas, directly
regulate or prescribe this intrastate switched access rate. Such regulation by
other states could materially and adversely affect Z-Tel's revenues and business
opportunities within that state.

         The Telecommunications Act generally preempts state statutes and
regulations that restrict the provision of competitive services. As a result of
this preemption, we will be generally free to provide the full range of local,
long distance, and data services in 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 Z-Tel's ability
to provide competitive services in some rural areas. In addition, the cost of
enforcing federal preemption against certain state policies and programs may be
large and may cause considerable delay. In particular, we expect to expand our
Z-LineHOME service by starting to market this service in several new states
during 2003. To effect entry into these markets, we have obtained proper state
regulatory certification and entered into interconnection agreements in all
states where we operate, except for Michigan and Wisconsin, where we obtain
interconnection and access to unbundled network elements through a state tariff.
In each jurisdiction where we operate, 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.

         As discussed above, State commissions have an important role to play in
implementing the Telecommunications Act, and discussion of particular issues and
risks related to that state implementation are contained in the "Federal
Regulation" section above. As a result of the FCC's Triennial Review decision,
over the next several months, state commissions will likely engage in extensive
and detailed review of the availability of unbundled local switching in their
states. Limitations or restrictions on the availability of unbundled local
switching in any area or to any customer classification could significantly,
materially, and adversely harm our business. In addition, in order to enter new
markets, we may be required to negotiate interconnection agreements with
incumbent local exchange carriers on an individual state basis. To continue to
provide service, we also need to renegotiate interconnection agreements with
incumbent local exchange carriers. 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



                                       19
<PAGE>


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. In addition, as discussed above, there is considerable legal
uncertainty as to how interconnection agreements are to be enforced before state
commissions and where appeals of state commission interconnection agreement
determinations may be heard.

         In addition, state lawmakers may consider bills that would alter the
pro-competitive regulatory structure of the Telecommunications Act and similar
state statutes. Passage of legislation that limits or restricts interconnection
or unbundled access to incumbent networks, or that limits the authority or
powers of the state regulatory commission, could have a material, harmful impact
on our business in those states. For example, SB 1518, pending before the
Illinois General Assembly, and SB 377/HB 1658, pending before the Texas
legislature, could significantly curtail pro-competitive state initiatives taken
in those states by limiting unbundled access and state commission authority.
Passage of such adverse legislative actions can have a significant and material
adverse impact on our business. Other changes to the market-opening and
enforcement provisions of the Communications Act could adversely affect our
ability to provide competitive services and could harm our business.

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 25, 2003, we had approximately 1,158 employees. None of our
employees is covered under collective bargaining agreements.

ACCESS TO INFORMATION

         The public may read and copy any materials we file with the Securities
and exchange commission at the SEC's Public Reference Room at 450 Fifth Street
N.W., Washington, D.C. 20549. The public may obtain information on the operation
of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC
maintains an Internet site that contains reports, proxy and information
statements, and other information regarding issuers that file electronically
with the SEC. The address of that site is http://www.sec.gov.

         Reports we file electronically with the SEC including annual reports on
Forms 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and
amendments to those filings are available free of charge soon after each filing
at the following Web site: http://www.z-tel.com. Select "Investor Relations"
from the drop down menu under "Learn."

ITEM 2.      PROPERTIES

         We currently lease our principal executive offices in Tampa, Florida
and our principal engineering offices in Atlanta, Georgia. Our principal network
facilities reside in our Tampa offices. We own our principal consumer services
offices in Atmore, Alabama.

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.       Case No. 01 CV 5074: In re Z-Tel Technologies, Inc. Initial Public
         Offering Securities Litigation, Master File No. 21 MC 92 (SAS), in the
         United States District Court for the Southern district of New York
         (original complaint filed June 7, 2001; Second Corrected Amended
         Complaint filed July 12, 2002)



                                       20
<PAGE>


         During June and July 2001, three separate class action lawsuits were
filed against the Company, certain of the Company's current and former directors
and officers (the "D&Os") and firms engaged in the underwriting (the
"Underwriters") of our initial public offering of stock (the "IPO"). Each of the
lawsuits is based on the allegations that the Company's registration statement
on Form S-1, filed with the Securities and Exchange Commission ("SEC") in
connection with the IPO, contained untrue statements of material fact and
omitted to state facts necessary to make the statements made not misleading by
failing to disclose that the underwriters had received additional, excessive and
undisclosed commissions from, and had entered into unlawful tie-in and other
arrangements with, certain customers to whom they allocated shares in the IPO.
Plaintiffs have asserted claims against the Company and the D&Os pursuant to
Sections 11 and 15 of the Securities Act of 1933 and Sections 10(b) and 20(a) of
the Securities Exchange Act of 1934 and Rule 10b-5 promulgated by the SEC
thereunder. The plaintiffs seek an undisclosed amount of damages, as well as
pre-judgment and post-judgment interest, costs and expenses, including
attorneys' fees, experts' fees and other costs and disbursements.

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

         Metropolitan Nashville Employee Benefit Board, one of our common
shareholders, alleges that we wrongfully and improperly delayed providing them
with a stock certificate and that during the time of such delay our stock price
plummeted and they were unable to sell or take steps to protect the value of
their shares. Metro Nashville seeks compensatory damages in excess of $18
million, plus interest, and punitive damages of $18 million.

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

         On August 6, 2002, we filed a complaint against Southwestern Bell
Telephone Company ("SWBT") before the Public Utility Commission of Texas (PUCT),
requesting that the PUCT enjoin SWBT from disconnecting our access to customers
in Texas on the basis of a billing dispute between the parties. The billing
dispute centered on whether we owed SWBT certain amounts for collect calls from
SWBT retail customers to Z-Tel retail customers. On August 23, 2002, the PUCT
issued in part the injunctive relief requested by Z-Tel, making clear that
service not be interrupted. Since that injunction, Z-Tel and SWBT have been
involved in a dispute resolution process over these and other billing disputes
between SWBT and SBC affiliates of SWBT.


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

MARKET INFORMATION

         The Company's common shares are traded on the Nasdaq SmallCap Market
under the symbol "ZTEL." Our shares were previously traded on the Nasdaq
National Market. We downlisted to the SmallCap Market on September 10, 2002.

         The following table sets forth, for the periods indicated, the range of
high and low closing sale prices for the common shares, as reported on the
Nasdaq National Market or the Nasdaq SmallCap Market, as the case may be.


                                       21
<PAGE>


                                      HIGH          LOW

         FISCAL YEAR 2001:
         First Quarter                $6.94        $3.63
         Second Quarter               $4.45        $1.40
         Third Quarter                $1.65        $0.78
         Fourth Quarter               $1.95        $0.80
         FISCAL YEAR 2002:
         First Quarter                $2.98        $1.25
         Second Quarter               $2.25        $0.35
         Third Quarter                $1.55        $0.41
         Fourth Quarter               $1.37        $0.70

         On March 26, 2003, the last reported sales price of the common stock
on the Nasdaq SmallCap Market was $1.36 per share.

HOLDERS

         As of March 26, 2003, there were approximately 5,200 shareholders of
our common stock.

DIVIDENDS

         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, our 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, E, and G
Convertible Preferred Stock, which have dividend preferences over our common
stock.

SECURITIES AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS

<TABLE>
<CAPTION>
               Plan category       Number of securities     Weighted-average      Number of securities
                                     to be issued upon      exercise price of     remaining available
                                        exercise of       outstanding options,    for future issuance
                                   outstanding options,    warrants and rights        under equity
                                    warrants and rights                            compensation plans
                                                                                 (excluding securities
                                                                                  reflected in column
                                                                                          (a))

           <S>                          <C>                    <C>                    <C>
                                            (a)                    (b)                    (c)

            Equity compensation          12,493,588             $4.59                  2,966,028
             plans approved by
              security holders

            Equity compensation
           plans not approved by
              security holders
                                         ----------             -----                  ---------
                   Total                 12,493,588             $4.59                  2,966,028
                                         ==========             =====                  =========
</TABLE>


RECENT SALES OF UNREGISTERED SECURITIES

SERIES D CONVERTIBLE PREFERRED STOCK

         During July 2000, we sold an aggregate of 4,688,247 shares of $0.01 par
value Series D Convertible Preferred Stock (the "Series D Preferred") and
warrants (the "Series D Warrants") for the purchase of 2,344,123 shares of our
common stock, for aggregate proceeds of approximately $56.3 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.

         Each Series D Preferred is convertible into the number of common shares
equal to the $12.00 divided by the conversion price, as adjusted. The initial
conversion price was $12.00. In addition upon conversion during the first five
years, three-fourths of the accrued and unpaid dividends are convertible into
common shares at $12.00 per share without adjustment. Each Series D Warrant
entitles its holder to purchase one share at an exercise price of $13.80, as
adjusted. The conversion price of the Series D Preferred is



                                       22
<PAGE>


subject to adjustment in the case of (i) a dividend or distribution to common
shareholders (whether such dividend or distribution is in stock, securities or
other property), (ii) a stock split, (iii) a stock combination, (iv) a
reclassification of the common stock, (v) the issuance of stock or securities
convertible into or exercisable for common stock at a price that is less than
the adjusted conversion price and other events that would cause dilution of
ownership to the Series D Preferred stock. The Series D Warrants are likewise
subject to adjustment upon the occurrence of certain dilutive events.

SERIES E CONVERTIBLE PREFERRED STOCK

         During November 2000, we sold an aggregate of 4,166,667 shares of $0.01
par value Series E Convertible Preferred Stock ("Series E Preferred") and a
warrant (the "Series E Warrant") for the purchase of 2,083,333 shares of our
common stock for aggregate proceeds of approximately $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.

         Each Series E Preferred is convertible into the number of common shares
equal to the $12.00, plus accrued and unpaid dividends, divided by the
conversion price, as adjusted. The initial conversion price was $12.00. The
Series E Warrant entitles its holder to purchase shares at an exercise price of
$13.80 per share, as adjusted. The conversion price of the Series D Preferred is
subject to adjustment in the case of (i) a dividend or distribution to common
shareholders (whether such dividend or distribution is in stock, securities or
other property), (ii) a stock split, (iii) a stock combination, (iv) a
reclassification of the common stock, (v) the issuance of stock or securities
convertible into or exercisable for common stock at a price that is less than
the adjusted conversion price and other events that would cause dilution of
ownership to the Series E Preferred stock. The Series E Warrant is likewise
subject to adjustment upon the occurrence of certain dilutive events.

SERIES G JUNIOR CONVERTIBLE PREFERRED STOCK

         On July 5 and August 3, 2001, we sold an aggregate of 175 shares of
$0.01 par value Series G Junior Convertible Preferred Stock (the "Series G
Preferred") and warrants (the "Series G Warrants") for the purchase of 3,000,000
shares of our common stock for aggregate proceeds of $17.5 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.

         Each Series G Preferred is convertible into the number of common shares
equal to the $100,000.00, plus accrued and unpaid dividends, divided by
conversion price, as adjusted. The initial conversion price was $1.49. Each
Series G Warrant entitles its holder to purchase one share at an exercise price
of $0.01 per share, as adjusted. The conversion price of the Series G Preferred
is subject to adjustment in the case of (i) a dividend or distribution to common
shareholders (whether such dividend or distribution is in stock, securities or
other property), (ii) a stock split, (iii) a stock combination, (iv) a
reclassification of the common stock, (v) the issuance of stock or securities
convertible into or exercisable for common stock at a price that is less than
the adjusted conversion price and other events that would cause dilution of
ownership to the Series G Preferred stock. The Series G Warrants are likewise
subject to adjustment upon the occurrence of certain dilutive events.

COMMON SHARES

         On March 20, 2002, we issued 1,000,000 shares of our common stock to
MCI WORLDCOM Communications, Inc. ("MCI") in connection with a certain Agreement
for Wholesale Telephone Exchange Services, Z-Node Services, Ancillary Services
and Technology License between Z-Tel Communications, Inc., our wholly-owned
subsidiary, and MCI. The shares were sold for $2,333,000 in cash; however, we
simultaneously delivered a like amount of money to MCI as a signing bonus in
connection with the contract. 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.



                                       23
<PAGE>


ITEM 6.      SELECTED CONSOLIDATED FINANCIAL DATA

     The following selected historical consolidated financial data has been
derived from our consolidated financial statements and 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,"
presented later in this document. Historical results are not necessarily
indicative of future results.

<TABLE>
<CAPTION>
                                                                                                                        PERIOD
                                                                                                                    JANUARY 15, 1998
                                                                                                                       (INCEPTION)
                                                                                                                        THROUGH
                                                                       YEARS ENDED DECEMBER 31,                       DECEMBER 31,
                                                  ---------------------------------------------------------------
                                                       2002            2001               2000 (8)        1999            1998
                                                  ------------    ------------       ------------    ------------    ------------
                                                                      (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

<S>                                               <C>             <C>                <C>             <C>            <C>
Revenues                                          $    235,255    $    275,897       $    177,668    $      6,615    $        140
                                                  ------------    ------------       ------------    ------------    ------------
Operating expenses:
   Network operations(9)                                91,374         155,164            107,077           6,518             382
   Sales and marketing                                  12,327          31,243             45,018           8,898           2,201
   General and administrative (4)                      122,537         156,107             99,606          20,055           9,446
   Asset impairment charge(3)                            1,129          59,247                                 --              --
   Wholesale development costs (6)                       1,018                                 --              --              --
   Restructuring charge(7)                               1,861                                                 --              --
   Depreciation and amortization                        23,936          23,277             17,166           4,372           1,283
                                                  ------------    ------------       ------------    ------------    ------------
         Total operating expenses                      254,182         425,038            268,867          39,843          13,312
                                                  ------------    ------------       ------------    ------------    ------------
         Operating loss                                (18,927)       (149,141)           (91,199)        (33,228)        (13,172)
                                                  ------------    ------------       ------------    ------------    ------------

Nonoperating income (loss):
   Interest and other income                             3,509           6,862              5,475             608             228
   Interest and other expense                           (4,137)         (3,789)            (2,313)         (3,351)           (178)
                                                  ------------    ------------       ------------    ------------    ------------
         Total nonoperating income (loss)                 (628)          3,073              3,162          (2,743)             50
                                                  ------------    ------------       ------------    ------------    ------------
           Net loss                                    (19,555)       (146,068)           (88,037)        (35,971)        (13,122)
         Less mandatorily redeemable
              convertible preferred
              stock dividends and accretion            (15,589)        (15,059)            (3,644)         (1,654)           (190)
         Less deemed dividend related to
              beneficial conversion feature               (186)         (9,356)           (20,027)             --              --
                                                  ------------    ------------       ------------    ------------    ------------
            Net loss attributable to common
                stockholders                      $    (35,330)   $   (170,483)      $   (111,708)   $    (37,625)   $    (13,312)
                                                  ============    ============       ============    ============    ============
Weighted average common shares outstanding          34,951,720      33,908,374         33,066,538      15,099,359       6,554,499
                                                  ============    ============       ============    ============    ============
Basic and diluted net loss per share              $      (1.01)   $      (5.03)      $      (3.38)   $      (2.49)   $      (2.03)
                                                  ============    ============       ============    ============    ============

CONSOLIDATED BALANCE SHEET DATA
Cash and cash equivalents (2) (5)                 $     16,037    $     18,892       $     46,650    $    101,657    $      7,973
Working capital (deficit)                              (19,380)        (11,983)            59,245          95,315           3,328
Total assets                                           106,711         116,737            246,461         137,677          20,274
Total debt                                              10,144          15,766             20,417          14,134             724
Mandatorily convertible redeemable
    preferred stock (5)                                127,631         112,570             84,585              --          15,154
Total stockholder's equity (deficit)                   (99,284)        (67,172)            89,100         114,378              (6)
OTHER FINANCIAL DATA
EBITDA (1)                                               5,009        (125,864)           (74,033)        (28,856)        (11,889)
Net cash provided by (used in) operating
    activities                                          18,399         (21,846)           (96,862)        (32,681)         (7,769)
Net cash used in investing activities                  (15,600)        (15,615)           (40,602)         (5,182)        (11,393)
Net cash provided by (used in) financing
    activities                                          (5,654)          9,701             82,455         131,547          27,135
</TABLE>



                                       24
<PAGE>


(1)  EBITDA consists of earnings before deducting interest, income taxes,
     depreciation and amortization. While not a measure under accounting
     principles generally accepted in the United States of America ("GAAP"),
     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 GAAP, it is included herein to provide an
     additional measure of our operating results. 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 GAAP. The following table reconciles EBITDA
     to the consolidated financial statements:


<TABLE>
<CAPTION>
                                                                                                     PERIOD
                                                                                                 JANUARY 15, 1998
                                                           YEARS ENDED                             (INCEPTION)
                                                           DECEMBER 31,                             THROUGH
                                                                                                  DECEMBER 31,
                                      2002            2001            2000            1999            1998
                                   ---------       ---------       ---------       ---------     --------------
                                                (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
<S>                                <C>             <C>             <C>             <C>           <C>
Net loss                           $ (19,555)      $(146,068)      $ (88,037)      $ (35,971)      $ (13,122)
Nonoperating (income) loss               628          (3,073)         (3,162)          2,743             (50)
Depreciation and amortization         23,936          23,277          17,166           4,372           1,283
                                   ---------       ---------       ---------       ---------       ---------
EBITDA                             $   5,009       $(125,864)      $ (74,033)      $ (28,856)      $ (11,889)
                                   =========       =========       =========       =========       =========
</TABLE>


(2) Included in the December 31, 1999 cash balance was approximately $109.1
    million of net proceeds after underwriter discount and commissions, from
    our December 15, 1999 initial public offering. This cash was obtained
    through the sale of 6,900,000 shares (including the underwriters' over-
    allotment option) of our common stock at $17.00 per share.

(3) We recorded a $1.1 and $59.2 million expense related to impaired assets in
    2002 and 2001, respectively. This expense was the result of management's
    decision to reduce telemarketing activity levels. In 2001, a majority of the
    operations and assets of telemarketing centers acquired from Touch 1 were
    either voluntarily closed or sold. In addition to the goodwill impairment of
    $54.9 million, we recorded a $4.3 million charge associated with the
    impairment of assets, composed of $3.0 million relating to unrealizable
    software and development projects, $0.9 million of a worthless telemarketing
    property and equipment, and $0.4 million of securities deemed to be
    worthless. As a result of management's decision in the second quarter of
    2002 to enhance future cash flow and operating earnings, we closed the
    remaining call centers in North Dakota and recorded a $1.1 million asset
    impairment. We also incurred restructuring charges as a result of this
    decision during 2002 as discussed in item (7).

(4) Included in the 2001 general and administrative expense was a write-off of
    accounts receivable that resulted in $29.9 million of additional bad debt
    expense.

(5) During 2000, we issued Series D and E preferred stock for approximately
    $56.3 and $50.0 million, respectively. During 2001 we issued Series G
    preferred stock for approximately $17.5 million.

(6) During 2002, we began to provide wholesale telephone service. We recorded
    start-up costs for developing this new service offering of approximately
    $1.0 million. All wholesale related costs after our initial wholesale
    services contract signed on March 20, 2002 are included in the operating
    expenses line items, rather than being segregated.

(7) During 2002, we closed two call centers in North Dakota and our New York
    sales office. We recorded approximately $1.9 million for termination
    benefits, lease abandonment and lease settlement costs.

(8) We completed the acquisition of Touch 1 Communications, Inc. ("Touch 1"), on
    April 14, 2000. We used the purchase accounting method for our acquisition
    of Touch 1. Therefore, our 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.

(9) During 2002, we received a $9.0 million retroactive rate reduction for the
    unbundled network elements from Verizon as a result of a settlement with the
    New York Public Service Commission.



                                       25
<PAGE>



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, success and profitability of our
wholesale services, 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 offer local and long distance telephone services in combination with
enhanced communication features accessible through the telephone or the
Internet. These features include Personal Voice Assistant ("PVA"), "Find-Me",
"Notify-Me", caller identification, call waiting and speed calling. Our PVA
allows users to store contacts in a virtual address book and then access and
utilize that information by voice from any telephone. PVA users can also send
voice e-mails. We are an emerging provider of advanced, integrated
telecommunications services targeted to residential and small business
subscribers. In addition to providing our services to consumers we are also
providing these services on a wholesale basis. Our wholesale services provide
other companies the ability to utilize our telephone exchange services, enhanced
services platform, infrastructure and back-office operations to provide services
to consumers and small business customers. For management purposes, we are
organized into two reportable operating segments: consumer services and
wholesale services. The nature of our business is rapidly evolving, and we have
a limited operating history.

HISTORY OF OPERATIONS

         We were founded in January of 1998. In our first year of operations, we
focused primarily on research and development activities, recruiting personnel,
purchasing operating assets, and developing our service offerings and marketing
plans. In the fourth quarter of 1998, we launched our first service offering
composed of an access card to make long-distance calls from any phone coupled
with enhanced services, such as voice mail, find-me, and community messaging. In
1998 our revenues totaled $0.1 million.

         During June of 1999 we launched our primary service offering Z-Line
Home Edition (currently called Z-LineHOME) in New York. This is our bundled
telecommunications service providing integrated local, long-distance and
enhanced services targeted at residential customers. Our revenues for 1999
increased to $6.6 million.

         On December 15, 1999, we filed our initial public offering of 6.9
million shares. This offering resulted in net proceeds to us of approximately
$109.1 million. This offering provided us with the opportunity, at the potential
expense of profitability, to accelerate our investments in the building of our
network, continued research and development, sales and marketing, and
professional services and general and administrative infrastructure. We
purchased Touch 1 Communications, Inc. ("Touch 1") in April 2000 to accelerate
our growth. These investments lead to our revenues growing to $177.7 million in
2000. Nevertheless, these investments also significantly increased our operating
and cash expenditures.

         This growth was slowed during 2001 as we moved our focus from growth to
profitability. We focused on lowering customer acquisition costs, improving
operating efficiencies, and attracting and maintaining a higher quality
customer, which initiatives resulted in a charge of $29.9 million relating to
the write-off of certain accounts receivables and a $59.2 million impairment of
assets relating to the sale of telemarketing centers. We also experienced a
reduction in overall headcount in 2001 through a workforce reduction, attrition
and the sale of the majority of the operations and assets of the telemarketing
centers that we acquired in 2000. In 2001, we had revenues of $275.9 million and
incurred a net loss of $146.1 million compared to a net loss of $88.0 million in
2000.

         We continued our focus on operating improvement and cash management
during 2002. We also decided to diversify our services and revenues streams by
offering wholesale services to other telephone companies. We signed a contract
with MCI



                                       26
<PAGE>


WorldCom Communications, Inc. ("MCI") at the end of the first quarter of 2002.
We recorded $235.3 million of revenues and net loss of $19.6 million during
2002. Our wholesale services represented 13.1% of total revenues.

         We have recently begun to focus on increasing revenues again. We
believe the improvements that we have made over the last two years and our
recent shift to focus on growth and innovation, including the recent launch of
our PVA will continue to result in the achievement of positive EBITDA and
positive cash flows for 2003 and possibly positive net income on a quarterly
basis during the third or fourth quarter of 2003.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

         Our discussion and analysis of financial condition and results of
operations are based upon our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States of America ("GAAP"). The preparation of these financial statements
requires us to make estimates and judgments that affect the reported amounts of
assets, liabilities, revenues and expenses, and related disclosure of contingent
assets and liabilities. On an on-going basis, we evaluate our critical
accounting policies and estimates, including those related to revenue
recognition, disputed payables related to network operations expense, valuation
of accounts receivable, property, plant and equipment, long-lived and intangible
assets, restructuring reserves, tax related accruals and contingencies. We base
our estimates on experience and on various other assumptions that we believe to
be reasonable under the circumstances, the results of which form the basis for
making judgments about the carrying values of assets and liabilities that are
not readily apparent from other sources. Actual results may differ materially
from these estimates under different assumptions or conditions.

         We believe the following critical accounting policies affect the more
significant judgments and estimates used in the preparation of our consolidated
financial statements.

