EQUALNET COMMUNICATIONS CORP, 10-K/A, 1999-06-18

EQUALNET COMMUNICATIONS CORP
10-K/A, 1999-06-18
TELEPHONE COMMUNICATIONS (NO RADIOTELEPHONE)

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K/A
(AMENDMENT NO. 1)

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934

FOR THE FISCAL YEAR ENDED JUNE 30, 1998 COMMISSION FILE NUMBER 0-025842

EQUALNET COMMUNICATIONS CORP.

A TEXAS IRS EMPLOYER
CORPORATION No. 76-0457803

1250 WOOD BRANCH PARK DRIVE

HOUSTON, TEXAS 77079

Telephone Number 281/529-4600

SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:

NONE

SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:

Common Stock, $.01 Par Value

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/A or any amendment to
this Form 10-K/A. [_]

Aggregate market value of the voting stock (common stock) held by
non-affiliates of registrant as of June 14, 1999 $2,536,016

Number of shares of registrant's common stock outstanding
as of June 14, 1999 27,651,277
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Item Page
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TABLE OF CONTENTS
PART I
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1. BUSINESS......................................................................... 1
2. PROPERTIES....................................................................... 10
3. LEGAL PROCEEDINGS................................................................ 10
4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.............................. 13

PART II

5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS........ 14
6. SELECTED FINANCIAL DATA.......................................................... 16
7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS....................................................................... 17
7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK....................... 36
8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA...................................... 36
9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE....................................................................... 36

PART III

10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT............................... 36
11. EXECUTIVE COMPENSATION........................................................... 39
12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT................... 41
13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS................................... 43

PART IV

14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K................. 47

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ALL DEFINED TERMS UNDER RULE 4-10(A) OR REGULATION S-X SHALL HAVE THEIR
STATUTORILY PRESCRIBED MEANINGS WHEN USED IN THIS REPORT.
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SPECIAL NOTE REGARDING FORWARD LOOKING STATEMENTS

This Annual Report on Form 10-K/A includes "forward-looking statements"
within the meaning of Section 27A of the Securities Act of 1933, as amended (the
"Securities Act"), and Section 21E of the Securities Exchange Act of 1934, as
amended (the "Exchange Act"). All statements other than statements of
historical facts included in this Annual Report on Form 10-K/A, including
without limitation, statements regarding the Company's (defined below) financial
position, business strategy, budgets and plans and objectives of management for
future operations, are forward-looking statements. Although the Company
believes that the expectations reflected in such forward-looking statements are
reasonable, it can give no assurance that such expectations will prove to be
correct. There are important factors that could cause actual results to differ
materially from the Company's expectations including, without limitation, the
Company's ability to obtain additional financing and the assumptions, risks and
uncertainties set forth below in "Item 7. Management's Discussion and Analysis
of Financial Condition and Results of Operations - Cautionary Statements",
including without limitation, in conjunction with the forward-looking statements
in this Annual Report on Form 10-K/A (collectively "Cautionary Statements").
All subsequent written and oral forward-looking statements attributable to the
Company, or persons acting on its behalf, are expressly qualified in their
entirety by the Cautionary Statements.

PART I

ITEM 1. BUSINESS

GENERAL

Equalnet Communications Corp. (the "Company"), a corporation incorporated
in the state of Texas on January 20, 1995, and previously known as EqualNet
Holding Corp., is a holding company currently comprising five operating
subsidiaries, EqualNet Corporation ("EqualNet"), a long-distance telephone
company that provides services to generally smaller commercial and residential
accounts nationwide, Netco Acquisition Corp., ("Netco") the owner of nine
switches located in major U.S. cities, USC Telecom, Inc. ("USC Telecom") formed
in the first quarter of fiscal 1999 to acquire the assets purchased from SA
Telecommunications, Inc. ("SA Telecom") (see "SA Telecom Acquisition"), ACMI
Acquisition Corp., a multilevel marketing company that primarily sells prepaid
calling cards and 1+ long distance services formed in the second fiscal quarter
of 1999 to acquire certain assets of LIMIT LLC (d/b/a/ ACMI) and Intelesis
Acquisition Corp., which was formed in the third fiscal quarter of 1999 in
connection with the proposed acquisition of The Intelesis Group Inc. The
Company began fiscal 1998 as a switchless reseller of long distance services
through EqualNet. During the third quarter of fiscal 1998 the Company
purchased, through its wholly-owned subsidiary Netco, nine switches and became a
switch-based reseller with leased line facilities (see "Industry Background,
Structure