         -        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 during the month of service.
                  Subscription services are billed monthly in advance and we
                  recognize revenues for this service ratably over the service
                  period. We defer certain installation charges and recognize
                  this revenue ratably over the estimated life of our customer.
                  Our wholesale services revenues are derived from contractual
                  arrangements. We perform a review of each contract and
                  determine the appropriate timing of revenues recognition
                  depending on the facts and circumstances of each individual
                  item within the contract. We are currently deferring certain
                  revenues over the life of our arrangements, rather than
                  recognizing revenues up-front. We use the gross method to
                  record our revenues for wholesale services. This method
                  involves the recording of revenues for items that we are
                  directly reimbursed by our wholesale customer with an
                  offsetting expense reported in the appropriate operating
                  expense line. We operate in a heavily regulated industry;
                  therefore, our pricing is subject to both state and federal
                  regulatory commission oversight. Such oversight could result
                  in changes to the amount we bill our customers in current and
                  future periods.

         -        Disputed Payables Related to Network Operations Expense.
                  Network operations expenses are primarily charges from the
                  Incumbent Local Exchange Carriers ("ILECs") for the leasing of
                  their lines, utilizing the unbundled network element platform
                  pricing ("UNE-P"), made available to us as a result of the
                  Telecommunication Act of 1996, and long distance and other
                  charges from inter-exchange carriers ("IXC"). We have disputed
                  billings with IXC and ILECs. Certain of these disputed amounts
                  are not recorded as an expense at the time of dispute. Our
                  disputes are for various reasons including but not limited to
                  incorrect rates, alternatively billed services, duplicate
                  billing, and line loss. This pricing is subject to both state
                  and federal oversight and therefore, our pricing is subject to
                  change. This change could have a material impact on our
                  business model.

         -        Valuation of Accounts Receivable. Considerable judgment is
                  required to assess the ultimate realization of receivables,
                  including assessing the probability of collection and the
                  current credit-worthiness of our customers. We have utilized a
                  consistent method, on a monthly basis, for calculating our bad
                  debts since our change in the second quarter of 2001. We
                  regularly analyze our approach as we gain additional
                  experience or new events and information are identified to
                  determine if any change to our calculation is required.

         -        Property, Plant and Equipment. Changes in technology or
                  changes in the intended use of property, plant and equipment
                  may cause the estimated period of use or the value of these
                  assets to change. We utilize straight-line depreciation for
                  property and equipment. We perform an annual analysis to
                  confirm the appropriateness of estimated economic useful lives
                  for each category of current property, plant and equipment.
                  Estimates and assumptions used in both setting depreciable
                  lives and testing for recoverability require considerable
                  judgment.


                                       27
<PAGE>


         -        Long-Lived and Intangible Assets. We periodically evaluate
                  long-lived and intangible assets, through the use of
                  discounted cash flow projections, for potential impairment
                  indicators. Additionally, long-lived assets are reviewed for
                  impairment whenever events or changes in circumstances
                  indicate that their carrying amounts may not be recoverable.
                  Our judgments regarding the existence of impairment indicators
                  are based on legal factors, market conditions, and operational
                  considerations. Future events could cause us to conclude that
                  impairment indicators exist and that intangible assets
                  associated with our acquired businesses are impaired. For
                  fiscal years beginning in 2002, the methodology for assessing
                  potential impairments of intangible asset changed as a result
                  of Statement of Financial Accounting Standards No. 142,
                  "Goodwill and Other Intangible Assets." Our intangible assets
                  continue to be amortized monthly, on a straight-line basis.

         -        Restructuring Reserves. In April of 2002, we approved and
                  implemented a restructuring to enhance our future cash flows
                  and operating earnings. The restructuring included a reduction
                  of force coupled with the closure of our North Dakota call
                  centers and our New York sales office. In accordance with EITF
                  94-3, "Liability Recognition for Certain Employee Termination
                  Benefits and Other Costs to Exit an Activity," the
                  restructuring costs were recognized as liabilities at the time
                  management committed us to the plan. Management determined
                  that these costs provided no future economic benefit to us.
                  The restructuring included termination benefits and lease
                  abandonment costs. In addition, we agreed to a settlement to
                  exit the two leases for our call centers in North Dakota as of
                  July 1, 2002. All termination benefits and settlements to exit
                  our leases in North Dakota are paid as of December 31, 2002.
                  We have recorded restructuring reserve equal to the future
                  lease payments for our New York office as we will be making
                  payments through August 2005.

         -        Tax Related Accruals. Our estimates of deferred and current
                  income taxes and the significant items giving rise to the
                  deferred assets and liabilities are shown in footnote 16 -
                  Income Taxes to our consolidated financial statements. These
                  reflect our assessment of actual current and future income
                  taxes to be paid on items reflected in the financial
                  statements, giving consideration to both timing and
                  probability of realization. Currently we have placed a 100%
                  valuation allowance on all deferred tax assets. A valuation
                  allowance to reduce deferred tax assets is required if the
                  weight of evidence it is more likely than not that the
                  deferred tax assets will not be realized. Actual income and
                  sales taxes could vary from these estimates due to future
                  changes in tax law or results from final review of our tax
                  returns by taxing authorities. We also are subject to various
                  tax audits from various federal, state, and local
                  jurisdictions and make estimates based on the available
                  information and consultation with experts where necessary. We
                  believe our estimates are reasonable, however, they may change
                  materially in the future due to new developments or changes.

         -        Contingencies. We are subject to proceedings, lawsuits, audits
                  and other claims related to lawsuits and other legal and
                  regulatory proceedings that arise in the ordinary course of
                  business. We are required to assess the likelihood of any
                  adverse judgments or outcomes to these matters as well as
                  potential ranges of provable losses. A determination of the
                  amount of loss accrual required, if any, for these
                  contingencies are made after careful analysis of each
                  individual issue. We consult with legal counsel and other
                  experts where necessary in connection with our assessment of
                  any contingencies. The required accrual for any such
                  contingency may change materially in the future due to new
                  developments or changes in each matter.

ACQUISITION OF TOUCH 1 COMMUNICATIONS, INC. AND SUBSIDIARIES

         We completed the acquisition of 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 provided us with employees in sales,
provisioning, and customer service. We used the purchase accounting method for
our acquisition of Touch 1. Therefore, our 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. As a result
of our purchase of Touch 1, we recorded goodwill of $58.6 million and intangible
assets related to customer lists of $9.2 million on April 1, 2000. During the
second quarter of 2001, we recorded a $54.9 million impairment of assets
relating to the goodwill acquired from Touch 1. See the "Impairment of Assets"
discussion in the Results of Operations for further details.





                                       28
<PAGE>
CONSOLIDATED RESULTS OF OPERATIONS

YEAR ENDED DECEMBER 31, 2002 COMPARED TO YEAR ENDED DECEMBER 31, 2001

         The following consolidated Management's Discussion and Analysis of
Financial Condition and Results of Operations should be read in conjunction with
results by segment. Key selected financial and operating data for the years
ended December 31, 2002 and 2001 are as follows:

<TABLE>
<CAPTION>
                                                           FOR THE YEARS ENDED     AMOUNT        PERCENTAGE
                                                               DECEMBER 31,        CHANGE         CHANGE     PERCENTAGE OF REVENUES
                                                           -------------------    FAVORABLE      FAVORABLE   ----------------------
                                                            2002        2001    (UNFAVORABLE)  (UNFAVORABLE)    2002        2001
                                                           ------      -------  -------------     ------      --------    --------
                                                                                       (IN MILLIONS)
<S>                                                        <C>         <C>         <C>          <C>          <C>         <C>
RESULTS OF OPERATIONS:
Revenues                                                   $235.2      $275.9      $(40.7)         (14.8)%     100.0%      100.0%
                                                           ------      -------     ------          -------     ------      ------

Operating expenses:
     Network operations                                      91.4        155.2       63.8            41.1%      38.9%       56.3%
     Sales and marketing                                     12.3         31.2       18.9            60.6%       5.2%       11.3%
     General and administrative                             122.5        156.1       33.6            21.5%      52.1%       56.6%
     Asset impairment charge                                  1.1         59.2       58.1            98.1%       0.4%       21.4%
     Wholesale development costs                              1.0           --       (1.0)             --%       0.4%         --%
     Restructuring Charge                                     1.9           --       (1.9)             --%       0.8%         --%
     Depreciation and amortization                           23.9         23.3       (0.6)          (2.6)%      10.2%        8.4%
                                                           ------      -------      ------          ------      -----       -----

        Total operating expenses                            254.1        425.0      170.9            40.2%     108.0%      154.0%
                                                           ------      -------     ------           ------     ------      ------

        Operating loss                                      (18.9)      (149.1)     130.2            87.3%     (8.0)%     (54.0)%
                                                           ------      -------     ------           ------     ------      ------

Nonoperating income (loss):
     Interest and other income                                3.5          6.9       (3.4)         (49.3)%       1.5%        2.5%
     Interest and other expense                              (4.1)        (3.8)      (0.3)          (7.9)%     (1.7)%      (1.4)%
                                                           ------      -------     ------         --------     ------      ------

        Total nonoperating income (loss)                     (0.6)         3.1       (3.7)        (119.4)%     (0.2)%        1.1%
                                                           ------      -------     ------         --------     ------      ------

        Net loss                                            (19.5)      (146.0)     126.5            86.6%     (8.2)%     (52.9)%

        Less mandatorily redeemable convertible
                 preferred stock dividends and accretion    (15.6)       (15.1)      (0.5)          (3.3)%     (6.6)%      (5.5)%
        Less deemed dividend related to beneficial
                 conversion feature                          (0.2)        (9.4)       9.2            97.9%     (0.1)%      (3.4)%
                                                           ------      -------     ------           ------     ------      ------

        Net loss attributable to common stockholders       $(35.3)     $(170.5)    $135.2            79.3%    (14.9)%     (61.8)%
                                                           ======      =======     ======           ======    =======     =======

EBITDA                                                     $  5.0      $(125.8)    $130.8           104.0%       2.2%     (45.6)%
                                                           ======      =======     ======           ======    =======     =======

CASH FLOW DATA:
Net cash provide by (used in) operating activities         $ 18.4      $(21.8)     $ 40.2           184.4%        (*)         (*)
Net cash used in investing activities                       (15.6)      (15.6)         --              --%        (*)         (*)
Net cash provided by (used in) financing activities          (5.7)        9.7       (15.4)        (158.8)%        (*)         (*)
                                                           ======      ======      ======         ========
Net decrease in cash and cash equivalents                  $ (2.9)     $(27.7)     $ 24.8            89.5%        (*)         (*)
                                                           ======      ======      ======         ========
</TABLE>

(*) Not meaningful


                                       29
<PAGE>

         The following special items reconciliation, in millions except for per
share data, shows items that management believes are important to be identified
and discussed separately to get a complete understanding of our operations:

<TABLE>
<CAPTION>
                                             YEAR ENDED DECEMBER 31, 2002                     YEAR ENDED DECEMBER 31, 2001
                                      ------------------------------------------    --------------------------------------------
                                                    NET LOSS                                       NET LOSS
                                                  ATTRIBUTABLE                                   ATTRIBUTABLE
                                      NET INCOME    TO COMMON                       NET INCOME     TO COMMON
                                        (LOSS)    STOCKHOLDERS  EBITDA     EPS        (LOSS)     STOCKHOLDERS  EBITDA      EPS
                                      ----------  -----------   ------   -------    -----------  ------------  -------   -------
<S>                                   <C>         <C>           <C>      <C>        <C>          <C>           <C>       <C>
REPORTED AMOUNTS                        $(19.5)    $(35.3)      $ 5.0    $(1.01)      $(146.0)     $(170.5)    $(125.8)  $(5.03)
SPECIAL ITEMS
  RETROACTIVE REDUCTION TO NETWORK
    ACCESS RATES                          (9.0)      (9.0)       (9.0)    (0.26)           --           --          --       --
  RESTRUCTURING CHARGE                     1.9        1.9         1.9      0.05            --           --          --       --
  ASSET IMPAIRMENT                         1.1        1.1         1.1      0.03          59.2         59.2        59.2     1.75
  MCI BANKRUPTCY                           1.3        1.3         1.3      0.04            --           --          --       --
  WHOLESALE DEVELOPMENT COSTS              1.0        1.0         1.0      0.03            --           --          --       --
  WRITE-DOWN OF ACCOUNTS RECEIVABLE         --         --          --        --          29.9         29.9        29.9     0.90
                                      --------    -------       -----    ------     ---------    ---------     -------   ------
TOTAL IMPACT OF NON-RECURRING ITEMS       (3.7)      (3.7)       (3.7)    (0.11)         89.1         89.1        89.1     2.65
                                      --------    -------       -----    ------     ---------    ---------     -------   ------

AMOUNTS AFTER SPECIAL ITEMS             $(23.2)    $(39.0)      $ 1.3    $(1.12)       $(56.9)     $ (81.4)    $ (36.7)  $(2.38)
                                      ========    =======       =====    ======     =========    =========     =======   ======
</TABLE>

     -    Retroactive reduction to network access rates. During 2002, we
          received a $9.0 million retroactive rate reduction for the unbundled
          network elements from Verizon as a result of their settlement with the
          New York Public Service Commission.

     -    Restructuring charge. During 2002, we closed two call centers in North
          Dakota and our New York sales office. We recorded $1.9 million for
          termination benefits, lease abandonment and lease settlement costs.

     -    Asset impairment. We recorded a $1.1 and $59.2 million of expenses
          related to impaired assets in 2002 and 2001, respectively. This
          expense was the result of management's decision to reduce
          telemarketing activity levels. In 2001, a majority of the operations
          and assets of telemarketing centers acquired from Touch 1 were either
          voluntarily closed or sold. In addition to the goodwill impairment of
          $54.9 million, we recorded a $4.3 million charge associated with the
          impairment of assets, composed of $3.0 million relating to
          unrealizable software and development projects, $0.9 million of a
          worthless telemarketing property and equipment, and $0.4 million of
          securities deemed to be worthless. As a result of management's
          decision in the second quarter of 2002 to enhance future cash flow and
          operating earnings, we closed the remaining call centers in North
          Dakota and recorded a $1.1 million asset impairment.

     -    MCI bankruptcy. We recorded $1.3 million for possible exposure to
          carrier receivables as a result of MCI's bankruptcy. We reversed $0.6
          million of revenue and recorded $0.7 million of additional bad debt
          expense.

     -    Wholesale development costs. During 2002, we began to provide
          wholesale telephone service. We recorded start-up costs for developing
          this new service offering of approximately $1.0 million.

     -    Write-down of accounts receivable. Included in the 2001 general and
          administrative expense was a write-off of accounts receivable that
          resulted in $29.9 million of additional bad debt expense.

         Revenues. Revenues decreased by $40.7 million to $235.2 million for the
year ended December 31, 2002, compared to $275.9 million the prior year. The
decrease was primarily attributable to the average Z-LineHOME and Z-LineBUSINESS
customer count of 229,000 for the year ended December 31, 2002, compared to
297,000 for the prior year. Additionally, the decrease in Touch 1 (1+) long
distance lines in service contributed an additional decrease of $6.1 million to
our 2002 revenues. The following table outlines the approximate number of
subscriber lines for Z-LineHOME and Touch 1 (1+) long distance services as of
the end of the period:


                                       30
<PAGE>

<TABLE>
<CAPTION>
                  TYPE OF SERVICE                            DECEMBER 31, 2002        DECEMBER 31, 2001
                  ---------------                            -----------------        -----------------
                  <S>                                        <C>                      <C>
                  Z-LineHOME and Z-LineBUSINESS                 203,000                    254,000
                  Touch 1 (1+) Long Distance Services           108,000                    160,000
</TABLE>

         The reduction in lines in service was a result of our effort to slow
growth for the first three quarters of 2002, while eliminating poor paying
customers and increasing the quality of our embedded subscriber base with
respect to payment experience. These decreases were off-set by the introduction
of our wholesale services which contributed $30.8 million to our revenues for
the nine-months that we offered this service during 2002.

         The following table, in millions, provides a summary of our revenues
for the years ended 2002 and 2001:

<TABLE>
<CAPTION>
                  TYPE OF REVENUES                                 2002                      2001
                  ---------------                            -----------------        -----------------
                  <S>                                        <C>                      <C>
                  Z-LineHOME and Z-LineBUSINESS                   $ 187.6                   $ 253.0
                  Touch 1 (1+) Long Distance Services                16.8                      22.9
                  Wholesale Services                                 30.8                       -0-
                                                                  -------                   -------
                  Total                                           $ 235.2                   $ 275.9
</TABLE>

         Our service offerings, Z-LineHOME and Z-LineBUSINESS, accounted for
79.8% of our total revenues in 2002, compared to 91.7% the prior year. These
offerings are currently available in 46 states. We expect Z-LineHOME to continue
to increase as a percentage of consumer revenues and relative to our Touch 1
(1+) Long Distance Services but decrease as an overall percentage of total
revenues as we expect continued growth in our wholesale service business. Our
Z-LineHOME and Z-LineBUSINESS revenues were primarily derived from the following
ten states shown in the below table (For both years 2002 and 2001 the
Z-LineBUSINESS revenues are immaterial):

<TABLE>
<CAPTION>
                                                       PERCENTAGE OF TOTAL
                                                  Z-LINEHOME AND Z-LINEBUSINESS
                                                            REVENUES
                                                  -----------------------------
                                                     2002              2001
                                                     ----              ----
                           <S>                       <C>               <C>
                           California                 1%                2%
                           Georgia                    4%                5%
                           Illinois                  13%                5%
                           Massachusetts              1%                2%
                           Maryland                   2%                2%
                           Michigan                  13%                9%
                           New York                  46%               53%
                           Pennsylvania               6%                9%
                           Texas                      8%               10%
                           Virginia                   2%                2%
                           All others                 4%                1%
                                                    ---               ---
                           Total                    100%              100%
                                                    ===               ===

</TABLE>

         Network Operations. Network operations expense decreased by $63.8
million to $91.4 million for the year ended December 31, 2002, compared to
$155.2 million the prior year. Our consolidated gross margin percentage
increased to 61.1% for the year ended December 31, 2002, compared to 43.8% the
prior year. Our network operations expense primarily consists of fixed and
variable transmission expenses for interconnection agreements with ILECs,
service level agreements with IXCs, and transmission services based on tariffed
arrangements. The decrease in network operation expenses was primarily the
result of having an overall lower average number of subscribers in service for
the year ended 2002 compared to the prior year.

         In addition, in early 2002, the New York Public Service Commission (the
"Commission") approved a settlement, which reduced the prices that we and other
competitive local exchange carriers pay for unbundled network elements and
expanded the availability of those elements. Specifically, rates for the
elements comprising the unbundled network element platform were reduced by
approximately $8 to $9 per month per subscriber, on average. These rate
decreases were effective March 1, 2002. In addition, the Commission directed
Verizon to provide bill credits to us in the amount of $9.0 million to implement
retroactive rate decreases for unbundled local switching. We have recorded this
credit during 2002 and have received the entire credit as of December 31, 2002


                                       31
<PAGE>

from Verizon. In the future we do not anticipate any further retroactive rate
reductions. As a result of the Federal Communication Commission's Triennial
Review the individual state commissions will be reviewing and determining the
availability and pricing of the UNE-P. We believe that the decision to allow
each individual state to determine the rules related to UNE-P will result in
both increases and decreases in availability of UNE-P and increases and
decreases to pricing that will result in more or less competition. We will be
focusing our efforts on insuring the pricing and availability of UNE-P is
conducive to our desire to compete, however, we recognize the wide-range of
possibilities that could occur. We will likely focus our efforts to increase
lines toward states that provide pricing that we determine is appropriate for
our growth model and expect an overall increase in network operations expenses
in 2002.

         Sales and Marketing. Sales and marketing expense decreased $18.9
million to $12.3 million for the year ended December 31, 2002, compared to $31.2
million the prior year. The sales and marketing expense primarily consists of
telemarketing, direct mail, brand awareness advertising, and independent sales
representative commissions and salaries and benefits paid to employees engaged
in sales and marketing activities.

         Our continued decrease in sales and marketing expense was a result of
our focus to conserve cash while focusing on improving internal operations and
subscriber quality. This focus and decrease in marketing activity contributed to
a decrease in lines of 54,000 or about 20% during 2002. Our primary source of
sales for 2002 was from independent sales representatives. It was not until the
last quarter of 2002 that we changed our focus to line growth and began a
multi-faceted marketing campaign in Atlanta, Georgia that combined radio,
billboard, and television advertising to launch our new service offering, PVA.
In addition to our marketing campaign we also contracted with several
independent sales representatives during the latter half of 2002 that
contributed to our fourth quarter line growth.

         We expect to continue to focus our sales and marketing efforts to
maintain acceptable acquisition costs per subscriber. We expect to increase our
advertising levels, grow our independent sales representatives sales force, and
increase our partnering opportunities throughout 2003. We will continue to build
our overall awareness of the "Z" brand, and explore alliances and ventures with
other companies. We expect sales and marketing expense to increase during 2003,
over that experienced during 2002, as we use our expected increase in cash flow
from our consumer and wholesale business to fund sales and marketing efforts in
additional metropolitan areas.

         General and Administrative. General and administrative expense
decreased $33.6 million to $122.5 million for the year ended December 31, 2002,
compared to $156.1 million the prior year. General and administrative expense
primarily consists of employee salaries and benefits, temporary services, bad
debt expense, billing and collection costs, occupancy costs, and provisioning
costs.

         The decrease in general and administrative expense was primarily
related to the write-off of accounts receivables in 2001 that resulted in $29.9
million of additional bad debt expense. Excluding the $29.9 million of bad debt
expense, general and administrative expense decreased only $3.7 million during
2002 and represented 52.1% of revenues in 2002 compared to 45.7% in 2001. This
increase as a percentage of revenues was largely the result of our decision in
2002 to continue our focus on internal operations, product offerings and
subscriber economics rather than investing in line growth for most of the year.
Excluding the 2001 write-off from general and administrative expense, our
decreased line count and focus on internal operations resulted in lower bad debt
expense, decreased billing and collection expenses and less salaries and benefit
expenses, all of which contributed to our reduced general and administrative
expenses in 2002 compared to 2001. We believe we are appropriately positioned
for the line and revenue growth that we are expecting during 2003.

         We anticipate general and administrative expenditures will continue to
increase in the future to support our expanding service offerings and our
expected increase in consumer and wholesale lines during 2003. We will continue
to evaluate our operations for efficiencies and our employee staffing
requirements as they relate to increased efficiencies or needs to expand or
outsource services. We expect to begin to see reductions of general and
administrative expense as a percentage of revenues in 2003. This reduction is
necessary for our achievement of profitability and the generation of positive
cash flow for 2003.

     Asset Impairment Charge. Asset impairment charges decreased $58.1 million
to $1.1 million for the year ended December 31, 2002, compared to $59.2 million
the prior year. The decrease in asset impairment is the result of our closure of
the remaining North Dakota call centers in 2002 after closing substantially all
of the centers in 2001.

         As a result of management's decision in the second quarter of 2002 to
enhance future cash flow and operating earnings, we decided to close the
remaining call centers in North Dakota acquired in our acquisition of Touch 1.
In April of 2002, we announced a restructuring plan that included a reduction in
force and the closure of the North Dakota call centers resulting in an asset
impairment


                                       32
<PAGE>

charge totaling $1.1 million for property, plant, and equipment sold in
conjunction with the settlement of the leases in these locations, in the second
quarter of 2002.

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

     Restructuring Charge. We recorded a restructuring charge of $1.9 million in
2002.

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

         The restructuring charge includes termination benefits and lease
abandonment costs. In addition, we agreed to a settlement to exit the two leases
for our call centers in North Dakota as of July 1, 2002. All termination
benefits and settlements to exit our leases in North Dakota were paid as of
December 31, 2002. We have recorded a lease abandonment charge representing the
future lease payments for our New York office as a liability and will make
payments through August 2005. As of December 31, 2002 we had an accrual of
approximately $0.6 million remaining for this restructuring charge.

         Depreciation and Amortization. Depreciation and amortization expense
increased $0.6 million to $23.9 million for the year ended December 31, 2002,
compared to $23.3 million the prior year. The slight increase in depreciation
and amortization is primarily a result of increased capital expenditures during
the last couple of years. We anticipate a flat to slightly increased
depreciation and amortization expense during 2003 depending on our requirements
to purchase additional computer equipment, switching equipment, furniture and
leasehold improvements as a result of our line growth or the introduction of new
services.

         Interest and Other Income. Interest and other income decreased $3.4
million to $3.5 million for the year ended December 31, 2002, compared to $6.9
million the prior year. Interest and other income consists of interest charged
to our Z-LineHOME customers for not paying their bills on-time and income from
interest earned from our cash balance and any gains from the sale of investments
or securities. The decrease for 2002 was primarily due to our having an overall
average of fewer customers in service in 2002 compared to 2001 and exercising
more effective treatment of poor paying customers resulting in fewer
delinquencies and more timely payments by customers.

         Interest and Other Expense. Interest and other expense increased $0.3
million to $4.1 million for the year ended December 31, 2002, compared to $3.8
million the prior year. Our interest expense is a result of late fees for vendor
payments, charges related to our RFC Capital Corporation ("RFC") accounts
receivable agreement, capital leases and our debt obligations. The overall
increase in interest expense is a result of $1.0 million of increased late
payment fees paid for network costs in 2002 compared to 2001. This increase was
offset by reduced interest expense on our debt obligations. The charges for the
utilization of our accounts receivable arrangement with RFC during 2002 remained
consistent with the prior year expenses, although we have decreased our sales of
receivables during the second half of 2002. We anticipate that interest expense
will decrease in the future as we continue to reduce our debt obligations and
improve our cash flow, which should result in more timely payment of our network
and other expenses. This decrease will be offset to the extent that we are able
to borrow money to support growth through new funding sources and to finance any
significant capital expenditures necessary to grow our business in 2003. We
expect the continued utilization of our RFC accounts receivable agreement during
2003.

         Income Tax Benefit. No provision for federal or state income taxes has
been recorded due to the full valuation allowance recorded against the deferred
tax asset for the years ended December 31, 2002 and 2001.

         Net Loss. Our net loss improved $126.5 million to $19.5 million for the
year ended December 31, 2002, compared to $146.0 million the prior year.
Excluding special items, as outlined in the table at the beginning of this
section labeled "Special Items Reconciliation", net loss improved $33.7 million
to $23.2 million for the year ended December 31, 2002, compared to $56.9 million
the prior year.

         Net Loss Attributable to Common Stockholders. Our net loss attributable
to common stockholders improved $135.2 million to $35.3 million for the year
ended December 31, 2002, compared to $170.5 million the prior year. Excluding
special items, net loss attributable to common stockholders improved $42.4
million to $39.0 million for the year ended December 31, 2002, compared to


                                       33
<PAGE>

$81.4 million the prior year. This decrease was primarily discussed above,
however, there was also a decrease of $9.2 million for the deemed dividend
related to beneficial conversion in 2002.

         During 2001, we recorded a deemed dividend of $1.1 million, which
resulted from the value assigned to the warrants and a beneficial conversion
feature associated with the Series G Preferred transaction. This deemed dividend
was originally accreted over an expected life through December 31, 2001 (the
earliest redemption date). Once shareholder approval was obtained on October 31,
2001, the remaining balance of $1.2 million began to be accreted over the
remaining 5-year redemption period that started at the date of grant.

         EBITDA. Many securities analysts use the measure of earnings before
deducting interest, income taxes, depreciation and amortization, also commonly
referred to as "EBITDA," as a way of evaluating our financial performance.
EBITDA is not a measure under GAAP, is not meant to be a replacement for GAAP
and should not be considered an alternative to net income as a measure of
performance 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 EBITDA
improved by $130.8 million to positive $5.0 million for the year ended December
31, 2002, compared to negative $125.8 million the prior year. Excluding special
items, EBITDA improved by $38.0 million to positive $1.3 million in 2002,
compared to negative $36.7 million the prior year. We expect to improve our
positive EBITDA during 2003. The expected generation of positive EBITDA will
primarily be attributed to increases in subscribers, operating efficiencies, and
the contribution of existing and new wholesale services and other new services.

RESULTS OF OPERATIONS BY SEGMENT

         Management evaluates the performance of each business unit based
segment results, exclusive of adjustments for special items. Special items are
transactions or events that are included in our reported consolidated results
but are excluded from segment results due to their nonrecurring or
non-operational nature. We have broken these special items out in a table
labeled Special Items Reconciliation at the beginning of this section of the
10-K. In addition, when changes in our business affect the comparability of
current versus historical results, we will adjust historical operating
information to reflect the current business structure.

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

<TABLE>
<CAPTION>
                                                 YEAR ENDED DECEMBER 31, 2002                 YEAR ENDED DECEMBER 31, 2001
                                         -----------------------------------------     ----------------------------------------
                                         CONSUMER        WHOLESALE    CONSOLIDATED     CONSUMER        WHOLESALE   CONSOLIDATED
                                         SERVICES       SERVICES(1)     RESULTS        SERVICES         SERVICES      RESULTS
                                         --------       -----------   ------------     --------        ---------   ------------
<S>                                      <C>            <C>           <C>              <C>             <C>         <C>
Revenues                                  $203.8          $ 30.8        $234.6          $275.9          $   --      $ 275.9
                                          ------          ------        ------          ------          ------      -------
Operating expenses:
    Network operations                      89.6            10.8         100.4           155.2              --        155.2
    Sales and marketing                     12.3              --          12.3            31.2              --         31.2
    General and administrative             111.9             8.7         120.6           126.2              --        126.2
    Depreciation and amortization           22.4             1.5          23.9            23.3              --         23.3
                                          ------          ------        ------          ------          ------      -------
        Total operating expenses           236.2            21.0         257.2           335.9              --        335.9
                                          ------          ------        ------          ------          ------      -------
        Segment results                   $(32.4)         $  9.8         (22.6)         $(60.0)         $   --      $ (60.0)
                                          ======          ======                        ======          ======
Reconciling Items:
    Interest and other income                                              3.5                                          6.9
    Interest and other expenses                                           (4.1)                                        (3.8)
    Special items (2)                                                      3.7                                        (89.1)
                                                                        ------                                      -------
    Net loss                                                            $(19.5)                                     $(146.0)
                                                                        ======                                      =======
</TABLE>


                                       34
<PAGE>

<TABLE>
<CAPTION>
                                                      REVENUES AND OPERATING EXPENSE AS A %
                                                         OF CONSOLIDATED SEGMENT RESULTS
                                         ---------------------------------------------------------------
                                         YEAR ENDED DECEMBER 31, 2002       YEAR ENDED DECEMBER 31, 2001
                                         ----------------------------       ----------------------------
                                            CONSUMER       WHOLESALE           CONSUMER     WHOLESALE
                                            SERVICES       SERVICES            SERVICES     SERVICES
                                            --------       ---------           --------     ---------
<S>                                         <C>            <C>                 <C>          <C>
Revenues                                      86.9%          13.1%               100.0%         --%
                                             -----          -----               ------       -----
Operating expenses:                                                                             --
    Network operations                        89.2%          10.8%               100.0%         --%
    Sales and marketing                      100.0%            --%               100.0%         --%
    General and administrative                92.8%           7.2%               100.0%         --%
    Depreciation and amortization             93.7%           6.3%               100.0%         --%
                                             -----          -----               ------       -----
        Total operating expenses              91.8%           8.2%               100.0%         --%
                                             =====          =====               ======       =====
</TABLE>

(1)  We began our wholesale services business in April of 2002. Therefore, there
     are only nine months of activity for this segment.

(2)  For a detail of the special items please refer to the Special Items
     Reconciliation at the beginning of this section.

CONSUMER SERVICES SEGMENT

         The following table, in millions, provides our consumer services
segment for 2002 compared to 2001. This is the first annual discussion of our
results by segment because prior to 2002 we had only one segment, consumer
services. Therefore, the 2001 consumer services segment is the same as our
consolidated 2001 results, excluding special items.

<TABLE>
<CAPTION>
                                                                        CONSUMER SERVICES SEGMENT
                                             -------------------------------------------------------------------------------
                                              FOR THE YEARS ENDED         AMOUNT       PERCENTAGE
                                                  DECEMBER 31,            CHANGE         CHANGE         PERCENTAGE OF REVENUES
                                             ---------------------       FAVORABLE      FAVORABLE      -----------------------
                                              2002           2001      (UNFAVORABLE)  (UNFAVORABLE)      2002           2001
                                             ------         ------     -------------  -------------     ------         ------
<S>                                          <C>            <C>        <C>            <C>               <C>            <C>
Revenues                                     $203.8         $275.9         $(72.1)        (26.1)%        100.0%         100.0%
                                             ------         ------         ------         -----          -----          -----
Operating expenses:
     Network operations                        89.6          155.2           65.6           42.3%         44.0%          56.3%
     Sales and marketing                       12.3           31.2           18.9           60.6%          6.0%          11.3%
     General and administrative               111.9          126.2           14.3           11.3%         54.9%          45.7%
     Depreciation and amortization             22.4           23.3            0.9            3.9%         11.0%           8.4%
                                             ------         ------         ------          -----         -----          -----
             Total operating expenses         236.2          335.9           99.7           29.7%        116.0%         121.7%
                                             ------         ------         ------          -----         -----          -----
             Segment results                 $(32.4)        $(60.0)        $ 27.6         (46.0)%       (16.0)%         (21.7%
                                             ======         ======         ======         =======       =======         ======
</TABLE>

         Revenues. Revenues decreased by $72.1 million to $203.8 million for the
year ended December 31, 2002, compared to $275.9 million the prior year. The
decrease was primarily attributable to a decline in Z-LineHOME customers in 2002
compared to 2001. The decrease in Touch 1 (1+) long distance lines in service
contributed an additional decrease of $6.1 million to our 2002 revenues. These
decreases were a result of focusing our efforts on establishing and growing our
wholesale services, which were launched during 2002, which partially reduced our
focus from our consumer services business. Therefore, consumer services revenues
decreased as a percentage of consolidated revenues by 13.1% to 86.9% for 2002,
compared to 100% the prior year. We changed our focus to increasing our line
growth for our consumer services in the final quarter of 2002 and expect to see
increased revenues during 2003. We expect consumer services revenues to grow at
a slower rate than our wholesale services revenues, resulting in consumer
services being a smaller percentage of consolidated revenues during 2003
compared to 2002.


                                       35
<PAGE>

         Network Operations. Network operations expense decreased by $65.6
million to $89.6 million for the year ended December 31, 2002, compared to
$155.2 million the prior year. Our gross margin percentage increased to 56.3%
for the year ended December 31, 2002, compared to 43.7% the prior year. Excluded
from this improved gross margin for 2002 is a $9.0 million retroactive reduction
to network access rates in New York; including this item, network operations
expense would have decreased by $56.6 million from 2001 and gross margin, as a
percentage of consumer services revenues would have been 60.6% for 2002. Our
network operations expense as a percentage of revenues decreased primarily as a
result of decreases in the unbundled network element platform rates we pay to
lease lines from the ILECs in the states we are operating and more specifically
the rate reduction in New York, our largest market with 46% of our 2002
Z-LineHOME and Z-LineBUSINESS revenues. Other reductions resulted from
improvements we have made to internal operations and processes that minimize our
network operations costs.

         Sales and Marketing. Sales and marketing expense decreased $18.9
million to $12.3 million for the year ended December 31, 2002, compared to $31.2
million the prior year. We continued to conserve cash during 2002 resulting in
less than historically reported sales and marketing expense. However, we have
already increased our advertising activity and independent sales representatives
programs during 2003. We intend to expand our marketing activity in order to add
additional metropolitan areas during 2003, in an attempt to increase our
consumer lines in service.

         General and Administrative. General and administrative expense
decreased $14.3 million to $111.9 million for the year ended December 31, 2002,
compared to $126.2 million the prior year. As a percentage of revenues general
and administrative expense increased by 9.2% to 54.9% of revenues in 2002
compared to 45.7% the prior year. This increase excluded special items in 2002
of $0.7 million of bad debt expense related to the WorldCom bankruptcy and the
2001 accounts receivable write-down totaling $29.9 million of bad debt expense.
Including these special items, general and administrative expense decreased by
$43.5 million during 2002 and was 55.3% of revenues compared to 56.6% for the
prior year. The increase as a percentage of revenues before special items was
the result of our decision in 2002 to focus on internal operations, product
offerings and future subscriber economics rather than investing in line growth
for most of 2002.

         With the change of focus to line growth, we expect general and
administrative expense to decrease as a percentage of revenues as a result of
the leveraging of certain elements of our fixed cost structure, although we
expect an increase in total dollars as we incur more charges for incremental
costs such as, billing, collection, and headcount related expenses during 2003.
During 2002 consumer services was 92.9% of consolidated segment general and
administrative expense. Included in the consumer services general and
administrative expense is all employee benefits, occupancy, insurance, and other
indirect or overhead-related expenses as only direct costs are recorded in our
wholesale services segment. We are in the process of reviewing and possibly
adopting a methodology for internal reporting purposes that would allocate these
indirect and overhead related expenses to the respective segments or possibly
separating these expenses from each segment. We expect that our consumer
services business will grow at a slower rate than our wholesale services during
2003, therefore, we expect consumer services to be a smaller percentage of
consolidated general and administrative expense during 2003.

         Depreciation and Amortization. Depreciation and amortization expense
decreased $0.9 million to $22.4 million for the year ended December 31, 2002,
compared to $23.3 million the prior year. The slight decrease in depreciation
and amortization is primarily a result of a small decrease in purchasing of
capital assets during the last two years. We anticipate depreciation to be
relatively flat during 2003, although we are contemplating various options for
new services and innovations to our current services that may require the
purchasing of additional hardware and software.


                                       36
<PAGE>

WHOLESALE SERVICES SEGMENT

This is the first annual discussion of our results by segment because prior to
April 1, 2002 we had only one segment, consumer services. Therefore, the 2001
wholesale services segment has no results. The following table, in millions,
provides our wholesale services segment for 2002 compared to 2001 to facilitate
our discussion of results for our wholesale services segment:

<TABLE>
<CAPTION>
                                                                       WHOLESALE SERVICES SEGMENT
                                             -------------------------------------------------------------------------------
                                              FOR THE YEARS ENDED         AMOUNT       PERCENTAGE
                                                  DECEMBER 31,            CHANGE         CHANGE         PERCENTAGE OF REVENUES
                                             ---------------------       FAVORABLE      FAVORABLE      -----------------------
                                              2002           2001      (UNFAVORABLE)  (UNFAVORABLE)      2002           2001
                                             ------         ------     -------------  -------------     ------         ------
<S>                                          <C>            <C>        <C>            <C>               <C>            <C>
Revenues                                     $ 30.8         $  --        $  30.8           100.0%        100.0%        --%
                                             ------         -----        -------           ------        ------       ----
Operating expenses:
     Network operations                        10.8            --          (10.8)        (100.0)%         35.1%        --%
     General and administrative                 8.7            --           (8.7)        (100.0)%         28.2%        --%
     Depreciation and amortization              1.5            --           (1.5)        (100.0)%          4.9%        --%
                                             ------         -----        -------         --------         -----       ----

             Total operating expenses          21.0            --          (21.0)        (100.0)%         68.2%        --%
                                             ------         -----        -------         --------         -----       ----

             Segment results                 $  9.8         $  --        $   9.8           100.0%         31.8%        --%
                                             ======         =====        =======           ======         =====       =====
</TABLE>

         Revenues. Revenues were $30.8 million or 13.1% of consolidated segment
revenues for 2002. These revenues are primarily from our wholesale contract with
MCI. We have recently signed an agreement with Sprint to provide wholesale
services. We expect the MCI revenues to decrease considerably during 2003 and
are already seeing a migration of customers from our systems. We recognize the
possibility of contract termination, however, we expect that Sprint could make
up for any shortfall in revenues should MCI terminate their contract. In
addition, our business development group is actively pursuing other potential
wholesale partners and working to develop new wholesale services. We expect
wholesale services to become a larger percentage of overall revenues during
2003.

         Network Operations. Network operations expense was $10.8 million or
10.8% of consolidated segment network operations expense. We expect this expense
to vary depending on each individual wholesale contract. We incur these expenses
when providing unbundled network elements that we lease from the ILEC to our
wholesale customers. Certain wholesale customers may not utilize this service or
may only use this service for a short period of time under the contract.
Therefore, it is difficult to anticipate the change to this expense during 2003.

         General and Administrative. General and administrative expense was $8.7
million or 7.2% of consolidated segment general and administrative expense. The
significant components of this expense mirror our consolidated expenses,
however, we only record the direct expenses associated with our wholesale
services. Therefore, we have not allocated any indirect or overhead expenses
such as employee benefits, occupancy, insurance or other similar expenses to the
wholesale services segment. These expenses are all included in the consumer
services segment.

         We expect general and administrative expense to increase in total
dollars and as a percentage of our consolidated expenses. We also expect that we
will begin to outsource certain functions, currently handled internally, to
mange the anticipated growth of our wholesale services, while limiting our cost
exposure. We have been receiving pre-prepayments from MCI for our wholesale
services as a result of their bankruptcy filing and have not recorded any bad
debt for wholesale services. We will continue to monitor our wholesale services
and determine the appropriate bad debt methodology for our wholesale services
based on each individual wholesale contract and partner.

         Depreciation and Amortization. Depreciation and amortization expense
was $1.5 million or 6.3% of consolidated depreciation and amortization. Although
we do not expect significant increases in our capital expenditures during 2003
we may have


                                       37
<PAGE>

an increase in capital expenditures for our wholesale services compared to
consumer services, which would lead to an increase percentage of our
consolidated depreciation expense being attributable to wholesale services. We
are also contemplating new wholesale service offerings that may require
additional capital expenditures that would also contribute to higher
depreciation and amortization expense.

YEAR ENDED DECEMBER 31, 2001 COMPARED TO YEAR ENDED DECEMBER 31, 2000

         Revenues. Revenues increased by $98.2 million to $275.9 million for the
year ended December 31, 2001, compared to $177.7 million the prior year. The
increase is attributable to the average Z-LineHOME customer count of 297,000 for
the year ended December 31, 2001, compared to 190,000 the prior year. Touch 1
contributed $22.9 million of revenues for the year ended December 31, 2001
compared to $29.7 million the prior year. The following table outlines the
approximate number of subscriber lines for Z-LineHOME and Touch 1 (1+) long
distance services as of the end of the period:


<TABLE>
<CAPTION>
                  TYPE OF SERVICE                               DECEMBER 31, 2001           DECEMBER 31, 2000
                  ---------------                              ------------------          ------------------
                  <S>                                          <C>                         <C>
                  Z-LineHOME                                         254,000                     340,000
                  Touch 1 (1+) Long Distance Services                160,000                     255,000
</TABLE>

         The reduction in lines during 2001 was a result of our effort to slow
growth while eliminating poor paying customers and increasing the overall
quality of our embedded subscriber base from a payment perspective.

         Our primary service offering, Z-LineHOME, which accounted for 91.7% of
our total revenues in 2001 compared to 83.3% the prior year. Our Z-LineHOME
product was available in 38 states in 2001, however, revenues were primarily
derived from the following ten states shown in the below table:

<TABLE>
<CAPTION>
                                                           PERCENTAGE OF TOTAL
                                                           Z-LINE HOME REVENUES
                                                         ------------------------
                                                         2001              2000
                                                         ----             ------
                           <S>                           <C>              <C>
                           California                      2%               0%
                           Georgia                         5%               2%
                           Illinois                        5%               0%
                           Massachusetts                   2%               3%
                           Maryland                        2%               0%
                           Michigan                        9%               0%
                           New York                       53%              69%
                           Pennsylvania                    9%               7%
                           Texas                          10%              17%
                           Virginia                        2%               0%
                           All others                      1%               2%
                                                         ---              ---
                           Total                         100%             100%
                                                         ===              ===
</TABLE>

         Network Operations. Network operations expense increased by $48.1
million to $155.2 million for the year ended December 31, 2001, compared to
$107.1 million the prior year. Our consolidated gross margin percentage
increased to 43.8% for the year ended December 31, 2001, compared to 39.7% for
the prior year.

         Sales and Marketing. Sales and marketing expense decreased $13.8
million to $31.2 million for the year ended December 31, 2001, compared to $45.0
million the prior year.

         Our focus on lower acquisition cost coupled with our changing customer
acceptance policies and reduced growth objectives during 2001 resulted in a
decrease of $10.1 million of sales and marketing expense. The remaining decrease
in sales and marketing expense is primarily attributable to the sale and closure
of substantially all of our telemarketing centers in Minot, North Dakota and
Canada as of June 30, 2001. This decrease in marketing has contributed to the
overall decrease of 86,000 lines during 2001.

         General and Administrative. General and administrative expense
increased $56.5 million to $156.1 million for the year ended December 31, 2001,
compared to $99.6 million the prior year.


                                       38
<PAGE>

         The increase in general and administrative expense primarily relates to
the write-off of accounts receivable that resulted in $29.9 million of
additional bad debt expense recorded during the second quarter of 2001.
Excluding the $29.9 million of bad debt expense, general and administrative
expense was 45.7% of 2001 revenues compared to 56.1% for the year ended December
31, 2000. This reduction as a percentage of revenues is the result of various
cost control measures implemented during 2001, to support our focus on improved
subscriber quality rather than growth, as well as an increased utilization of
fixed costs within our business.

         Asset Impairment Charge. We recorded a $59.2 million expense related to
impaired assets in the second quarter of 2001.

         As a result of management's decision in the second quarter to reduce
telemarketing efforts, a majority of the operations and assets of telemarketing
centers acquired from Touch 1 were either voluntarily closed or sold. On June
30, 2001 the telemarketing centers sold accounted for approximately $1.0 million
in property, plant and equipment. For these assets, we received 270,000 shares
of preferred stock of the privately held acquirer and a note receivable of
approximately $0.5 million. The loss recorded on this transaction equated to
approximately $1.0 million.

         As a result of the decision to reduce telemarketing efforts noted above
and the subsequent transactions, management performed an assessment of the value
of the intangible assets recorded in the Touch 1 acquisition, in accordance with
SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of." In the second quarter 2001, it was
determined that undiscounted future cash flows over the remaining amortization
period of certain intangible assets indicated that the value assigned to the
intangible assets might not be recoverable. Therefore, we undertook an effort to
determine the amount of expense to be recorded relating to the impairment.

         The carrying value of the goodwill and identifiable intangible assets
recorded on our books approximated $61.7 million prior to the impairment
analysis. We calculated the fair value of goodwill by performing a discounted
cash flow analysis related to the remaining assets acquired in the Touch 1
purchase. As we determined that we would effectively cease any telemarketing
efforts in the future, the sole remaining assets from the Touch 1 purchase were
certain amounts of property, plant and equipment and intangible assets
(consisting of customer lists and goodwill) acquired in the Touch 1 transaction.
Assuming an attrition rate of 4.5% and a discount rate of 17.5%, it was
determined that the remaining operations acquired from Touch 1 have a
liquidation value which approximates the identifiable intangible assets
associated with the carrying value of the customer lists acquired from Touch 1.
At June 30, 2001, the carrying value of the identifiable intangible assets
associated with the customer lists was approximately $6.8 million. Therefore, we
recorded a loss of $54.9 million, the difference between the carrying value of
all intangibles and the carrying value of the customer lists.

         We recorded an additional $4.3 million charge associated with the
impairment of assets, composed of $3.0 million relating to unrealizable software
and development projects, $0.9 million of a worthless telemarketing property and
equipment, and $0.4 million of securities deemed to be worthless.

         We had $5.9 million of intangible assets relating to customer lists
recorded as of December 31, 2001.

         Depreciation and Amortization. Depreciation and amortization expense
increased $6.1 million to $23.3 million for the year ended December 31, 2001,
compared to $17.2 million the prior year. The increase in depreciation and
amortization was primarily a result of having more fixed assets in service
during 2001.

         Interest and Other Income. Interest and other income increased $1.4
million to $6.9 million for the year ended December 31, 2001, compared to $5.5
million the prior year. Interest and other income consists of interest charged
to our Z-LineHOME customers for not paying their bills on-time and income from
interest earned from our cash balance and any gains from the sale of investments
or securities. The increase for 2001 was primarily due to an overall average of
more customers in service in 2001 compared to 2000 resulting in larger late
payment fees being assessed to customers.

         Interest and Other Expense. Interest and other expense increased $1.5
million to $3.8 million for the year ended December 31, 2001, compared to $2.3
million the prior year. Our interest expense is a result of the interest charged
related to our RFC accounts receivable agreement, capital leases and other debt
obligations. The increased interest expense relates to the utilization of our
accounts receivable arrangement with RFC Capital, Corporation during 2001.

         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 years ended December 31, 2001 and 2000.


                                       39
<PAGE>

         Net Loss. Our net loss increased $58.1 million to $146.1 million for
the year ended December 31, 2001, compared to $88.0 million the prior 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 $58.8 million to $170.5 million for the year
ended December 31, 2001, compared to $111.7 million the prior year. This
increase was due primarily to the increases in expenses described above and the
issuance of the Series D, E and G Preferred shares. In conjunction with the
Series D, E and G Preferred, we incurred an aggregate of $15.1 million of
non-cash charges relating to preferred stock dividends and accretion and an
aggregate of $9.4 million of a deemed dividend relating to a beneficial
conversion feature. This compared to $3.6 million of preferred stock dividends
and accretion and $20.0 million of a deemed dividend for the year ended December
31, 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. The
Company recorded a $12.6 million cumulative catch-up adjustment, included in the
$20.0 million beneficial conversion feature, as a result of the Securities and
Exchange Commission requiring retroactive application of this method.

         During 2001, we recorded a deemed dividend of $1.1 million, which
resulted from the value assigned to the warrants and a beneficial conversion
feature associated with the Series G Preferred transaction. This deemed dividend
was originally accreted over an expected life through December 31, 2001 (the
earliest redemption date). Once shareholder approval was obtained on October 31,
2001, the remaining balance of $1.2 million began to be accreted over the
remaining 5-year redemption period that started at the date of grant. As a
result of the Series G Preferred transaction certain anti-dilution clauses in
the Series D Preferred stock agreement triggered an additional deemed dividend
relating to a beneficial conversion feature that was accreted immediately in the
amount of $7.8 million.

         EBITDA. Many securities analysts use the measure of earnings before
deducting interest, income taxes, depreciation and amortization, also commonly
referred to as "EBITDA," as a way of evaluating our financial performance.
EBITDA is not a measure under accounting principles generally accepted in the
United States of America (GAAP), is not meant to be a replacement for GAAP and
should not be considered an alternative to net income as a measure of
performance 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 $51.9 million to $125.9 million for the year ended December 31,
2001, compared to $74.0 million the prior year.

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
colocation of switching and transmission equipment in incumbent local exchange
carriers' central offices. Although we will continue to make capital
expenditures, we do not expect that the growth of our business will require the
levels of capital investment in fiber optics and switches that existed in
historical telecommunications facilities-based models. Instead, we will devote
significant amounts of our capital resources to continued operations, software
development, new service offerings and marketing efforts that we have designed
to achieve penetration of our target markets.

         We have incurred accumulated losses since our inception as a result of
developing our business, research and development, building and maintaining
network infrastructure and technology, sales and promotion of our services, and
administrative expenditures. As of December 31, 2002, we had an accumulated
deficit of $302.8 million, a net tax operating loss carryforward of $262.8
million, and $16.0 million in cash and cash equivalents. We have funded our
expenditures primarily through operating revenues, private securities offerings,
a sale-leaseback credit facility, sales of accounts receivable and an initial
public offering that raised net proceeds of $109.1 million. We intend to
continue building our organization in anticipation of future growth and believe
that our operating expenditures will also continue to increase.

         Net cash provided by operating activities improved by $40.2 million to
$18.4 million for the year ended December 31, 2002, compared to $21.8 million
used in the prior year. The improvement resulted from our overall improvement to
net loss after eliminating non-cash items. We also benefited from prepayment of
service revenues resulting in a large increase to deferred revenues as a result
of our wholesale services agreement with MCI, however, this increase more than
off-set the change in other operating assets and liabilities.


                                       40
<PAGE>

         Included in our net cash operating activities was the sale of $135.2
and $156.3 million of receivables, for net proceeds of $107.3 and $106.5
million, as of December 31, 2002 and 2001, respectively. A net receivable
servicing asset of $8.5 and $12.9 million is included in accounts receivable and
$3.4 and $3.5 million of advances on unbilled receivables are included in
accounts payable and accrued liabilities as of December 31, 2002 and 2001,
respectively. The costs relating to the agreement of $1.3 and $1.1 million is
included in interest and other expense for years ended December 31, 2002 and
2001, respectively.

         The RFC agreement allows us to sell up to $25 million of receivables,
subject to the selection criteria utilized by RFC for the selection of
receivables they agree to purchase. There are no minimum sales requirements
under this agreement. RFC currently purchases receivables from us at a discount
of 23%; this rate is negotiated and may change according to collection
experience. Prior to March 2002 RFC purchased our receivables at a 32% discount
rate. Our collection percentages during 2002 and 2001 were 92.9% and 89.7%,
respectively. Under the agreement we are responsible for the continued servicing
of the receivables and any amount collected over the 32% discount rate is paid
to us by RFC for providing the servicing less certain fees. We have reduced the
amount of receivables available for sale during the last quarter of 2002.

         Our net cash used in investing activities was $15.6 million for both
years ended December 31, 2002 and 2001. We purchased slightly less property and
equipment totaling $15.2 million for the year ended December 31, 2002, compared
to $15.4 million the prior year. This decrease was off set by the net change in
related party payments and issuances of notes receivable. We expect to maintain
similar levels of purchases of property and equipment, but will invest
additional resources if additional cash is available as a result of our improved
operating activities. We are also working to collect our related party notes and
do not expect to be issuing any similar notes during 2003.

         Our net financing activities decreased by $15.4 million to $5.7 million
used in financing activities for the year ended December 31, 2002 compared to
$9.7 million provided by financing activities in the prior year. This decrease
is primarily a result of receiving $17.5 million of mandatorily redeemable
preferred stock in 2001, and not having any similar stock issuance in 2002. This
decrease was off set by $1.9 million reduction of payments on long-term debt and
capital lease obligations totaling $5.6 million for the year ended December 31,
2002, compared to $7.5 million for the prior year. We expect to maintain a low
amount of long-term debt although if appropriate terms became available to
obtain a more traditional loan we would likely replace our existing accounts
receivable agreement. Our existing debt is primarily related party, with fixed
interest that is payable in monthly installments.

         During 1998, several of our management issued full recourse promissory
notes, totaling approximately $3.3 million to us in connection with the purchase
of 2,929,575 shares of common stock. These notes were collateralized by the
shares of common stock acquired with the notes, and we hold those shares as
collateral. The accompanying consolidated financial statements include the notes
as a decrease in stockholders' equity. There were three notes outstanding,
totaling approximately $0.9 million at December 31, 2002 and 2001. The principal
balance of the notes and the related accrued interest (8% per annum) were
originally due December 31, 2001, however in January of 2002, we extended the
notes due dates until December 31, 2002. In February 2003, we received a payment
for the full outstanding balance of approximately $0.5 million from one of our
executive officer's that is also a member of our Board of Directors. The other
notes in the amounts of $0.3 and $0.1 million were further extended to being due
November 22, 2004 and on demand, respectively. The note for $0.3 million also
had the annual interest rate reduced to 5%. Interest income on these notes
receivable was $0.1 million for each of the years ended December 31, 2002, 2001
and 2000.

         In February 2000, we paid $14.4 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.

         In April 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. We
recorded a $59.2 million impairment charge during 2001 as a result of the sale
and closure of the telemarketing centers acquired from Touch 1. In April of
2002, we announced a restructuring plan that included the closure of the
remaining call centers in North Dakota resulting in $1.1 million of impaired
assets being recorded in conjunction with the sale of property, plant and
equipment. As of December 31, 2002 and 2001 there were $4.1 and $5.9 million,
respectively, of intangible assets remaining related solely to customer lists.

         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 received aggregate proceeds of $56.3 million in
connection with the sale of 4,688,247 shares of Series D Preferred at a price of
$12.00 per share. The costs associated with the transaction were $0.4 million.
The


                                       41
<PAGE>

Series D Preferred had an original conversion price of $12.00, which price is
subject to adjustment for such items as; (i) a dividend or distribution to
common shareholders (whether such dividend or distribution is in stock,
securities, or other property), (ii) a stock split, (iii) a stock combination,
(iv) a reclassification of common stock, (v) the issuance of stock or securities
convertible into or exercisable for our common stock at a price that is less
than the conversion price, and (vi) other events the would cause dilution in the
ownership of the holders of the Series D Preferred stock. As a result of these
events the conversion price at December 31, 2002 is $8.63. The Series D
Preferred is convertible 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- 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's
original exercise price was $13.80 per share subject to certain adjustments that
have lowered the exercise price to $10.06 per share, at December 31, 2002.

         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. In July 2002, we renewed the RFC
agreement for an additional two years under substantially similar terms.

         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. We terminated this
contract in 2001 and recorded a $3.0 million impairment charge in 2001. We have
no further obligations under this agreement.

         In August 2000, we entered into an agreement with a service firm to
outsource customer provisioning and other ordering through electronic bonding
with the incumbent local exchange carriers. In September 2002, we renegotiated
this agreement with resulting in a lowering of our monthly minimum payments and
an increase to the fees we pay on a per transaction basis fees incurred over the
minimum payments. Our reduced monthly payments result in the annual commitment,
subject to certain adjustments, of approximately $9.6 million for both the years
ending December 31, 2003 and 2004. We made payments under the agreement totaling
$9.7, $6.3 and $0.5 million for the years ended December 31, 2002, 2001 and
2000, respectively. The minimum payments are required by us, regardless of our
use of the services provided for in the contract. This contract provides, under
certain circumstances, for early termination and severance fees for such action.

         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 per share. 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. Series E Preferred was originally convertible at a conversion price of
$12.00, which price is subject to adjustment, for such items as; (i) a dividend
or distribution to common shareholders (whether such dividend or distribution is
in stock, securities, or other property), (ii) a stock split, (iii) a stock
combination, (iv) a reclassification of common stock, (v) the issuance of stock
or securities convertible into or exercisable for our common stock at a price
that is less than the conversion price, and (vi) other events that would cause
dilution in the ownership of the holders of the Series E Preferred stock. As a
result of certain of these events the conversion price at December 31, 2002 is
$8.25. The Series E Preferred is convertible 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 E Preferred is mandatorily redeemable 8 years from the original issue
date has an 8% cumulative dividend payable in-kind and has certain liquidation
preferences and voting rights. Each warrant is exercisable at a price of $13.80
per share subject to certain adjustments that have lowered the exercise price to
$7.91 per share, at December 31, 2002.

         In December 2000, we sold marketable securities for $3.5 million; this
sale resulted in a gain of $2.7 million. The proceeds were used to fund
operations.

         In December 2000, we agreed to guarantee three employees' margin loans.
Each employee executed an agreement with us in which each pledges security
interest in all shares of our 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 the creditor who made the
margin loan to these employees draw any amounts on our guarantee, such amounts
would be considered advances under a secured promissory note and would bear
interest until paid. As of December 31, 2001 one of the three employees
fulfilled their obligations leaving approximately $1.0 million of the guarantee.
In July and August 2002, we loaned the employees who we were originally
providing a loan guarantee, approximately $0.1 and $0.9 million, to cover margin
balances and prevent the liquidation of the employees' holdings of our common
stock. The loans were originally demand loans bearing interest at an annual rate
equal to the prime rate plus 2%. In


                                       42
<PAGE>

October 2002, we established terms with the employee owing us $0.3 million to
make eight quarterly payments beginning in December 2002, with a balloon payment
for the remaining balance due December 2, 2004. Interest accrues on the unpaid
balance at an annual rate of 5%. The employee pledged shares of our stock, owned
outright by the employee, as collateral for the loan. We received principal
payments totaling $0.6 million from these employees during 2002. As of December
31, 2002 there was approximately $0.4 million receivable for this loan.

         In January 2001, we accelerated the vesting of 50,000 stock options
granted to an executive as part of a severance agreement. This acceleration
resulted in the employee being fully vested in stock options with a strike price
of $3.64 when the stock was trading at $4.50. We recorded approximately $0.1
million in general and administrative expense as a result of this transaction.

         In February 2001, we made a loan to an employee in the amount of 0.1
million. The interest rate of this note is 9.5% and it is payable as a balloon
payment on February 23, 2003. This note is collateralized by any and all stock
options, rights to salary and wages, and all property personal, tangible, and
intangible of the employee.

         In July 2001, we filed a Certificate of Designation authorizing the
issuance of 175 shares of Series G junior convertible preferred stock ("Series G
Preferred"). On July 2 and August 3, 2001, we issued an aggregate of 175 shares
of Series G Preferred for aggregate proceeds of $17.5 million, initially
convertible into 11,739,970 shares of common stock, subject to adjustment upon
the occurrence of certain events that would cause dilution in the ownership of
the holders of the Series G Preferred, such as; (i) a dividend or distribution
to common shareholders (whether such dividend or distribution is in stock,
securities, or other property), (ii) a stock split, (iii) a stock combination,
(iv) a reclassification of common stock, and, (v) the issuance of stock or
securities convertible into or exercisable for our common stock at a price that
is less than the conversion price. As of December 31, 2001 the conversion price
was $1.49. In conjunction with the issuance of the Series G Preferred, we issued
warrants to purchase 3,000,000 shares of common stock at an exercise price of
$0.01 per share. The Series G Preferred become mandatorily redeemable 5 years
from September 18, 2001. The Series G Preferred have a 12% cumulative dividend,
payable in cash or in-kind, is convertible at the option of the holder and has
certain liquidation rights; however, there are certain circumstances that
provide for a automatic conversion of the Series G Preferred.

         In accordance with GAAP, we recorded a deemed dividend of approximately
$1.5 million, which results from the value assigned to the warrants and a
beneficial conversion feature associated with the Series G Preferred
transaction. These deemed dividends were originally accreted over a life through
December 31, 2001, the earliest redemption date. Once shareholder approval was
obtained, on October 30, 2001, the remaining balance has been and will continue
to be accreted over the remaining 5-year redemption period.

         As a result of certain anti-dilution clauses in the Series D Preferred
agreement, the issuance of Series G Preferred triggered an additional beneficial
conversion feature related to the Series D agreement. The deemed dividend of
approximately $7.9 million was accreted immediately in the third quarter of
2001.

         In June 2001, we as part of an executive severance agreement paid an
executive approximately $0.3 million. This same executive received an interest
free loan of approximately $0.8 million, utilized to exercise stock options to
purchase 187,000 shares of common stock. This note is collateralized by the
shares of common stock acquired with the note, and we hold those shares as
security.

         In July 2001, we agreed to settle a lawsuit with AT&T in which we
alleged that AT&T had received originating and terminating access service from
us and had unlawfully withheld access charges for such services. As part of the
settlement, we entered into a switched access agreement setting forth terms and
conditions under which AT&T will purchase access services from us in the future.

         In August 2001, we cancelled approximately $0.7 million of notes
receivable and reacquired 61,875 shares of common stock at $1.14 per share from
an employee. At December 31, 2001 these shares are presented as treasury shares,
at cost.

         In October 2001, we loaned an employee $0.1 million. The interest rate
of the note is 6.5% and was payable as a balloon payment on June 13, 2002. In
September 2002, we extended the due date for this note until March 12, 2003, in
accordance with the severance agreement executed for the employee's termination.
The employee received a forgiveness of six thousand dollars of interest and the
annual interest rate of the note was reduced to 6.0%. This note was for
relocation of the employee. There is no collateral pledged for this note.


                                       43
<PAGE>

         In January 2002, we accelerated the vesting of 96,471 stock options
granted to an executive as part of his severance agreement. This acceleration
resulted in the employee being fully vested in stock options with a strike price
of $1.30 when the stock was trading at $1.80. The employee forfeited 76,471 of
his vested options in return for the exercise of 20,000 shares of stock. We
recorded approximately $0.1 million in general and administrative expense as a
result of this transaction.

         In January 2002, we entered into an agreement with a company that
provided us with software to automate the processing, auditing, dispute
tracking, management reporting and various other functions over our ILEC and
long-distance network costs. In addition to the set-up and implementation fees,
under this agreement, we have committed to minimum cash payments of $6.0 million
for 2003. In accordance with the contract we make monthly payments based on a
schedule that correlates to net monthly carrier invoice volume. We made payments
under this agreement totaling $0.8 million for the year ended December 31, 2002.

         We recently transferred the listing of our common shares from the
Nasdaq National Market to the Nasdaq SmallCap Market. Among other requirements
for our continued listing on the Nasdaq SmallCap Market we must have a market
value of our listed securities exceeding $35 million and maintain a minimum bid
price of not less than $1.00 per share.

         On February 27, 2002, the New York Public Service Commission (the
"Commission") approved a settlement, which reduced the prices that we and other
competitive local exchange carriers pay for unbundled network elements and
expanded the availability of those elements. Specifically, rates for the
elements comprising the unbundled network element platform were reduced by
approximately $8 to $9 per month per subscriber, on average. These rate
decreases took effect on March 1, 2002. In addition, the Commission directed
Verizon to provide bill credits to us in the amount of approximately $9.0
million to implement retroactive rate decreases for unbundled local switching.
We have recorded and received the full impact of this credit as a reduction to
our network operations expenses during 2002.

         On March 20, 2002, we entered into a 48-month agreement with MCI for
wholesale telephone exchange services, ancillary services and a limited-term
technology license. The agreement was cancelable by either party after eighteen
months. This agreement was significantly amended on November 1, 2002.

         Under the original terms of the agreement, MCI was to pay us a maximum
of $50 million related to the use of our network in the form of a technology
license fee, should the agreement not be terminated early. Cash flows related to
the license were to be paid based on the number of MCI customers on our network,
as defined in the contract, and were subject to monthly minimum amounts. In
addition, MCI was to pay for services provided through usage-based fees
according to certain per line and per minute calculations defined in the
agreement and MCI was to also pay fees to us for providing telephone exchange
services, payroll costs and certain vendor fees. We are the primary obligor for
all costs incurred under this agreement.

         We recognized the $50 million license fee, and amounts received in
advance of the contract, on a straight-line basis over the four-year contract
period beginning in April 2002. In connection with the agreement, we issued MCI
one million shares of our common stock at a price of $2.33, the market price of
our stock at the date of the agreement. As a result of this transaction an asset
totaling $2.3 million is being amortized on a straight-line basis as a reduction
to revenues over the 48-month term of the agreement with the remaining balance
recorded in other non-current assets. Monthly usage-based charges and cost
reimbursements were recognized when earned.

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

         As of December 31, 2002, we have recorded approximately $30.2 million
in revenues under the contract with MCI. Included in our consolidated balance
sheet as of December 31, 2002, are approximately $3.6 and $6.3 million of
long-term and short-term deferred revenues, respectively. These amounts
represent advance billings under the contract. We expensed the costs related to
our wholesale business as incurred, with the exception of certain internal-use
software development costs that qualified for capitalization. We incurred
approximately $1.0 million of start-up costs for our wholesale services, which
are shown as wholesale development costs in the Statement of Operations, and
capitalized approximately $2.0 million in software development costs relating
directly to our wholesale services efforts.


                                       44
<PAGE>

         On July 21, 2002, WorldCom, Inc. ("WorldCom") and certain of its
subsidiary corporations, including MCI, filed voluntary petitions for relief
under chapter 11 of the United States Bankruptcy Code. Under the Bankruptcy Code
a vendor that provides post-petition goods or services to a debtor on a
continuous basis is entitled to payment for those goods and services on a timely
basis if the debtor wants the vendor to continue supplying the goods or
services. Neither the Bankruptcy Code nor the applicable case law requires
vendors to provide post-petition goods and services to a debtor without payment.
Although MCI has paid us in a timely manner since its bankruptcy filing, we have
no assurance that MCI has the resources to continue to pay its vendors on a
timely basis.

         For MCI's customers provisioned using our company code, we are the
customer of record for the regional bell operating companies wholesale billing.
It is very likely that the state commissions would require us to continue
providing services to MCI's customers for at least the 90-day period contained
in the guidelines described below, regardless of whether MCI continues its
relationship with these customers.

         Under the New York Public Service Commission's ("Commission") mass
migration guidelines, when a local exchange carrier discontinues service its
customers must have the ability to migrate to another carrier without
interruption of service. Carriers are required to file an exit plan with the
Commission at least 90 days in advance of discontinuance of service, or must
demonstrate that 90 days' notice was not feasible. Customers must be notified
not less than 60 days prior to discontinuance of service, and a second notice
must be provided if the customer has not taken action to change to a new
provider. Other states in which MCI and we operate are developing similar rules
for carriers exiting markets, generally using the Commission's guidelines as a
framework.

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

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

         In February 2003, we executed an agreement for the resale of local
wireline telecommunications services and provision of ancillary services with
Sprint Communications Company L.P. ("Sprint"). Under this agreement we will
provide Sprint access to our web-integrated enhanced communications platform and
operational support systems. This contract includes various per minute, per
line, and other charges that we will analyze to determine the appropriate timing
of revenue recognition. As of December 31, 2002 we had recorded approximately
$1.3 million of deferred revenue for payments received prior to the signing of
the agreement. This agreement is success based and non-exclusive in nature.

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

         Our short-term liquidity relies heavily upon our accounts receivable
agreement, cash provided from operations, cash management strategies, and if
needed, our ability to reduce certain discretionary capital and marketing
expenses costs and growth of our consumer and wholesale services. We have
historically had negative cash flows and although we achieved positive EBITDA
for 2002, and our net cash decreased by only $2.9 million in 2002 compared to
$27.8 in the prior year, and we expect that trend to improve to the achievement
of positive cash-flows during 2003, we are also aware of the risks, discussed
throughout this document, of not achieving our goals and the impact thereof on
our liquidity.

         Our ongoing capital requirements will depend on several factors,
including market acceptance of our services, the amount of resources we devote
to investments in our networks, facilities, build-out of additional enterprise
management centers, services development and brand promotions, the resources we
devote to sales and marketing of our services, and other factors. We will


                                       45
<PAGE>

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

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

         On January 22, 2002, the Securities and Exchange Commission issued
FR-61, Commission Statement about Management's Discussion and Analysis of
Financial Condition and Results of Operations. The release sets forth certain
views of the Commission regarding disclosure that should be considered by
registrants. Disclosure matters addressed by the release are liquidity and
capital resources including off-balance sheet arrangements, certain trading
activities that include non-exchange traded contracts accounted for at fair
value, and effects of transactions with related and certain other parties. The
following table sets forth the information and format described in the release
with regard to disclosures about contractual obligations and commercial
commitments. These disclosures are also included in the notes to the financial
statement and cross-referenced in the tables below.

         The following table discloses aggregate information about our
contractual obligations and the periods in which payments are due:


<TABLE>
<CAPTION>
                                             LESS THAN                                     AFTER
 CONTRACTUAL OBLIGATIONS        TOTAL         1 YEAR-      1-3 YEARS      4-5 YEARS       5 YEARS
 -----------------------      ---------      ---------     ---------      ---------      ---------
<S>                           <C>            <C>           <C>            <C>            <C>
Long-term debt (1)            $   8,944       $ 5,193       $ 3,751        $    --       $      --
Operating leases                  1,378           897           481             --              --
Capital leases                    2,703         1,635         1,068
Mandatorily redeemable
  preferred stock               145,503            --            --         20,536         124,967
redemption
Unconditional purchase
  obligations                    25,200        15,600         9,600             --              --
                              ---------      --------      --------       --------       ---------
Total contractual cash
  obligations                 $ 183,728       $23,325       $14,900        $20,536       $ 124,967
                              =========       =======       =======        =======       =========
</TABLE>

(1)  The Company has no related party obligations other than those listed in
footnote 12 - Long-Term Debt, of our Consolidated Financial Statements.

NEW ACCOUNTING PRONOUNCEMENTS

         In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations." This statement provides accounting and reporting
standards for recognizing obligations related to asset retirement costs
associated with the retirement of tangible long-lived assets. Under this
statement, legal obligations associated with the retirement of long-lived assets
are to be recognized at their fair value in the period in which they are
incurred if a reasonable estimate of fair value can be made. The fair value of
the asset retirement costs is capitalized as part of the carrying amount of the
long-lived asset and subsequently allocated to expense using a systematic and
rational method over the assets' useful life. Any subsequent changes to the fair
value of the liability due to passage of time or changes in the amount or timing
of estimated cash flows is recognized as an accretion expense. We adopted this
statement January 1, 2003. This statement should have no impact on our results
of operations, financial position and cash flows.

         In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB
Statements Nos. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections." Among other things, this statement rescinds SFAS No. 4, "Reporting
Gains and Losses from Extinguishment of Debt", which required all gains and
losses from extinguishment of debt to be aggregated and, if material, classified
as an extraordinary item, net of the related income tax effect. As a result, the
criteria in Accounting Principles Board Opinion ("APB") No. 30, "Reporting the
Results of Operations - Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions," which requires gains and losses on extinguishments of debt to be
classified as income or loss from continuing operations, will now be applied. We
will apply the provisions of SFAS No. 145 prospectively to all debt
extinguishments beginning in 2003.


                                       46
<PAGE>

         In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities", which addresses financial
accounting and reporting for costs associated with exit or disposal activities
and nullifies Emerging Issues Task Force ("EITF") No. 94-3, "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a Restructuring)". The principal
difference between SFAS No. 146 and EITF No. 94-3 relates to SFAS No. 146's
requirements for recognition of a liability for a cost associated with an exit
or disposal activity. SFAS No. 146 requires that a liability for a cost
associated with an exit or disposal activity be recognized when the liability is
incurred. Under EITF No. 94-3, a liability for an exit cost as generally defined
in EITF No. 94-3 was recognized at the date of an entity's commitment to an exit
plan. We adopted the new standard effective January 1, 2003.

            In December 2002, the FASB issued SFAS No. 148, "Accounting for
Stock-Based Compensation - Transition and Disclosure, an Amendment of SFAS No.
123, Accounting for Stock-Based Compensation." SFAS No. 148, which is effective
for years ending after December 15, 2002, provides alternative methods for a
voluntary change to the fair value based method of accounting for stock-based
employee compensation and requires prominent disclosure about the method of
accounting for stock-based employee compensation and the effect of the method
used on reported results. We will continue to account for our stock based
compensation according to the provisions of APB Opinion No. 25.

            CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

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 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:

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

         -        our ability to retain a high percentage of our customers;

         -        the possibility of unforeseen capital expenditures and other
                  upfront investments required to deploy new technologies or to
                  effect new business initiatives;

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

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

         -        additions or departures of key personnel;

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

         -        existing and future laws or regulations affecting our business
                  and our ability to comply with these laws or regulations;

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

         -        technological innovations;

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


                                       47
<PAGE>

         -        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. Moreover,
we launched our principal service Z-LineHOME in June 1999 and initiated
wholesale operations in January 2002. We have had fewer than five 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 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 began marketing our products and services in
September 1998. In June 1999, we focused our product offering on sales of our
Z-LineHOME service. Our Z-LineBUSINESS service and wholesale initiative are only
recently established. 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. User acceptance of our
products and services could be limited by:

         -        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;

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

         -        the perception of complexity in using our services;

         -        the reliability of our technology and network infrastructure;

         -        the quality of our billing, provisioning and customer service;
                  and

         -        the prices of our services.

         We have determined that substantial marketing effort, time and expense
are required to stimulate initial demand for our retail 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.

         Possibility 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.

         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 47 states using unbundled


                                       48
<PAGE>

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 of our Z-LineHOME or
Z-LineBUSINESS or adversely affect our wholesale initiatives. 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.

         Uncertainties Relating to Wholesale Initiative. Our wholesale
initiative is newly developed. There is no assurance that it will contribute to
gross profit or otherwise be successful. We believe we are the first competitive
local exchange carrier to offer wholesale local exchange services. We
undoubtedly will encounter unforeseen delays, capital expenditures and upfront
costs, regulatory and legal issues (which may include legal challenges to our
wholesale strategy by incumbent local exchange carriers), technical difficulties
and other challenges. There can be no assurance that we will overcome these
challenges successfully or without expenditure of substantial resources.
Moreover, since we must pay the incumbent local exchange carrier fees relating
to local telephone usage by both our retail and wholesale customers, we will be
highly dependent upon our wholesale customers. Their failure to pay fees to us
may make it difficult or impossible for us to pay fees to the incumbent local
exchange carriers upon which we rely.

         Rapid Expansion. 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:

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

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

         -        introduce and market new products and services and new pricing
                  plans in addition to Z-LineHOME and our other service
                  offerings;

         -        enhance and upgrade the features of our software;

         -        capitalize on new opportunities in the competitive
                  marketplace; and

         -        control our expenses.

         The strains posed by these demands are magnified by the emerging 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 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. Recently, several long distance
carriers have encountered financial difficulties, including at least one carrier
utilized by us. Financial difficulties encountered by any of our carriers could
cause disruption of service to our customers and could diminish the value of any
receivables or credits that may be due to us from such carriers. Our agreements
with long distance carriers 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. To date, we have not paid any
material underutilization charges.


                                       49
<PAGE>

         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 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.


                                       50
<PAGE>

         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.
We have an accounts receivable facility with RFC Corporation that provides for
the sale of up to $25 million of our receivables to RFC. This facility expires
in July 2004.

         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 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.

         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.


                                       51
<PAGE>

         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 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. To date, we have not encountered material fraud or theft of our
service.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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

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

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


                                       52
<PAGE>

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

<TABLE>
<CAPTION>
                                                                                 PAGE
                  <S>                                                            <C>
                  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
</TABLE>


                                      F-1
<PAGE>

               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, of changes in stockholders' equity
(deficit) and comprehensive income and of cash flows present fairly, in all
material respects, the financial position of Z-Tel Technologies, Inc. and its
subsidiaries at December 31, 2002 and 2001, and the results of their operations
and their cash flows for each of the three years in the period ended December
31, 2002 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
March 26, 2003


                                      F-2
<PAGE>

                    Z-TEL TECHNOLOGIES, INC. AND SUBSIDIARIES
                           CONSOLIDATED BALANCE SHEETS
                      (IN THOUSANDS, EXCEPT PER SHARE DATA)

<TABLE>
<CAPTION>
                                                                                                    DECEMBER 31,
                                                                                            ---------------------------
                                                                                               2002             2001
                                                                                            ---------         ---------
<S>                                                                                         <C>               <C>
ASSETS
Current assets:
   Cash and cash equivalents                                                                $  16,037         $  18,892
   Accounts receivable, net of allowance for doubtful
       accounts of $17,401 and $17,064                                                         26,749            27,042
   Prepaid expenses and other current assets                                                    5,741             3,961
                                                                                            ---------         ---------
     Total current assets                                                                      48,527            49,895

Property and equipment, net                                                                    48,320            56,231
Intangible assets, net                                                                          4,116             5,945
Other assets                                                                                    5,748             4,666
                                                                                            ---------         ---------
       Total assets                                                                         $ 106,711         $ 116,737
                                                                                            =========         =========

LIABILITIES, MANDATORILY REDEEMABLE CONVERTIBLE PREFERRED
         STOCK AND STOCKHOLDERS' DEFICIT

Current liabilities:
   Accounts payable and accrued liabilities                                                 $  51,771         $  49,622
   Deferred revenue                                                                            10,172             5,951
   Current portion of long-term debt
       and capital lease obligations                                                            5,964             6,305
                                                                                            ---------         ---------
     Total current liabilities                                                                 67,907            61,878

Long- term deferred revenue                                                                     6,277                --
Long-term debt and capital lease obligations                                                    4,180             9,461
                                                                                            ---------         ---------

       Total liabilities                                                                       78,364            71,339
                                                                                            ---------         ---------

Mandatorily redeemable convertible preferred stock, $.01 par value; 50,000,000
       shares authorized; 8,855,089 issued; 8,805,089 and 8,855,089
       outstanding (aggregate liquidation value of $145,503 and $135,298)                     127,631           112,570
                                                                                            ---------         ---------

Commitments and contingencies (Note 17)

Stockholders' deficit:
   Common stock, $.01 par value; 150,000,000
       shares authorized; 35,609,803 and 34,341,855 shares issued;
       35,268,253 and 34,000,305 outstanding                                                      356               343
   Notes receivable from stockholders                                                          (1,589)           (1,589)
   Unearned stock compensation                                                                     --              (122)
   Additional paid-in capital                                                                 205,090           217,782
   Accumulated deficit                                                                       (302,753)         (283,198)
   Treasury stock, 341,550 shares at cost                                                        (388)             (388)
                                                                                            ---------         ---------

     Total stockholders' deficit                                                              (99,284)          (67,172)
                                                                                            ---------         ---------

       Total liabilities, mandatorily redeemable convertible preferred
            stock and stockholders' deficit                                                 $ 106,711         $ 116,737
                                                                                            =========         =========
</TABLE>

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


                                      F-3
<PAGE>

                    Z-TEL TECHNOLOGIES, INC. AND SUBSIDIARIES
                      CONSOLIDATED STATEMENTS OF OPERATIONS
                 (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

<TABLE>
<CAPTION>
                                                                              YEARS ENDED
                                                                              DECEMBER 31,
                                                           --------------------------------------------------
                                                               2002               2001                2000
                                                           ------------       ------------       ------------
<S>                                                        <C>                <C>                <C>
Revenues                                                   $    235,255       $    275,897       $    177,668
                                                           ------------       ------------       ------------
Operating expenses:
   Network operations                                            91,374            155,164            107,077
   Sales and marketing                                           12,327             31,243             45,018
   General and administrative                                   122,537            156,107             99,606
   Asset impairment charge                                        1,129             59,247                 --
   Wholesale development costs                                    1,018                 --                 --
   Restructuring charge                                           1,861                 --                 --
   Depreciation and amortization                                 23,936             23,277             17,166
                                                           ------------       ------------       ------------

     Total operating expenses                                   254,182            425,038            268,867
                                                           ------------       ------------       ------------

     Operating loss                                             (18,927)          (149,141)           (91,199)
                                                           ------------       ------------       ------------

Nonoperating income (loss):
   Interest and other income                                      3,509              6,862              5,475
   Interest and other expense                                    (4,137)            (3,789)            (2,313)
                                                           ------------       ------------       ------------

     Total nonoperating income (loss)                              (628)             3,073              3,162
                                                           ------------       ------------       ------------

     Net loss                                                   (19,555)          (146,068)           (88,037)

     Less mandatorily redeemable convertible
         preferred stock dividends and accretion                (15,589)           (15,059)            (3,644)
     Less deemed dividend related to beneficial
         conversion feature                                        (186)            (9,356)           (20,027)
                                                           ------------       ------------       ------------

     Net loss attributable to common stockholders          $    (35,330)      $   (170,483)      $   (111,708)
                                                           ============       ============       ============

Weighted average common shares outstanding                   34,951,720         33,908,374         33,066,538
                                                           ============       ============       ============

Basic and diluted net loss per share                       $      (1.01)      $      (5.03)      $      (3.38)
                                                           ============       ============       ============
</TABLE>

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


                                      F-4
<PAGE>

                    Z-TEL TECHNOLOGIES, INC. AND SUBSIDIARIES
      CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT)
                            AND COMPREHENSIVE INCOME
                        (In thousands, except share data)

<TABLE>
<CAPTION>
                                                                        Common Stock            Notes Receivable    Unearned
                                                                -----------------------------        from            Stock
                                                                  Shares           Par Value      Stockholders    Compensation
                                                                ----------        -----------     -----------     -----------
<S>                                                             <C>               <C>             <C>             <C>
Balances, December 31, 1999                                     31,880,236        $       322     $    (1,683)    $    (2,487)

Issuance of common stock for
      acquisition or Touch 1                                     1,100,000                 11
Issuance of common stock for exercise
       of stock options                                            773,999                  7
Repayment of stockholders' notes                                                                          844
Vesting of stock options granted below
      intrinsic value                                                                                                   2,232
Warrants extinguished with debt
Warrants issued for litigation settlement
Mandatorily convertible redeemable
      dividends and preferred stock accretion
Warrants issued with preferred stock

Net Loss
Foreign currency translation adjustment

Comprehensive Income
                                                                ----------        -----------     -----------     -----------
Balance, December 31, 2000                                      33,754,235                340            (839)           (255)

Issuance of common stock for exercise
       of stock options                                            254,731                  3            (820)
Issuance of common stock for exercise
      of warrants                                                   25,714
Issuance of common stock for the
      purchase of software                                          27,500               --
Vesting of stock options granted below
      intrinsic value                                                                                                     133
Accelerated vesting of stock options
Mandatorily convertible redeemable
      dividends and preferred stock accretion
Warrants issued with preferred stock
Treasury stock received upon cancellation
      of notes receivable from stockholder                         (61,875)              --                70

Net loss
Foreign currency translation adjustment

Comprehensive loss
                                                                ----------        -----------     -----------     -----------
Balance, December 31, 2001                                      34,000,305                343          (1,589)           (122)
Issuance of common stock                                         1,000,000                 10
Issuance of common stock for exercise of warrants                  171,429                  2
Issuance of common stock for exercise of options                       361               --
Conversion of mandatorily convertible redeemable
      preferred stock                                               76,158                  1
Vesting of stock options granted below
      intrinsic value                                                                                                     122
Accelerated vesting of stock options and issuance of shares         20,000               --
Mandatorily redeemable convertible preferred
      stock dividends and accretion
Net loss
                                                                ----------        -----------     -----------     -----------
Balance, December 31, 2002                                      35,268,253        $       356     $    (1,589)    $      --
                                                                ==========        ===========     ===========     ===========

<CAPTION>
                                                                                              Accumulated
                                                              Additional                         Other       Total
                                                               Paid-In       Accumulated     Comprehensive  Treasury  Stockholders'
                                                               Capital         Deficit           Loss       Stock       Deficit

<S>                                                          <C>            <C>              <C>           <C>        <C>
Balances, December 31, 1999                                  $   167,637    $   (49,093)          $--      $ (318)    $   114,378

Issuance of common stock for
      acquisition or Touch 1                                      39,275                                                   39,286
Issuance of common stock for exercise
       of stock options                                            2,405                                                    2,412
Repayment of stockholders' notes                                                                                              844
Vesting of stock options granted below
      intrinsic value                                             (2,621)                                                    (389)
Warrants extinguished with debt                                      655                                                      655
Warrants issued for litigation settlement                            611                                                      611
Mandatorily convertible redeemable
      dividends and preferred stock accretion                     (3,070)                                                  (3,070)
Warrants issued with preferred stock                              22,412                                                   22,412

Net Loss                                                                        (88,037)                                  (88,037)
Foreign currency translation adjustment                                                                                        (2)
                                                                                                                      -----------
Comprehensive Income                                                                              (2)                     (88,039)
                                                             -----------    -----------        --------    ------     -----------
Balance, December 31, 2000                                       227,304       (137,130)          (2)        (318)         89,100

Issuance of common stock for exercise
       of stock options                                            1,000                                                      183
Issuance of common stock for exercise
      of warrants                                                     --                                                       --
Issuance of common stock for the
      purchase of software                                           155                                                      155
Vesting of stock options granted below
      intrinsic value                                                                                                         133
Accelerated vesting of stock options                                  49                                                       49
Mandatorily convertible redeemable
      dividends and preferred stock accretion                    (15,059)                                                 (15,059)
Warrants issued with preferred stock                               4,333                                                    4,333
Treasury stock received upon cancellation
      of notes receivable from stockholder                                                                    (70)           --

Net loss                                                                       (146,068)                                 (146,068)
Foreign currency translation adjustment                                                                         2               2
                                                                                                                      -----------
Comprehensive loss                                                                                                       (146,066)
                                                             -----------    -----------        --------    ------     -----------
Balance, December 31, 2001                                       217,782       (283,198)           --        (388)        (67,172)
Issuance of common stock                                           2,320                                                    2,330
Issuance of common stock for exercise of warrants                                                                               2
Issuance of common stock for exercise of options                                                                               --
Conversion of mandatorily convertible redeemable
      preferred stock                                                679                                                      680
Vesting of stock options granted below
      intrinsic value                                                                                                         122
Accelerated vesting of stock options and issuance of shares           84                                                       84
Mandatorily redeemable convertible preferred
      stock dividends and accretion                              (15,775)                                                 (15,775)
Net loss                                                                        (19,555)                                  (19,555)
                                                             -----------    -----------        --------    ------     -----------
Balance, December 31, 2002                                   $   205,090    $  (302,753)          $--      $ (388)    $   (99,284)
                                                             ===========    ===========        ========    ======     ===========
</TABLE>

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



                                      F-5
<PAGE>

                    Z-TEL TECHNOLOGIES, INC. AND SUBSIDIARIES
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (In thousands)

<TABLE>
<CAPTION>
                                                                                      Year Ended
                                                                                      December 31,
                                                                        -------------------------------------
                                                                           2002          2001          2000
                                                                        ---------     ---------     ---------
<S>                                                                     <C>           <C>           <C>
Cash flows from operating activities:
Net loss                                                                $ (19,555)    $(146,068)    $ (88,037)
                                                                        ---------     ---------     ---------
Adjustments to reconcile net loss to net cash used in
     operating activities:
  Depreciation and amortization                                            23,936        23,277        17,166
  Provision for bad debts                                                  31,964        55,530        17,804
  Asset impairment charge                                                   1,129        59,247          --
  Expense charged for granting of stock options                               206           182          (389)
  Expense charged for issuance of warrants for litigation settlement         --            --             611
  Expense charged for issuance of warrants to extinguish debt                --            --             655
  Gain on disposal of assets                                                 (132)         (329)       (2,124)
  Change in operating assets and liabilities:
     Increase in accounts receivable                                      (31,671)      (17,140)      (71,581)
     (Increase) decrease in prepaid expenses                               (1,780)        1,106        (5,594)
     (Increase) decrease in other assets                                    1,655        (1,070)         (995)
     Increase in accounts payable and accrued liabilities                   2,149         5,138        28,473
     Increase (decrease) in deferred revenue                               10,498        (1,715)        7,149
                                                                        ---------     ---------     ---------
        Total adjustments                                                  37,954       124,226        (8,825)
                                                                        ---------     ---------     ---------
        Net cash provided by (used in) operating activities                18,399       (21,842)      (96,862)
                                                                        ---------     ---------     ---------

Cash flows from investing activities:
  Principal repayments received on notes receivable                           590             7           766
  Purchases of property and equipment                                     (15,193)      (15,426)      (34,849)
  Issuance of note receivable                                                (997)         (196)         --
  Proceeds from sale of securities                                           --            --           3,486
  Purchase of securities                                                     --            --          (1,050)
  Purchase of Touch 1, net of cash acquired                                  --            --          (8,955)
                                                                        ---------     ---------     ---------
        Net cash used in investing activities                             (15,600)      (15,615)      (40,602)
                                                                        ---------     ---------     ---------

Cash flows from financing activities:
  Payments on long-term debt and capital lease obligations                 (5,622)       (7,532)      (22,884)
  Payment of preferred stock dividends                                        (34)         --          (2,713)
  Proceeds from exercise of common stock warrants                               2          --            --
  Proceeds from issuance of mandatorily redeemable
     convertible preferred stock                                             --          17,500       106,260
  Payment of issuance cost for mandatorily redeemable                        --            (450)         --
     convertible preferred stock                                             --            --          (1,464)
  Proceeds from exercise of stock options                                    --             183         2,412
  Principal repayments received on stockholders notes                        --            --             844
                                                                        ---------     ---------     ---------
        Net cash provided by (used in) financing activities                (5,654)        9,701        82,455
                                                                        ---------     ---------     ---------

Adjustment for foreign currency translation                                  --              (2)            2
                                                                        ---------     ---------     ---------

Net decrease in cash and cash equivalents                                  (2,855)      (27,758)      (55,007)
Cash and cash equivalents, beginning of period                             18,892        46,650       101,657
                                                                        ---------     ---------     ---------

Cash and cash equivalents, end of period                                $  16,037     $  18,892     $  46,650
                                                                        =========     =========     =========
</TABLE>


                                      F-6
<PAGE>


<TABLE>
<S>                                                                      <C>         <C>          <C>
Supplemental disclosure of cash flow information:
   Cash paid for interest                                                $  2,788    $  2,648     $  1,592
                                                                         ========    ========     ========
Non-cash investing and financing activities:
  Property and equipment acquired under capital
    lease obligations                                                    $    222    $  2,395     $   --
  Increase in additional paid-in capital for stock
    options granted                                                      $     84    $  1,051     $  2,405
Common stock granted for wholesale services contract                     $  2,330
  Net increase in unearned stock
  compensation for stock options granted                                 $    122    $    133     $  2,232
  Accrued dividends and accretion on preferred stock                     $ 15,589    $ 15,059     $  3,644
  Notes receivable issued for common stock                               $   --      $    820     $   --
  Forgiveness of note receivable issued for common stock                 $   --      $    (70)    $   --
  Common stock issued for purchase of assets                             $   --      $    155     $   --
  Treasury stock received upon cancellation of
    note receivable for common stock                                     $   --      $    (70)    $   --
  Conversion of preferred stock to common stock                          $    680    $   --       $   --
  Beneficial conversion associated with preferred
    stock issuance                                                       $    186    $  9,356     $ 20,027
  Warrants extinguished with satisfaction of debt                        $   --      $   --       $    655
  Warrants issued in litigation settlement                               $   --      $   --       $    611
  Acquisition of Touch 1
  Assets acquired, net of cash received                                  $   --      $   --       $ 85,967
    Liabilities assumed                                                  $   --      $   --       $ 37,979
    Cash acquired                                                        $   --      $   --       $  1,168
    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>



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

1.       NATURE OF BUSINESS

DESCRIPTION OF BUSINESS

Z-Tel Technologies, Inc. and subsidiaries ("we" or "us") 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.

We are an emerging provider of advanced, integrated telecommunications services
targeted to residential and small business subscribers. We offer local and long
distance telephone services in combination with enhanced communication features
accessible through the telephone, the Internet and certain personal digital
assistants. We offer our Z-LineHOME and Z-LineBUSINESS services in forty-six
states. Our customer's are primarily in ten states. We also provide
long-distance telecommunications services to customers nationally.

We introduced our wholesale services during the first quarter of 2002. This
service provides other companies with the opportunity to provide local,
long-distance and enhanced telephone service to residential and small business
customers by utilizing our telephone exchange services, enhanced services
platform, infrastructure and back-office operations.

LIQUIDITY AND CAPITAL RESOURCES

We have incurred significant losses since our inception, resulting in an
accumulated deficit at December 31, 2002 of approximately $302.8 million. We
also had debt outstanding of approximately $10.1 million. We experienced
positive cash flows from operations for the first time during 2002. Prior to
2002, we have historically been dependent on financing from investors to sustain
our operating activities.

At December 31, 2002, we had cash on hand of approximately $16.0 million. In
addition, we have an accounts receivable factoring agreement which provides us
with up to $25 million dollars to fund operations. This factoring agreement was
renewed in July 2002 for an additional two years under substantially similar
terms. Currently, we anticipate generating, through normal operations, the cash
flows necessary to meet our operating, investing and financing requirements. If
actual results differ materially from our current plan, management believes we
have the ability to continue as a going-concern through the implementation of
cash management strategies, the reduction of certain discretionary capital and
marketing costs or the implementation of a workforce reduction. We also may seek
additional financing to replace our current factoring agreement. There can be no
assurance, however, that we will be able to implement our strategies or obtain
additional financing under favorable terms.

2.       SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

PRINCIPLES OF CONSOLIDATION

The consolidated financial statements include all our accounts and our wholly-
owned subsidiaries. All intercompany accounts and transactions have been
eliminated.

CASH AND CASH EQUIVALENTS

We consider all highly liquid investments with original maturity dates of three
months or less to be cash equivalents.

PREPAID EXPENSES AND OTHER CURRENT ASSETS

Prepaid expenses and other current assets consist primarily of prepaid
maintenance and support contracts, advances to suppliers and certain disputes
with vendors that require payment and the filing of a dispute claim.


                                      F-8
<PAGE>


PROPERTY AND EQUIPMENT, NET

Property and equipment are recorded at historical cost. Depreciation and
amortization are calculated on a straight-line basis over the assets' useful
life. 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 accounts and any
gain or loss is recognized in operations. Under the Statement of Position
("SOP") 98-1, "Accounting for the Cost of Computer Software Developed or
Obtained for Internal Use," we expense computer software costs related to
internal software that is incurred in the preliminary project stage. When the
capitalization criteria of SOP 98-1 have been met, costs of developing or
obtaining internal-use computer software are capitalized. We capitalized
approximately $3.7, $3.9 and $3.1 million of employee salary costs for
internally developed software for the years ended December 31, 2002, 2001 and
2000, respectively. Internal use software is included as a component of property
and equipment on the consolidated balance sheet. We also incur research and
development costs, such as employee salaries and outside consultants, that are
expensed in our general and administrative expense. We expensed approximately
$13.2, $8.9 and $8.3 million of research and development costs for the years
ended December 31, 2002, 2001 and 2000, respectively.

LONG-LIVED ASSETS

We review 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 expected
undiscounted cash flows 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. We recognized an impairment of $59.2 million related to goodwill acquired
from the acquisition of Touch 1 as a result of the sale of our telemarketing
centers in 2001.

We adopted Statement of Financial Accounting Standards ("SFAS") No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets" on a
prospective basis on January 1, 2002. This statement supercedes SFAS No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of." However, SFAS 144 retains the fundamental provisions of SFAS
No. 121 for the recognition and measurement of the impairment of long-lived
assets to be held and used and the measurement of long-lived assets to be
disposed of by sale. Impairment of Goodwill is not included in the scope of SFAS
No. 144 and will be treated in accordance with the accounting standards
established in SFAS No. 142, Goodwill and Other Intangible Assets." According to
SFAS No. 144, long-lived assets are to be measured at the lower of carrying
amount or fair value less cost to sell, whether reported in continuing or
discontinued operations. The statement applies to all long-lived assets,
including discontinued operations, and replaces the provisions of APB Opinion
No. 30, "Reporting the Results of Operations -- Reporting the Effects of
Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently
Occurring Events and Transactions," for the disposal of segments of a business.

INTANGIBLE ASSETS, NET

We adopted SFAS No. 141 "Business Combinations" and SFAS No. 142, "Goodwill and
Other Intangible Assets," as of January 1, 2002. SFAS 141 addresses the initial
recognition and measurement of goodwill and other intangible assets acquired in
a business combination. SFAS No. 142 addresses the initial recognition and
measurement of intangible assets acquired outside of a business combination,
whether acquired individually or with a group of other assets, and the
accounting and reporting for goodwill and other intangible assets subsequent to
their acquisition. These standards require all future business combinations to
be accounted for using the purchase method of accounting. Certain intangible
assets will no longer be amortized ratably but instead will be subject to
impairment tests at least annually.

Intangible assets on the consolidated balance sheet consist of customer lists
resulting from our acquisition of Touch 1 in 2000 (see Footnote 3 -- Acquisition
of Touch 1). The customer lists are amortized over five years using the
straight-line method and reviewed for impairment as outlined in our long-lived
assets policy above. All goodwill was written-down to a zero value in 2001.

INVESTMENTS

In accordance with 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. We 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. We had no
investments or sales of investments for the years ended December 31, 2002 and
2001.


                                      F-9


<PAGE>

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. Charges for our bundled
services are billed monthly in advance and we recognize revenues for this
service ratably over the service period. Revenues from installations and
activation activities are deferred and recognized over the average life of a
customer.

We began offering wholesale services during 2002. This service offering includes
fees for services provided according to certain per line, per minute, and other
certain activities as defined in our agreements and also the payments of
providing telephone exchange, vendor and personnel expenses. We perform a review
of each contract and determine the appropriate timing of revenues recognition
depending on the facts and circumstances of each individual item within the
contract. We are currently deferring certain revenues over the life of our
arrangements, rather than recognizing revenues up-front. We use the gross method
to record our revenues for wholesale services. This method involves the
recording of revenues for items that we are directly reimbursed by our wholesale
customer with an offsetting expense reported in the appropriate operating
expense line.

STOCK-BASED COMPENSATION

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

Had compensation cost for the our stock options granted been determined based on
the fair value at the date of grant, consistent with the provisions of SFAS No.
123, our net loss and loss per share of common stock for the years ended
December 31, 2002, 2001 and 2000, respectively, would have been increased to the
pro forma amounts shown below.

<TABLE>
<CAPTION>
                                                YEAR ENDED
                                                DECEMBER 31,
                               -------------------------------------------
                                   2002            2001            2000
                               ------------     -----------      ---------
<S>                            <C>              <C>               <C>
NET LOSS
   As presented                $    (19,555)    $  (146,068)     $  (88,037)
   As adjusted                      (32,530)       (158,929)        (99,174)
BASIC AND DILUTED NET
LOSS PER COMMON SHARE
   As presented                $     (1.01)     $     (5.03)     $   (3.38)
   As adjusted                       (1.38)           (5.41)         (3.72)
</TABLE>

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.

These adjusted amounts were determined using the Black-Scholes valuation model
with the following key assumptions: (a) a discount rate of approximately 3.1%,
4.7% and 6.5%, for each of the years ended December 31, 2002, 2001, 2000, (b) a
volatility factor of approximately 93%, 87% and 123% for each of the years
ending December 31, 2002, 2001 and 2000, 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.

ADVERTISING

Advertising costs are expensed as incurred. Included in sales and marketing
expenses are advertising costs of approximately $5.2, $8.8 and $21.8 million for
the years ended December 31, 2002, 2001 and 2000, respectively.

INCOME TAXES

We utilize 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 financially reported amounts at each year-end based on enacted laws
and statutory rates applicable to the periods in which differences are expected
to

                                      F-10
<PAGE>

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.

FOREIGN CURRENCY TRANSLATION

We sold our only foreign subsidiary during 2001.

The assets and liabilities of our 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 income but is included in accumulated
other comprehensive income, which is reflected as a separate component of
shareholder's equity. Foreign currency transaction 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 us to concentrations of credit
risk consist principally of cash and cash equivalents and accounts receivable.
We place our cash and cash equivalents in financial institutions considered by
management to be high quality. We maintain cash balances at financial
institutions in excess of the $100,000 insured by the Federal Deposit Insurance
Corporation ("FDIC"). We had approximately $2.7 and $8.1 million invested in
interest bearing money market and short-term fixed income investments that are
not insured by the FDIC at December 31, 2002 and 2001, respectively. We have not
experienced any losses in these accounts and believe we are not exposed to any
significant credit risk on cash balances.

During the normal course of business, we extend credit to residential customers
residing in the United States. We are concentrated in New York with
approximately 46% of our business from that state and an additional 13% from
both Illinois and Michigan. The rest of our business is primarily concentrated
in seven other states. This results in a concentration of credit to residential
customers in these states. We believe our credit policies, collection procedures
and allowance for doubtful accounts minimize the exposure to significant credit
risk of accounts receivable balances.

We rely 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 and Williams
Communications Group, Inc. (now WillTel Communications, Group, Inc.) are the
primary suppliers for our long-distance calling. We have not incurred any
material impact to our operations or financial statements as a result of the
Chapter 11 bankruptcy filings made by these companies.

We rely upon two separate service providers for provisioning and billing
services essential to support our operations.

SEGMENT REPORTING

SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information," requires that we report financial and descriptive information
about reportable segments, and how these segments were determined. We determine
the allocation and performance of resources based on total operations. Based on
these factors, management has determined that we operate as two segments as
defined by SFAS No. 131 during 2002, and one segment for all other periods
presented. Our segments are consumer services and wholesale services.

FINANCIAL INSTRUMENTS

The recorded amounts of cash and cash equivalents approximate fair value due to
the short-term nature of these instruments. We have determined that due to the
interest rates and short-term nature of the capital lease obligation, the fair
value approximates the value recorded. We have 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
we believe the debt is properly recorded at fair value.

MANAGEMENT'S USE OF ESTIMATES

The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America 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.

                                      F-11
<PAGE>

NEW ACCOUNTING PRONOUNCEMENTS

In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement
Obligations." This statement provides accounting and reporting standards for
recognizing obligations related to asset retirement costs associated with the
retirement of tangible long-lived assets. Under this statement, legal
obligations associated with the retirement of long-lived assets are to be
recognized at their fair value in the period in which they are incurred if a
reasonable estimate of fair value can be made. The fair value of the asset
retirement costs is capitalized as part of the carrying amount of the long-lived
asset and subsequently allocated to expense using a systematic and rational
method over the assets' useful life. Any subsequent changes to the fair value of
the liability due to passage of time or changes in the amount or timing of
estimated cash flows is recognized as an accretion expense. We adopted this
statement January 1, 2003. This statement should have no material impact on our
results of operations, financial position and cash flows.

In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements Nos.
4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections."
Among other things, this statement rescinds SFAS No. 4, "Reporting Gains and
Losses from Extinguishment of Debt", which required all gains and losses from
extinguishment of debt to be aggregated and, if material, classified as an
extraordinary item, net of the related income tax effect. As a result, the
criteria in Accounting Principles Board Opinion ("APB") No. 30, "Reporting the
Results of Operations - Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions," which requires gains and losses on extinguishments of debt to be
classified as income or loss from continuing operations, will now be applied. We
will apply the provisions of SFAS No. 145 prospectively to all debt
extinguishments beginning in 2003.

In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities", which addresses financial accounting and
reporting for costs associated with exit or disposal activities and nullifies
Emerging Issues Task Force ("EITF") No. 94-3, "Liability Recognition for Certain
Employee Termination Benefits and Other Costs to Exit an Activity (including
Certain Costs Incurred in a Restructuring)". The principal difference between
SFAS No. 146 and EITF No. 94-3 relates to SFAS No. 146's requirements for
recognition of a liability for a cost associated with an exit or disposal
activity. SFAS No. 146 requires that a liability for a cost associated with an
exit or disposal activity be recognized when the liability is incurred. Under
EITF No. 94-3, a liability for an exit cost as generally defined in EITF No.
94-3 was recognized at the date of an entity's commitment to an exit plan. We
will apply the provision of SFAS No. 146, prospectively to all exit, disposal,
termination or restructuring charges beginning in 2003.

In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure, an Amendment of SFAS No. 123,
Accounting for Stock-Based Compensation." SFAS No. 148, which is effective for
years ending after December 15, 2002, provides alternative methods for a
voluntary change to the fair value based method of accounting for stock-based
employee compensation and requires prominent disclosure about the method of
accounting for stock-based employee compensation and the effect of the method
used on reported results. We will continue to account for our stock based
compensation according to the provisions of APB Opinion No. 25.

RECLASSIFICATION

Certain amounts in the December 31, 2001 and 2000 financial statements have been
reclassified to conform to the December 31, 2002 presentation.

3.       WHOLESALE SERVICES

On March 20, 2002, we entered into a 48-month agreement with MCI for wholesale
telephone exchange services, ancillary services and a limited-term technology
license. The agreement was cancelable by either party after eighteen months.
This agreement was significantly amended on November 1, 2002.

Under the original terms of the agreement, MCI was to pay us a maximum of $50
million related to the use of our network in the form of a technology license
fee, should the agreement not be terminated early. Cash flows related to the
license were to be paid based on the number of MCI customers on our network, as
defined in the contract, and were subject to monthly minimum amounts. In
addition, MCI was to pay for services provided through usage-based fees
according to certain per line and per minute calculations defined in the
agreement and MCI was to also pay fees to us for providing telephone exchange
services, payroll costs and certain vendor fees. We are the primary obligor for
all costs incurred under this agreement.

We recognized the $50 million license fee, and amounts received in advance of
the contract, on a straight-line basis over the four-year contract period
beginning in April 2002. In connection with the agreement, we issued MCI one
million shares of our common stock at



                                      F-12
<PAGE>

a price of $2.33, the market price of our stock at the date of the agreement. As
a result of this transaction an asset totaling $2.3 million is being amortized
on a straight-line basis as a reduction to revenues over the 48-month term of
the agreement with the remaining balance recorded in other non-current assets.
Monthly usage-based charges and cost reimbursements were recognized when earned.

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

As of December 31, 2002, we have recorded approximately $30.2 million in
revenues under the contract with MCI. Included in our consolidated balance sheet
as of December 31, 2002, are approximately $3.6 and $6.3 million of long-term
and short-term deferred revenues, respectively. These amounts represent advance
billings under the contract. We expensed the costs related to our wholesale
business as incurred, with the exception of certain internal-use software
development costs that qualified for capitalization. We incurred approximately
$1.0 million of start-up costs for our wholesale services, which are shown as
wholesale development costs in the Statement of Operations, and capitalized
approximately $2.0 million in software development costs relating directly to
our wholesale services efforts.

4.  ACQUISITION OF TOUCH 1

We 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 our 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 consolidated financial statements. The acquisition of Touch 1
resulted in approximately $67.8 million of intangible assets. The intangible
assets were comprised of approximately $9.2 million for customer lists and
approximately $58.6 million for goodwill, which were being amortized, on the
straight line basis, over periods of five and twenty years, respectively. As
disclosed in Footnote 8 -- Asset Impairment, during 2001, we recorded an
impairment of assets acquired of approximately $59.2 million, including
approximately $54.9 million related to goodwill associated with the Touch 1
purchase. We recorded $1.8, $3.3 and $3.6 million of amortization of the
intangible assets for the years ended December 31, 2002, 2001 and 2000,
respectively.

Touch 1 and its wholly owned subsidiary, direcTEL Inc. ("direcTEL"), filed a
voluntary petition for relief under Chapter 11 of the Bankruptcy Code on June
29, 1998 and July 9, 1998, 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.

5.  ACCOUNTS RECEIVABLE AGREEMENT

In July 2000, we entered into an accounts receivable agreement with RFC Capital
Corporation, a division of Textron, Inc. ("RFC"), providing for the sale of
certain of our accounts receivable to RFC. RFC has agreed to purchase up to
$25.0 million of certain of our accounts receivable. In July 2002, we extended
our agreement with RFC under substantially similar terms for an additional two
years. The purchase of the receivables is at the option of RFC and they utilize
selection criteria to determine which receivables will be purchased. We
currently sell receivables to RFC at a 23% discount; this rate is negotiable and
may change according to collection experience. Prior to March 2002 we sold our
receivables at a 32% discount. Our collection percentage for receivables sold to
RFC was 92.9% and 89.7% for the years ended December 31, 2002 and 2001,
respectively. We receive an additional payment from RFC for servicing the assets
in an amount equal to every dollar collected over the advance rate, less certain
fees. The accounts receivable agreement does not have a minimum receivable sales
requirement.

We sold approximately $135.2 and $156.3 million of receivables to RFC, for net
proceeds of approximately $107.3 and $106.5 million, during the years ended
December 31, 2002 and 2001, respectively. A net receivable servicing asset of
approximately $8.5 and $12.9 million is included in the accounts receivable
balance at December 31, 2002 and 2001, respectively. We recorded costs related
to the agreement of approximately $1.3 and $1.1 million for the years ended
December 31, 2002 and 2001. Included in accounts


                                      F-13
<PAGE>

payable and accrued liabilities are advances for unbilled receivables in the
amount of $3.4 and $3.5 million at December 31, 2002 and 2001, respectively. We
are responsible for the continued servicing of the receivables sold.

6.  ACCOUNTS RECEIVABLE WRITE-OFF

During the second quarter of 2001, management performed a detailed analysis of
accounts receivable and also reviewed its credit policies relating specifically
to acceptance and provisioning of service to new customers. As a result of the
analysis and subsequent change in credit policy, we switched our focus from
collection efforts on overdue and delinquent account balances to a stringent
credit policy surrounding customer acceptance and a collection effort focused on
fewer delinquent accounts. The detailed analysis and change in credit policy
lead to a write-off of delinquent receivables and revisions to the estimates
used to develop the allowance for doubtful accounts in the current and future
periods.

As a result of the receivables write-off, an additional approximately $29.9
million of bad debt expense was recorded in the second quarter of 2001 and is
included in general and administrative expense for the year ended December 31,
2001. We had write-offs of accounts receivables totaling approximately $31.6,
$43.9 and $21.2 million for the years ended December 31, 2002, 2001 and 2000,
respectively.

7.  PROPERTY AND EQUIPMENT

At the respective dates, property and equipment consist of the following:

<TABLE>
<CAPTION>
                                          DEPRECIABLE
                                             LIVES             2002      2001
                                          -----------       ---------  ---------
<S>                                       <C>               <C>        <C>
Switching equipment                           5-10          $  14,170  $ 14,589
Computer equipment                            5-10             32,092    28,263
Software                                         3             46,753    35,462
Furniture and office equipment                5-10              9,034     9,537
Leasehold improvements                        3-15              6,244     6,611
Land and building                            20-30              4,439     4,192
Construction-in-progress                                           --       792
                                                            ---------  --------
                                                              112,732    99,446
Less accumulated depreciation
and amortization                                               64,412    43,215
                                                            ---------  --------
Property and equipment, net                                 $  48,320  $ 56,231
                                                            =========  ========
</TABLE>


Depreciation expense related to property and equipment amounted to approximately
$10.5, $11.5, and $8.2 million for the years ended December 31, 2002, 2001 and
2000, respectively. Amortization expense related to software amounted to
approximately $11.3, $8.5, and $5.4 million for the years ended December 31,
2002, 2001 and 2000, respectively.

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

<TABLE>
<CAPTION>

                                                      2002     2001
<S>                                                 <C>       <C>
                                                    --------  -------
Computer equipment                                  $  1,288 $  1,288
Software                                                 824      704
                                                    -------- --------
                                                       2,112    1,992
Less accumulated depreciation and amortization           788      312
                                                    -------- --------
Capital leases, net                                 $  1,324 $  1,680
                                                    ======== ========
</TABLE>


8.  ASSET IMPAIRMENT

In the second quarter of 2001 management decided to reduce telemarketing
efforts, resulting in a majority of the operations and assets of telemarketing
centers acquired from Touch 1 being voluntarily closed or sold. On June 30,
2001, the telemarketing centers sold accounted for approximately $1.0 million in
property, plant and equipment. For these assets, we received 270,000 shares of
preferred


                                      F-14
<PAGE>

stock of the privately held acquiring company and a note receivable of
approximately $0.5 million. The loss recorded from this transaction was
approximately $1.0 million.

As a result of the decision to reduce telemarketing efforts noted above and the
subsequent transactions, management performed an assessment of the value of the
intangible assets recorded in the Touch 1 acquisition. In the second quarter of
2001, it was determined that undiscounted future cash flows over the remaining
amortization period of certain intangible assets indicated that the value
assigned to the intangible asset might not be recoverable. Therefore, we
undertook an effort to determine the amount of expense to be recorded relating
to the impairment.

The carrying value of the goodwill and identifiable intangibles recorded on the
books approximated $61.7 million prior to the impairment analysis. We calculated
the fair value of the intangibles by performing a discounted cash flow analysis
related to the remaining assets acquired in the Touch 1 purchase. When we
determined we would effectively cease any telemarketing efforts in the future,
the sole remaining assets from the Touch 1 purchase were certain amounts of
property, plant and equipment and intangibles (consisting of customer lists and
goodwill) acquired in the Touch 1 transaction. Assuming a monthly attrition rate
of 4.5% and a discount rate of 17.5% over an 18 month period, it was determined
that the remaining operations acquired from Touch 1 had a liquidation value
which approximated the carrying value of the customer lists acquired from Touch
1. At June 30, 2001, the carrying value of the identifiable intangibles
associated with the customer lists was approximately $6.8 million. Therefore,
during the second quarter of 2001, we recorded a loss of $54.9 million, the
difference between the carrying value of all intangibles and the carrying value
of the customer lists.

For the year ended December 31, 2001, we recorded an additional $4.3 million of
impaired asset charges, composed of $3.0 million relating to unrealizable
software and development projects, $0.9 million of telemarketing property and
equipment and $0.4 million of securities deemed to be worthless. As of December
31, 2002 and 2001, we had approximately $4.1 and $5.9 million, respectively, of
net intangible assets related to customer lists.

As a result of management's decision in the second quarter of 2002 to enhance
future cash flow and operating earnings, we decided to close the remaining call
centers in North Dakota acquired in our acquisition of Touch 1. In April of
2002, we announced a restructuring plan that included a reduction in force and
the closure of the North Dakota call centers resulting in approximately $1.1
million in property, plant, and equipment being sold in conjunction with the
settlement of the leases in these locations, resulting in an asset impairment
charge totaling approximately $1.1 million being recorded in the second quarter
of 2002.

9.  INTANGIBLE ASSETS

In accordance with SFAS No. 142, we reassessed the expected useful lives of
existing intangible assets. This reassessment resulted in no changes to the
expected useful lives of our customer lists. We only have one intangible asset
as of December 31, 2002 a result of all of our goodwill being written-off during
2001 as discussed in footnote 8 - Impairment of assets.

Summarized below are the major classes of intangible assets as a result of our
acquisition of Touch 1 in April of 2000 that will continue to be amortized under
SFAS No. 142, as we do not have any intangible assets that will not be
amortized:

<TABLE>
<CAPTION>
                                                        DECEMBER 31, 2002                             DECEMBER 31, 2001
                                            ----------------------------------------     -------------------------------------------
                                            CARRYING    ACCUMULATED   NET INTANGIBLE     CARRYING      ACCUMULATED    NET INTANGIBLE
                                             AMOUNT    AMORTIZATION       ASSETS          AMOUNT      AMORTIZATION        ASSETS
<S>                                         <C>        <C>            <C>                 <C>         <C>              <C>
INTANGIBLE ASSETS SUBJECT TO AMORTIZATION:
Customer related intangible assets            $9,145        $5,029         $4,116         $9,145         $3,200          $5,945
</TABLE>

The following table presents current and expected amortization expense of the
existing intangible assets as of December 31, 2002 for each of the following
periods:


                                      F-15
<PAGE>

AGGREGATE
AMORTIZATION
EXPENSE:

<TABLE>

<S>                                                                     <C>
For the year ended December 31, 2002                                    $1,829

Expected amortization expense for the years ending December 31,
         2003                                                            1,829
         2004                                                            1,829
         2005                                                              458
</TABLE>

10.  OTHER ASSETS

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

<TABLE>
<CAPTION>
                                          2002     2001
                                         ------   ------
<S>                                      <C>      <C>
Deposits                                 $3,166   $3,625
Contract signing bonus                    1,885
Certificates of deposit, restricted         573      647
Interest receivable                          57      176
Other                                        67      218
                                         ------   ------
                                         $5,748   $4,666
                                         ======   ======
</TABLE>


The certificates of deposit are pledged as collateral on outstanding letters of
credit in the amount of approximately $0.6 million at December 31, 2002 and
2001, related to lease obligations on two of the our office spaces.

11.  ACCOUNTS PAYABLE AND ACCRUED LIABILITIES

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

<TABLE>
<CAPTION>
                                        2002           2001
                                      --------       -------
<S>                                   <C>            <C>
Trade accounts payable                $ 33,326       $33,602
Accrued sales and use tax payable        6,391         4,128
Advances on accounts receivable          3,425         3,479
Accrued payroll                          2,038         2,070
Accrued rent                             1,423         1,533
Accrued transmission                     1,256         3,644
Other accrued liabilities                3,912         1,166
                                       -------       -------
                                       $51,771       $49,622
                                       =======       =======
</TABLE>

12.  LONG-TERM DEBT

Long-term debt consists of the following:

<Table>
<Caption>
                                                                 2002       2001
                                                               ---------   -------
<S>                                                            <C>         <C>
RELATED PARTIES:
Note payable to Corman Elegre, customer base pledged
 as collateral payable in monthly installments, due
 September, 2004, interest rate at 6%                          $ 5,070     $ 7,595
Note payable to First Revocable Trust of W. F.
 Corman, unsecured payable in monthly installments,
 due September 2004, interest rate at 6%                           315         472

Note payable to James F. Corman, unsecured, payable
 in monthly installments, due September 2004, interest
 rate at 6%                                                        106         159

</TABLE>


                                      F-16
<PAGE>

<TABLE>
<S>                                                            <C>         <C>

UNRELATED PARTIES:
Note payable to Franklin Investment Funds, unsecured,
 payable in monthly installments, due September 2004,
 interest rate of 6%                                             2,183       3,271

Note payable to First National Bank of Atmore,
 unsecured, personally guaranteed by James F. Corman,
 payable in monthly installments, due September 2004,
 interest rate at 6%                                               293         439

Notes payable to pre-petition creditors (trade
 vendors), unsecured, payable in monthly installments,
 due September 2004, interest rate at 6%                           732       1,169

Notes payable to pre-petition creditors (trade
 vendors), priority unsecured, payable in monthly
 Installments, due September 2005, interest rate at 6%             245         304
                                                               -------     -------
                                                                 8,944      13,409
Less: Current portion                                           (5,193)     (4,880)
                                                               -------     -------
Total long-term debt                                           $ 3,751    $  8,529
                                                               =======    ========
</TABLE>

OPERATING LEASES

We have entered into various non-cancelable operating leases for equipment and
office space with monthly payments through the year 2009. Included in general
and administrative expense is rental expense relating to operating leases of
approximately $2.9, $2.8, and $1.7 million for the years ended December 31,
2002, 2001, and 2000, respectively. Sales and marketing expense includes $0.3
and $0.6 and $0.6 million of rental expense relating to operating leases for the
year ended December 31, 2002, 2001 and 2000, respectively.

CAPITAL LEASES

We have entered into various capital lease obligations that have effective
interest rates ranging from 8.0% to 10.7%, with three capital leases remaining
with payments through 2005.

Future minimum lease payments under non-cancelable operating and capital leases
and long-term debt as of December 31, 2002 are as follows:


<Table>
<Caption>
                                                                               CAPITAL
                                                                 OPERATING      LEASE            LONG-TERM
YEAR ENDING DECEMBER 31,                                           LEASES     OBLIGATIONS          DEBT
                           <S>                                 <C>            <C>                <C>
                           2003                                $ 2,856              $  897         $ 5,193
                           2004                                  2,939                 435           3,680
                           2005                                  2,035                  46              71
                           2006                                  1,411
                           2007                                  1,461
                           Thereafter                            2,425                  --
                           Less amount representing
                           estimated executory costs
                           (taxes, etc.), including
                           profit thereon, included
                           in minimum lease payments                --                  74              --
                                                              --------               -----         -------
                           Net minimum payment                $ 13,127               1,304         $ 8,944
                                                              ========                             =======

                           Less amount representing
                           interest on obligations
                           under capital lease                                         104
                                                                                   -------
                           Present value of minimum
                           lease payments (including
                           approximately $770 due
                           within one year)                                        $ 1,200
                                                                                   =======
</TABLE>

                                      F-17
<PAGE>


13.  MANDATORILY REDEEMABLE CONVERTIBLE PREFERRED STOCK

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

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 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 per share. The costs associated with the transaction were
approximately $0.4 million. The Series D Preferred is convertible at an original
conversion price of $12.00, which price is subject to adjustment for such items
as; (i) a dividend or distribution to common shareholders (whether such dividend
or distribution is in stock, securities or other property), (ii) a stock split,
(iii) a stock combination, (iv) a reclassification of the common stock, (v) the
issuance of stock or securities convertible into or exercisable for our common
stock at a price that is less than the adjusted conversion price and other
events that would cause dilution of ownership to the Series D Preferred stock.
As a result of certain of these events the conversion price at December 31, 2002
is $8.63. The Series D Preferred is convertible 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 us to force a conversion of the
stock. Series D Preferred is mandatorily redeemable in 2008, 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 our shares of 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 that have lowered the exercise
price to $10.06 per share, at December 31, 2002.

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

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 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 per share. The purchaser of Series E Preferred
received a warrant to purchase a number of our shares of common stock equal to
one-half of the amount of Series E Preferred purchased by such investor. These
warrants are exercisable at a price of $13.80 per share subject to certain
adjustments that have lowered the exercise price to $7.91 per share, at December
31, 2002. Series E Preferred is convertible at an original conversion price of
$12.00, which price is subject to adjustment for such items as (i) a dividend or
distribution to common shareholders (whether such dividend or distribution is in
stock, securities or other property), (ii) a stock split, (iii) a stock
combination, (iv) a reclassification of the common stock, (v) the issuance of
stock or securities convertible into or exercisable for our common shares at a
price that is less than the adjusted conversion price, and (vi) other events
that would cause dilution in the ownership of the holders of the Series E
Preferred stock. As a result of these events the conversion price at December
31, 2002 is $8.25. The Series E Preferred is convertible 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 us the ability to force a
conversion of the stock. Series E Preferred is mandatorily redeemable 8 years
from the original issue date, has an 8% cumulative dividend payable in-kind and
has certain liquidation preferences and voting rights.

In July 2001, we filed a Certificate of Designation authorizing the issuance of
175 shares of Series G junior convertible preferred stock ("Series G
Preferred"). On July 2 and August 3, 2001, we issued an aggregate of 175 shares
of Series G Preferred for aggregate proceeds of $17.5 million, initially
convertible into 11,739,970 shares of common stock, at a conversion price of
$1.49, subject to adjustment for such items as; (i) a dividend or distribution
to common shareholders (whether such dividend or distribution is in stock,
securities or other property), (ii) a stock split, (iii) a stock combination,
(iv) a reclassification of the common stock, (v) the issuance of stock or
securities convertible into or exercisable for our common stock at a price that
is less than the adjusted conversion price and upon the occurrence of certain
other events that would cause dilution in the ownership of the holders of the
Series G Preferred. To date there has been no change in the conversion price. In
conjunction with the issuance of the Series G Preferred, we issued warrants to
purchase 3,000,000 shares of common stock at an exercise price of $0.01 per
share. Series G Preferred become mandatorily redeemable 5 years from September
18, 2001. The Series G Preferred has a 12% cumulative dividend, is convertible
at the option of the holder and has certain liquidation rights; however, there
are certain circumstances that provide for an automatic conversion of the Series
G Preferred.

                                      F-18
<PAGE>

In accordance with generally accepted accounting principles, we recorded a
deemed dividend of approximately $2.3 million, which results from the value
assigned to the warrants and a beneficial conversion feature associated with the
Series G Preferred transaction. These deemed dividends were originally accreted
over an expected life through December 31, 2001 (the earliest redemption date).
Once shareholder approval was obtained on October 30, 2001, the remaining
balance of $1.2 million will continue to be accreted over the remaining 5-year
redemption period. We recorded approximately $0.2 and $1.6 million of a deemed
dividend related to a beneficial conversion feature in 2002 and 2001,
respectively.

As a result of certain anti-dilution clauses in the Series D Preferred stock
agreement, the issuance of Series G Preferred triggered an additional beneficial
conversion feature related to the Series D Preferred agreement. The deemed
dividend of approximately $7.8 million was accreted immediately, in the third
quarter of 2001.

During the year ended December 31, 2000 we 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, EITF 00-27 required that all beneficial conversions be calculated using
the "accounting conversion price" method. We 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.

In accordance with EITF 98-5, "Accounting for Convertible Securities with
Beneficial Conversion Features or Contingently Adjustable Conversion Ratios,"
APB Opinion No. 14, "Accounting for Convertible Debt and Debt Issued with Stock
Purchase Warrants," EITF 00-27, "Application of Issue No. 98-5 to Certain
Convertible Instruments" and SFAS No. 128 "Earnings Per Share" we recorded
non-cash charges relating to a beneficial conversion, cumulative dividends and
preferred stock accretion. We recorded preferred stock dividends and accretion
of $15.6, $15.1, and $3.6 million for the years ended December 31, 2002, 2001
and 2000, respectively. We also recorded a deemed dividend related to a
beneficial conversion feature in the amounts of approximately $0.2, $9.4, and
$20.0 million for the years ended December 31, 2002, 2001 and 2000,
respectively.

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 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 the Series D, E and G 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 net loss per share calculation.

14.  COMMON STOCK

The board of directors has declared no dividends on common stock since January
15, 1998 (Inception).

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

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 our common stock, par
value $0.01 per share and a corresponding number of rights for each outstanding
share of our Series D and E Preferred Stock outstanding at the close of business
on March 7, 2001. Until the rights become exercisable, additional common stock
or Series D and E Preferred we issued will also have one right attached.

The rights will become exercisable only upon certain triggering events whereby
certain persons or groups of persons 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 our Series F Junior Participating Preferred
Stock, 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 of our securities) having a value
equal to two times the exercise price of the right. Except as otherwise provided
in the plan, we 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.

                                      F-19
<PAGE>


15.      RESTRUCTURING CHARGES

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

The restructuring charge includes termination benefits in connection with the
termination of 167 employees and lease abandonment costs. In addition, we agreed
to a settlement to exit the two leases for our call centers in North Dakota as
of July 1, 2002. All termination benefits and settlements to exist our leases in
North Dakota are paid as of December 31, 2002. We have recorded a lease
abandonment charge representing the future lease payments for our New York
office as a liability and will make payments through August 2005. As of December
31, 2002 we had an accrual of approximately $0.6 million remaining for this
restructuring charge.

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

<Table>
<Caption>
                                     EMPLOYEE            LEASE             LEASE
                                    TERMINATION       SETTLEMENT        ABANDONMENT
                                      BENEFITS          COSTS              COSTS         TOTAL
                                    -----------       ----------        -----------     -------
<S>                                 <C>               <C>               <C>             <C>
Balance at January 1, 2002          $  --              $  --             $  --          $    --
Plan Charges                          913                325               623            1,861
Cash paid                            (913)              (325)              (72)          (1,310)
                                    -----              -----             -----          -------
Balance at December 31, 2002        $  --              $  --             $ 551          $   551
                                    =====              =====             =====          =======
</Table>

16.  INCOME TAXES

We account 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.

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

<TABLE>
<CAPTION>
                                        2002         2001
                                     ----------   ----------
<S>                                  <C>          <C>
Tax at U.S. statutory rate           $   (6,844)  $  (51,145)
State taxes, net of federal benefit        (573)      (2,698)
Goodwill amortization                        --       19,725
Change in valuation allowance             7,255       36,779
Other                                       162       (2,661)
                                     ----------   ----------
                                     $       --   $       --
                                     ==========   ==========
</TABLE>

Significant components of our deferred tax assets are liabilities are as
follows:

<TABLE>
<CAPTION>
                                           2002         2001
                                       ------------ ------------
<S>                                    <C>          <C>
Current deferred tax assets:
  Accounts receivable                  $      6,612 $      6,484
  Other                                          95          127
Noncurrent deferred tax assets:
  Net operating loss carryforward            99,869       98,817
  Deferred revenue                            2,385           --
  Deferred compensation                         616          538
  Excess capital losses                         133           --
  Accrued expenses                              696           --
  Other                                         541          674
                                       ------------ ------------
Gross deferred tax assets                   110,947      106,640

Less: Valuation allowance                  (106,093)    (100,438)
                                       ------------ ------------
                                              4,854        6,202
Noncurrent deferred tax liabilities:
Property and equipment                       (3,290)      (3,943)
Intangible assets                            (1,564)      (2,259)
                                       ------------ ------------
Net deferred tax asset                 $         -- $         --
                                       ============ ============
</TABLE>




                                      F-20
<PAGE>

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, management has
determined that a valuation allowance of approximately $106.1 and $100.4 million
is necessary at December 31, 2002 and 2001, respectively.

At December 31, 2002 and 2001, our net operating loss carryforward for federal
income tax purposes is approximately $262.8 and $260.0 million, respectively,
expiring in various amounts from 2018 through 2022. Utilization of our net
operating loss carryforwards may be subject to annual limitations due to
ownership change rules as provided by the Internal Revenue Code and similar
state provisions.

17.  COMMITMENTS AND CONTINGENCIES

We have disputed billings and access charges from certain inter-exchange
carriers ("IXCs") and incumbent local exchange carriers ("ILECs"). We contend
that the invoicing and billings of access charges are not in accordance with the
interconnection, service level, or tariff agreements between us and certain IXCs
and ILECs. We have not paid a portion of these disputed amounts and management
believes that we will prevail in these disputes. At December 31, 2002, the
disputed amounts not recorded in the financial statements were approximately
$13.3 million.

In August 2000, we entered into an agreement with a service firm to outsource
customer provisioning and other ordering through electronic bonding with the
incumbent local exchange carriers. In September 2002, we renegotiated this
agreement, resulting in a lowering of our monthly minimum payments and an
increase to the fees we pay on a per transaction basis fees incurred over the
minimum payments. Our annual commitment, subject to certain adjustments, is
approximately $9.6 million for both the years ending December 31, 2003 and 2004.
We made payments under the agreement totaling $9.7, $6.3 and $0.5 million for
the years ended December 31, 2002, 2001 and 2000, respectively. The minimum
payments are required by us, regardless of our use of the services provided for
in the contract. This contract provides, under certain circumstances, for early
termination and severance fees for such action.

On July 21, 2002, WorldCom, Inc. ("WorldCom") and certain of its subsidiary
corporations, including MCI, filed voluntary petitions for relief under chapter
11 of the United States Bankruptcy Code. Under the Bankruptcy Code, a vendor
that provides post-petition goods or services to a debtor on a continuous basis
is entitled to payment for those goods and services on a timely basis if the
debtor wants the vendor to continue supplying the goods or services. Neither the
Bankruptcy Code nor the applicable case law requires vendors to provide
post-petition goods and services to a debtor without payment. The Bankruptcy
Code also entitles a debtor to reject "executory" contracts, that is, contracts
where some future act remains to be done, as in the case of our contract with
MCI. Therefore, on November 1, 2002 we significantly amended the terms of our
agreement with MCI as described more fully in the prior footnote 3- Wholesale
Services. Although MCI continues to prepay us in a timely manner since its
bankruptcy filing, we have no assurance that MCI has the resources to continue
to pay its vendors on a timely basis.

Under the New York Public Service Commission's ("Commission") mass migration
guidelines, when a local exchange carrier discontinues service its customers
must have the ability to migrate to another carrier without interruption of
service. Carriers are required to file an exit plan with the Commission at least
90 days in advance of discontinuance of service, or must demonstrate that 90
days' notice was not feasible. Customers must be notified not less than 60 days
prior to discontinuance of service, and a second notice must be provided if the
customer has not taken action to change to a new provider. Other states in which
MCI and we operate are developing similar rules for carriers exiting markets,
generally using the Commission's guidelines as a framework.

For MCI customers provisioned using our company code we are the customer of
record for the regional bell operating companies' wholesale billing. It is very
likely that the state commissions would require us to continue providing
services to MCI's customers for at least the 90-day period contained in the
guidelines described above, regardless of whether MCI continues its relationship
with these customers.

                                      F-21
<PAGE>

In January 2002, we entered into an agreement with a company that provides us
with software to automate the processing, auditing, dispute tracking, management
reporting and various other functions over our ILEC and long-distance network
costs. In addition to the set-up and implementation fees, under this agreement,
we have committed to minimum cash payments of $0.6 million in 2003. In
accordance with the contract we make monthly payments based on a schedule that
correlates to net monthly carrier invoice volume. We made payments under this
agreement totaling $0.8 million for the year ended December 31, 2002.

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

In connection with our wholesale services agreements we have agreed to certain
service level agreements ("SLA"s) for providing service. If we were to not
fulfill the SLAs after the phase-in period there are certain remedies including
but not limited to financial compensation. We have not had any financial
compensation paid as a result of any SLAs since our inception.

18.  RELATED PARTY TRANSACTIONS

During 1998, several members of our management issued full recourse promissory
notes, totaling approximately $3.3 million to us in connection with the purchase
of 2,929,575 shares of common stock. These notes were collateralized by the
shares of common stock acquired with the notes, and we hold those shares as
collateral. The accompanying consolidated financial statements include the
remaining balance of the notes as a decrease in stockholders' equity. There were
three notes outstanding, totaling approximately $0.8 million at December 31,
2002 and 2001. The principal balance of the notes and the related accrued
interest (8% per annum) were originally due December 31, 2001, however in
January of 2002, we extended the notes due dates until December 31, 2002. We
received a payment for approximately $0.5 million (see footnote 24 - Subsequent
Events) and the other notes in the due dates of the amounts of $0.3 and $0.1
million were further extended to being due November 22, 2004 and on demand,
respectively. The note for $0.3 million also had the annual interest rate
reduced to 5%. Interest income on these notes receivable was $0.1 million for
each of the years ended December 31, 2002, 2001 and 2000.

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 a former executive of our
company and is a significant shareholder.

During 2000, we 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 12 - Long-Term Debt, under Related Party.

During 2000, a member of our Board of Directors received approximately $0.2
million and an option to purchase 12,500 shares of common stock at $7.06 from
Breckenridge Securities Corporation ("BSC"), which fee was paid from amounts
paid by us 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, we made $0.1 million in rental payments to Olympus Management
Group, Inc., an entity 100% owned by one of our executives.

In December 2000, we agreed to guarantee three employees' margin loans. Each
employee executed an agreement with us in which each pledges security interest
in all shares of our 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 the creditor who made the margin
loan to these employees draw any amounts on our guarantee, such amounts would be
considered advances under a secured promissory note and would bear interest
until paid. As of December 31, 2001 one of the three employees fulfilled their
obligations leaving approximately $1.1 million of the guarantee. In July and
August 2002, we loaned the employees who we were originally providing a loan
guarantee, approximately $0.1 and $0.9 million, to cover margin balances and
prevent the liquidation of the employees' holdings of our common stock. The
loans were originally demand loans bearing interest at an annual rate equal to
the prime rate plus 2%. In October 2002, we established terms with the employee
owing us $0.3 million to make eight quarterly payments beginning in December
2002, with a balloon payment for the remaining balance due December 2, 2004.
Interest accrues on the unpaid balance at


                                      F-22
<PAGE>

an annual rate of 5%. The employee pledged shares of our stock, owned outright
by the employee, as collateral for the loan. We received principal payments
totaling $0.6 million from these employees during 2002. As of December 31, 2002
there was approximately $0.4 million receivable for these loans.

In January 2001, we accelerated the vesting of 50,000 stock options granted to
an executive as part of his severance agreement. This acceleration resulted in
the employee being fully vested in stock options with a strike price of $3.64
when the stock was trading at $4.50. We recorded approximately $0.1 million in
general and administrative expense as a result of this transaction.

In February 2001, we made a loan to an employee in the amount of $0.1 million.
The interest rate of the note is 9.5% and was payable as a balloon payment on
February 20, 2003. We are taking collection action on this note. This note is
collateralized by any and all stock options, rights to salary and wages, and all
property personal, tangible, and intangible of the employee.

In June 2001, as part of an executive severance agreement, we paid an executive
approximately $0.3 million. This same executive received an interest free loan
of approximately $0.8 million, utilized to exercise stock options to purchase
187,000 shares of common stock. This note is collateralized by the shares of
common stock acquired with the note, and we hold those shares as security. As of
December 31, 2002 and 2001 there was approximately $0.8 million receivable for
this loan. This loan is due on June 12, 2005.

In August 2001, we cancelled approximately $0.7 million of notes receivable and
reacquired 61,875 shares of common stock at $1.14 per share from an employee.
These shares are presented as treasury shares, at cost.

In October 2001, we loaned an employee $0.1 million. The interest rate of the
note is 6.5% and was payable as a balloon payment on June 13, 2002. In September
2002, we extended the due date for this note until March 12, 2003, in accordance
with the severance agreement executed for the employee's termination. The
employee received a forgiveness of six thousand dollars of interest and the
annual interest rate of the note was reduced to 6.0%. This note was for
relocation of the employee. There is no collateral pledged for this note.

In January 2002, we accelerated the vesting of 96,471 stock options granted to
an executive as part of his severance agreement. This acceleration resulted in
the employee being fully vested in stock options with a strike price of $1.30
when the stock was trading at $1.80. The employee forfeited 76,471 of his vested
options in return for the exercise of 20,000 shares of stock. We recorded
approximately $0.1 million in general and administrative expense as a result of
this transaction.

19.  EMPLOYEE BENEFIT PLAN

In 1999, we established a 401(k) plan covering defined employees who meet
established eligibility requirements. Under the original plan provisions, we did
not make matching contributions. Effective September 15, 2000, we 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. Our contribution was approximately $0.5,
$0.5 and $0.2 million for the years ended December 31, 2002, 2001 and 2000,
respectively.

20.  STOCK-BASED COMPENSATION

Effective October 30, 1998, we 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 our 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, we 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 our common
stock. The 2000 Plan automatically increases the number of shares available for
grant on the first day of our 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.

Our plans are 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.

                                      F-23
<PAGE>

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, 2002,
2001 and 2000 is presented below:

<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, DECEMBER 31, 1999    3,338,333      $2.91    3,177,864    $ 5.79           --    $   --     6,516,197     $ 4.31
          Granted                             --        --     1,415,100     27.29    1,897,440     11.52     3,312,540      18.26
          Exercised                     (415,450)      2.47     (435,545)     4.15           --        --      (850,995)      3.33
          Forfeited                      (34,631)      2.67     (530,231)    14.71     (145,800)    12.34      (710,662)     13.64
                                       ---------               ---------              ---------    ------    ----------
     OUTSTANDING, DECEMBER 31, 2000    2,888,252       2.98    3,627,188     13.07    1,751,640     11.45     8,267,080       9.20
          Granted                             --         --           --        --    4,257,450      1.69     4,257,450       1.69
          Exercised                      (47,486)      2.32     (130,253)     3.64           --        --      (177,739)      3.29
          Forfeited                      (97,144)      2.49     (638,227)    12.70     (727,376)     9.84    (1,462,747)     10.60
                                       ---------               ---------              ---------    ------    ----------
     OUTSTANDING, DECEMBER 31, 2001    2,743,622       3.01    2,858,708     13.58    5,281,714      3.81    10,884,044       6.17

          Granted                             --         --           --        --    3,370,475      1.29     3,370,475       1.29
          Exercised                           --         --           --        --      (20,361)     1.30       (20,361)      1.30
          Forfeited                      (17,593)      3.31     (480,845)    19.97   (1,242,132)     3.58    (1,740,570)      8.10
                                       ---------               ---------             ----------    ------    ----------
     OUTSTANDING, DECEMBER 31, 2002    2,726,029      $3.01    2,377,863   $ 12.29    7,389,696    $ 2.70    12,493,588     $ 4.59
                                       =========               =========             ==========              ==========
</TABLE>

We did not grant any options to non-employees during 2002, 2001 and 2000.

The following table summarizes information about stock options outstanding at
December 31, 2002:

<TABLE>
<CAPTION>

                                     REMAINING
                         NUMBER    CONTRACTUAL LIFE    NUMBER
EXERCISE PRICES        OUTSTANDING    (IN YEARS)     EXERCISABLE
---------------        ----------- ----------------  -----------
<S>                    <C>         <C>               <C>
 $0.60 - $4.00           9,660,325      7.96         4,646,728
  5.45 - 10.00           1,129,823      7.15         1,022,289
 12.00 - 19.00           1,378,840      7.36         1,197,918
 23.00 - 47.00             324,600      7.26           291,054
                        ----------                   ---------
                        12,493,588                   7,157,989
                        ==========                   =========
</TABLE>

21.  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.


Net loss per share is calculated as follows:

<TABLE>
<CAPTION>
                                                                                        YEAR ENDED
                                                                                       DECEMBER 31,
                                                                       ----------------------------------------------
                                                                            2002            2001           2000
                                                                       ------------     ------------     ------------
<S>                                                                    <C>              <C>              <C>
BASIC AND DILUTED NET LOSS PER SHARE:
    Loss attributable to common
     stockholders:
      Net loss                                                         $    (19,555)    $   (146,068)    $    (88,037)
      Less mandatorily redeemable convertible preferred stock
        dividends and accretion                                             (15,589)         (15,059)          (3,644)
      Less deemed dividend related to beneficial conversion feature            (186)          (9,356)         (20,027)
                                                                       ------------     ------------     ------------
         Net loss attributable to common stockholders                  $    (35,330)    $   (170,483)    $   (111,708)
                                                                       ============     ============     ============
   Weighted average common shares outstanding                            34,951,720       33,908,374       33,066,538
                                                                       ============     ============     ============
   Basic and diluted net loss per share                                $      (1.01)    $      (5.03)    $      (3.38)
                                                                       ============     ============     ============
</TABLE>

                                      F-24
<PAGE>

For each of the periods presented, basic and diluted net loss per share are the
same. The following table includes potentially dilutive items that were not
included in the computation of diluted net loss per share for all periods
presented because to do so would be anti-dilutive in each case:

<TABLE>
<CAPTION>
                                                                         YEAR ENDED
                                                                        DECEMBER 31,
                                                      ---------------------------------------------
                                                         2002              2001             2000
                                                      ----------        ----------        ---------
<S>                                                   <C>               <C>               <C>
Unexercised stock options                             12,493,588        10,884,044        8,267,080
Unexercised warrants                                  10,443,330        10,425,982        4,602,457
Mandatorily redeemable preferred stock
  convertible into common shares                      27,901,655        25,941,982        9,174,605
                                                      ----------        ----------       ----------
         Total potentially dilutive shares of common
           stock equivalents                          50,838,573        47,252,008       22,044,142
                                                      ==========        ==========       ==========
</TABLE>

22.  LEGAL AND REGULATORY PROCEEDINGS

On June 9, 2000, PTEK Holdings, Inc. and Premiere Communications, Inc.
(collectively, "PTEK") filed a lawsuit against us, Z-Tel Communications, Inc.,
David Gregory Smith, our Chairman, Chief Executive Officer and President, Eduard
Mayer, a former director and James Kitchen, a Senior Vice President (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, we agreed to issue a warrant to PTEK Holdings, Inc. to purchase
175,000 shares of our common stock at an exercise price of $12.00, which price
is subject to certain adjustments. The warrant has expired as it was fully
vested and non-forfeitable but is was only exercisable on November 14, 2002 and
was not exercised. As a result of the issuance of the warrant and the accrual of
legal fees related to the Lawsuit, we recognized an expense of approximately
$1.0 million for the year ended December 31, 2000.

On March 15, 2001, we filed suit against AT&T. In that suit, we alleged that
AT&T had received originating and terminating access service from us and had
unlawfully withheld access charges for such services from us. In July 2001, we
agreed to a settlement with AT&T. In connection with that settlement, which
approximated the amounts recorded by us as receivables, we resolved the issues
relating to charges for access services rendered. We entered into a switched
access agreement setting forth terms and conditions under which AT&T will
purchase access services from us in the future.

During June and July 2001, three separate class action lawsuits were filed
against us, certain of our current and former directors and officers (the
"D&Os") and firms engaged in the underwriting (the "Underwriters") of our
initial public offering of stock (the "IPO"). The lawsuits, along with
approximately 310 other similar lawsuits filed against other issuers arising out
of initial public offering allocations, have been assigned to a Judge in the
United States District Court for the Southern District of New York for pretrial
coordination. The lawsuits against us have been consolidated into a single
action. A consolidated amended complaint was filed on April 20, 2002. A Second
Corrected Amended Complaint (the "Amended Complaint"), which is the operative
complaint, was filed on July 12, 2002.

The Amended Complaint is based on the allegations that our registration
statement on Form S-1, filed with the Securities and Exchange Commission ("SEC")
in connection with the IPO, contained untrue statements of material fact and
omitted to state facts necessary to make the statements made not misleading by
failing to disclose that the underwriters had received additional, excessive and
undisclosed commissions from, and had entered into unlawful tie-in and other
arrangements with, certain customers to whom they allocated shares in the IPO.
The plaintiffs in the Amended Complaint assert claims against us and the D&Os
pursuant to Section 11 of the Securities Act of 1933 and Section 10(b) of the
Securities Exchange Act of 1934 and Rule 10b-5 promulgated by the SEC


                                      F-25
<PAGE>


thereunder. The plaintiffs in the Amended Complaint assert claims against the
D&Os pursuant to Sections 11 and 15 of the Securities Act of 1933 and Sections
10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5
promulgated by the SEC thereunder. The plaintiffs seek an undisclosed amount of
damages, as well as pre-judgment and post-judgment interest, costs and expenses,
including attorneys' fees, experts' fees and other costs and disbursements. On
July 15, 2002, we and the individual defendants moved to dismiss all claims. The
Court has denied our motion. We intend to vigorously defend against this
lawsuit. Furthermore, we believe we are entitled to indemnification from our
Underwriters. We are unable to determine the final outcome of this litigation.

On September 20, 2002 one of our shareholders, Metropolitan Nashville Employee
Benefit Board ("Metro Nashville"), filed suit against us alleging that we
wrongfully and improperly delayed providing them with a stock certificate and
that during the time of such delay our stock price plummeted and they were
unable to sell or take steps to protect the value of their shares. Metro
Nashville seeks compensatory damages in excess of $18 million, plus interest,
and punitive damages of $18 million. We filed a motion to dismiss on October 14,
2002. Our motion was denied. We believe the lawsuit is without merit and intend
to oppose the allegations vigorously. We are unable to determine the final
outcome of this litigation.

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

We recently transferred the listing of our common shares from the Nasdaq
National Market to the Nasdaq SmallCap Market. Among other requirements for our
continued listing on the Nasdaq SmallCap Market we must have a market value of
our listed securities exceeding $35 million and maintain a minimum bid price of
not less than $1.00 per share.

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

23.      SEGMENT REPORTING

We have two reportable operating segments: Consumer Services and Wholesale
Services.

Prior to 2002 we had only one reportable segment our consumer services segment.

The consumer services segment includes our Z-LineHOME and Z-LineBUSINESS
services that offer bundled local and long-distance telephone services in
combination with enhanced communication features accessible through the
telephone, the Internet and certain personal digital assistants. We offer
Z-LineHOME and Z-LineBUSINESS in 46 states. Our customers are concentrated
primarily in metropolitan areas in 10 states for both our Z-LineHOME and
Z-LineBUSINESS services. This segment also includes our Touch 1 residential
long-distance offering that is available nation-wide.

The wholesale services segment allows companies to offer telephone exchange and
enhanced services to residential and small business customers. This service is
currently available in 46 states and MCI is our primary customer for this
offering.

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

                                      F-26
<PAGE>

The following summarizes the financial information concerning our reportable
segments for the years ended December 31, 2002:



<TABLE>
<CAPTION>
                                                                  FOR THE YEARS ENDED
                                    -----------------------------------------------------------------------------
                                                DECEMBER 31, 2002                       DECEMBER 31, 2001
                                    -----------------------------------     -------------------------------------
                                    CONSUMER   WHOLESALE                    CONSUMER   WHOLESALES
                                    SERVICES    SERVICES   CONSOLIDATED     SERVICES    SERVICES     CONSOLIDATED
                                    --------   ---------   ------------     --------   ----------    ------------
<S>                                  <C>        <C>        <C>              <C>        <C>              <C>
Revenues                             203,824    30,774       234,598         275,255      --           275,255
Operating income (loss)              (32,407)    9,811      (22,596)         (59,998)     --           (59,998)
Depreciation and amortization         22,428     1,508        23,936          23,277      --            23,277
Capital expenditures                   6,657     8,536        15,193          15,426      --            15,426
Identifiable assets                   97,914     8,797       106,711         116,737      --           116,737
</TABLE>

The following table reconciles our segment information to the consolidated
financial information for 2002 and 2001:

<Table>
<Caption>
                              2002
-------------------------------------------------------------------
<S>                                                     <C>
Revenues:
Consolidated segment revenues                           $  234,598
    MCI bankruptcy revenue reversal                            657
                                                        ----------
Total consolidated revenues                             $  235,255
                                                        ==========
Operating loss:
Consolidated segment operating loss                     $  (22,596)
    Retroactive reduction to network access rates            8,981
    MCI bankruptcy                                          (1,304)
    Restructuring charge                                    (1,861)
    Asset Impairment                                        (1,129)
    Wholesale development costs                             (1,018)
                                                        ----------
Total consolidated operating loss                       $  (18,927)
                                                        ==========
<Caption>
                              2001
-------------------------------------------------------------------
<S>                                                     <C>
Operating loss:
Consolidated segment operating loss                     $  (59,998)
    Write-off of accounts receivable                       (29,949)
    Asset Impairment                                       (59,994)
                                                        ----------
Total consolidated operating loss                       $ (149,941)
                                                        ==========
</Table>

24.  SUBSEQUENT EVENTS

In February 2003, we received a payment for the full outstanding balance of
approximately $0.5 million from one of our executive officer's that is also a
member of our Board of Directors.

In February 2003, we executed an agreement for the resale of local wireline
telecommunications services and provision of ancillary services with Sprint
Communications Company L.P. ("Sprint"). Under this agreement we will provide
Sprint access to our web-integrated enhanced communications platform and
operational support systems. This contract includes various per minute, per
line, and other charges that we will analyze to determine the appropriate timing
of revenue recognition. As of December 31, 2002 we had recorded approximately
$1.3 million of deferred revenue for payments received prior to the signing of
the agreement. This agreement is success based and non-exclusive in nature.

                                      F-27
<PAGE>

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

SUPPLEMENTAL QUARTERLY FINANCIAL INFORMATION (UNAUDITED)

In the following summary of quarterly financial information, all adjustments
necessary for a fair presentation of each period were included.

<TABLE>
<CAPTION>
                                            QUARTER ENDED
                     -------------------------------------------------------------
                       MARCH 31,     JUNE 30,        SEPTEMBER 30,    DECEMBER 31,
                         2001          2001              2001             2001
                     ------------   ------------     -------------    ------------
<S>                  <C>            <C>              <C>              <C>
Revenues             $     75,044   $     73,142     $     68,569     $     59,142
Operating loss            (19,630)      (107,878)         (12,213)          (9,420)
Net loss (2)(3)           (17,580)      (107,743)         (11,855)          (8,890)
Loss per share (1)   $      (0.60)  $      (3.27)    $      (0.77)    $      (0.40)
Weighted average
shares outstanding     33,790,809      3,880,327       33,982,665       33,977,666
</TABLE>

<TABLE>
<CAPTION>
                                                  QUARTER ENDED
                         ---------------------------------------------------------------
                          MARCH 31,         JUNE 30,       SEPTEMBER 30,    DECEMBER 31,
                             2002            2002              2002             2002
                         ------------     ------------     -------------    ------------
<S>                       <C>             <C>              <C>              <C>
Revenues                 $     57,269     $    62,224        $    58,715      $   57,047
Operating income (loss)       (11,172)          1,355             (5,127)         (3,983)
Net income (loss)             (10,607)            259             (4,962)         (4,245)

Loss per share (1)(4-6)  $      (0.42)    $     (0.11)       $     (0.26)     $    (0.22)
Weighted average
shares outstanding         34,307,194      35,074,936         35,191,836      35,220,240
</TABLE>

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

(2)      We recorded a $59.2 million expense related to impaired assets in
         second quarter 2001.

(3)      We recorded a write-off of accounts receivable that resulted in $29.9
         million of additional bad debt expense in second quarter 2001.

(4)      We recorded start-up costs of approximately $1.0 million for the
         development our new wholesale services offering during the first
         quarter of 2002.

(5)      We recorded approximately $1.9 million for termination benefits, lease
         abandonment and lease settlement costs in connection with the closure
         of two call centers in North Dakota and our New York sales office in
         the second quarter of 2002.

(6)      We recorded approximately $9.0 million as a reduction to network
         operations expense as a result of a retroactive rate reduction for the
         unbundled network elements as result of a settlement by Verizon with
         the New York Public Service Commission during the second quarter of
         2002.

                                      F-28
<PAGE>


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

         Information regarding directors, nominees for director and executive
officers is in our 2003 Annual Meeting proxy statement and is incorporated
herein by reference.

ITEM 11. EXECUTIVE COMPENSATION

         Information regarding executive compensation is included in our 2003
Annual Meeting proxy statement and is incorporated herein by reference.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

         Information required by this item is included in our 2003 Annual
Meeting proxy statement and is incorporated herein by reference.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

         Information required by this item is included in our 2003 Annual
Meeting proxy statement and is incorporated herein by reference.


ITEM 14. CONTROLS AND PROCEDURES


  Evaluation of Controls and Procedures


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

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

  Changes in Controls and Procedures

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

PART IV

ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

(a)      1. The following financial statements of Z-Tel Technologies, Inc. and
         the report thereon of PricewaterhouseCoopers LLP dated March 26, 2003
         are filed as part of this report:

                                      53
<PAGE>

    Report of Independent Certified Public Accountants.

    Consolidated Balance Sheets, December 31, 2002 and December 31, 2001

    Consolidated Statements of Operations for the years ended December 31, 2002,
    2001, 2000.

    Consolidated Statements of Changes in Stockholders' Equity (Deficit) for the
    years ended December 31, 2002, 2001 and 2000.

    Consolidated Statements of Cash Flows for the years ended December 31, 2002,
    2001 and 2000.

    Notes to Financial Statements.

(a)      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
   ---------      -------------------------------------------------------------
         3.1      Amended and Restated Certificate of Incorporation of Z-Tel, as
                  amended(A)*

         3.2      Amended and Restated Bylaws of Z-Tel(B)*

         4.1      Form of Common Stock Certificate(B)*

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

         4.3      Stock Purchase Agreement, dated July 6, 2000, by and between
                  us and the various purchasers of our Series D Convertible
                  Preferred Stock(C)*

         4.4      Certificate of Designations, Preferences and Relative Rights,
                  Qualifications, Limitations and Restrictions relating to
                  our Series D Convertible Preferred Stock(C)*

         4.5      Form of Registration Rights Agreement by and between us
                  and each of the purchasers of our Series D Convertible
                  Preferred Stock(C)*

         4.6      Form of Warrant for the purchase of shares of our common stock
                  by each of the purchasers of our Series D Convertible
                  Preferred Stock(C)*

         4.7      Stock and Warrant Purchase Agreement, dated October 19, 2000,
                  by and among us and The 1818 Fund III, L.P.(D)*

         4.8      Certificate of Designation of 8% Convertible Preferred Stock,
                  Series E, Setting Forth the Powers, Preferences, Rights,
                  Qualifications, Limitations and Restrictions of such
                  preferred shares, as amended(A)*

         4.9      Registration Rights Agreement between and among us and The
                  1818 Fund III, L.P.(D)*

         4.10     Warrant issued to The 1818 Fund III, L.P. for the purchase of
                  shares of our common stock(D)*

                                      54
<PAGE>

         4.11     Certificate of Designation of Series F Junior Participating
                  Preferred Stock(E)*

         4.12     Rights Agreement dated as of February 19, 2001 between us
                  and American Stock Transfer Trust Company, as Rights Agent, as
                  amended July 2, 2001(E)*

         4.13     Stock and Warrant Purchase Agreement, dated as of July 2,
                  2001, by and between us, D. Gregory Smith, and others(F)*

         4.14     Warrant for the Purchase of Shares of Common Stock of Z-Tel,
                  dated as of July 2, 2001(G)*

         4.15     Certificate of Designation for the Series G Preferred
                  Stock(H)*

         4.16     Backup Purchase Agreement, dated as of July 2, 2001, by and
                  among Z-Tel Communications, Inc., a Delaware corporation and
                  our wholly owned subsidiary, Touch 1 Communications, Inc., an
                  Alabama corporation and our wholly owned subsidiary, D.
                  Gregory Smith and others(I)*

         4.17     Additional Investor Registration Rights Agreement, dated as of
                  July 2, 2001, between Z-Tel, D. Gregory Smith and others(J)*

         4.18     Voting Agreement, dated as of June 29, 2001, between us and
                  certain of our stockholders(K)*

         4.19     Employee Stock Restriction Agreement, dated September 1, 1999,
                  by and between us and D. Gregory Smith(L)*

       10.2.1     1998 Equity Participation Plan(B)*

       10.2.2     2000 Equity Participation Plan(M)*

         10.3     Employment Agreement of D. Gregory Smith, dated July 30,
                  2002(N)*

         10.4     Receivables Sales Agreement dated as of July 27, 2000 by and
                  between Z-Tel Communications, Inc., as seller and subservicer,
                  Touch 1 Communications, Inc., as seller and subservicer, and
                  RFC Capital Corporation, as purchaser(O)*

         10.5     Form of Indemnification Agreement for our executive officers
                  and directors(E)*

         10.6     Employment Agreement of Ned Dumas Garrett, dated August 14,
                  2002(N)*

         10.7     Employment Agreement of J. Bryan Bunting, dated August 14,
                  2002(N)*

         10.8     Employment Agreement of Charles W. McDonough, dated August 14,
                  2002(N)*

         10.9     Employment Agreement of Robert A. Curtis, dated July 30,
                  2002(N)*

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

                                      55
<PAGE>

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

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

         10.13    Agreement for Wholesale Telephone Exchange Services, Z-Node
                  Services, Ancillary Services and Technology License, dated
                  March 20, 2002, between Z-Tel Communications, Inc. and MCI
                  WORLDCOM Communications, Inc.(P)*

         21.      List of Subsidiaries

         23.      Consent of PricewaterhouseCoopers LLP

         99.1     Written Statement of the Chief Executive Officer Pursuant to
                  18 U.S.C.ss.1350

         99.2     Written Statement of the Chief Financial Officer Pursuant to
                  18 U.S.C.ss.1350

---------------------------
*

(A)   Incorporated by reference to the correspondingly numbered exhibit to our
      Quarterly Report on Form 10-Q for the quarter ended June 30, 2001, filed
      on August 13, 2001.

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

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

(D)   Incorporated by reference to the correspondingly numbered exhibits to our
      Quarterly Report on Form 10-Q for the quarterly period ended September 30,
      2000, filed on November 14, 2000.

(E)   Incorporated by reference to the correspondingly numbered exhibits to our
      Annual Report on Form 10-K for the annual period ended December 31, 2000,
      filed on March 30, 2001.

(F)   Incorporated by reference to Exhibit 1 to Amendment No. 1 of the Schedule
      13D filed July 12, 2001 with respect to our common stock by, among other
      persons, The 1818 Fund III, L.P.

(G)   Incorporated by reference to Exhibit 2 to Amendment No. 1 of the Schedule
      13D filed July 12, 2001 with respect to our common stock by, among other
      persons, The 1818 Fund III, L.P.

(H)   Incorporated by reference to Exhibit 3 to Amendment No. 1 of the Schedule
      13D filed July 12, 2001 with respect to our common stock by, among other
      persons, The 1818 Fund III, L.P.

(I)   Incorporated by reference to Exhibit 4 to Amendment No. 1 of the Schedule
      13D filed July 12, 2001 with respect to our common stock by, among other
      persons, The 1818 Fund III, L.P.

(J)   Incorporated by reference to Exhibit 5 to the Schedule 13D filed July 24,
      2001 with respect to our common stock by, among other persons, D. Gregory
      Smith.

(K)   Incorporated by reference to Exhibit 5 to Amendment No. 1 of the Schedule
      13D filed July 12, 2001 with respect to our common stock by, among other
      persons, The 1818 Fund III, L.P.

(L)   Incorporated by reference to Exhibit 7 to the Schedule 13D filed July 24,
      2001 with respect to our common stock by, among other persons, D. Gregory
      Smith.

(M)   Incorporated by reference to Appendix B to our Preliminary Proxy Statement
      filed on April 14, 2000, with the following amendment effective May 31,
      2001:

      Section 2.1(a) of the Plan is hereby amended in its entirety to read as
      follows:


                                      56
<PAGE>
     The shares of stock subject to Options, awards of Restricted Stock,
     Performance Awards, Dividend Equivalents, awards of Deferred Stock, Stock
     Payments or Stock Appreciation Rights shall be Common Stock, initially
     shares of the Company's Common Stock, par value $0.01 per share. The
     aggregate number of such shares which may be issued upon exercise of such
     options or rights or upon any such awards under the Plan shall be Four
     Million Five Hundred Thousand (4,500,000) plus an annual increase to be
     added on the first day of the Company's fiscal year beginning in 2001
     equal to the lesser of (i) Three Million (3,000,000) shares of the
     Company's Common Stock, (ii) 6% of the outstanding shares on such date, or
     (iii) a lesser amount determined by the Board. The shares of Common Stock
     issuable upon exercise of such options or rights or upon any such awards
     may be either previously authorized but unissued shares or treasury shares.

(N)  Incorporated by reference to the correspondingly numbered exhibits to our
     Quarterly Report on Form 10-Q for the quarterly period ended September 30,
     2002, filed on November 14, 2002.

(O)  Incorporated by reference to the correspondingly numbered exhibit to our
     Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2000,
     filed on August 14, 2000, with an amendment extending the agreement until
     July 27, 2004.

(P)  Incorporated by reference to the correspondingly numbered exhibit to our
     Quarterly Report on Form 10-Q for the quarterly period ended March 31,
     filed on May 15, 2002



(b)  Reports on Form 8-K

     On October 14, 2002, we filed a Form 8-K to disclose the filing of a
     lawsuit against us by the Metropolitan Government of Nashville. That
     lawsuit is described under Item 3 of this report.


                                       57
<PAGE>
                                   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 31st day
of March, 2003.

                                            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.


           SIGNATURE                         TITLE                      DATE

/s/ D. Gregory Smith                                          March 31, 2003
----------------------------   President, CEO, Chairman
D. Gregory Smith               of the Board and Director
                               (Principal Executive Officer)

/s/ Horace J. Davis III                                       March 31, 2003
----------------------------   Senior Vice President-- Chief
Horace J. Davis III            Financial Officer
                               (Principal Financial and
                               Accounting Officer)

/s/Charles W. McDonough                                       March 31, 2003
----------------------------   Senior Vice President--
Charles W. McDonough           Chief Technology Officer, and
                               Director

/s/ Jeffrey A. Bowden          Director                       March 31, 2003
----------------------------
Jeffrey A. Bowden

/s/ Charles D. Hyman           Director                       March 31, 2003
----------------------------
Charles D. Hyman

/s/ Andrew C. Cowen            Director                       March 31, 2003
----------------------------
Andrew C. Cowen

/s/ John K. Aurrell            Director                       March 31, 2003
----------------------------
John K. Aurrell

/s/ Richard F. LaRoche, Jr.    Director                       March 31, 2003
----------------------------
Richard F. LaRoche, Jr

/s/ Lawrence C. Tucker
----------------------------
Lawrence C. Tucker             Director                       March 31, 2003




                                       58

<PAGE>

                                 CERTIFICATIONS


     I, D. Gregory Smith, certify that-

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

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

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

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

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

         b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing of this annual
report (the "Evaluation Date"); and

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

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

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

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

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




Date:  March 31, 2003


                                                         /s/ D. GREGORY SMITH
                                                         --------------------
                                                         D. Gregory Smith
                                                         Chief Executive Officer




    I, Horace J. Davis, certify that-


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

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

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

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

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

         b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing of this annual
report (the "Evaluation Date"); and

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

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

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

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

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




Date:  March 31, 2003

                                                       /s/HORACE J. DAVIS III
                                                       ----------------------
                                                       Horace J. Davis
                                                       Chief Financial Officer



                                       58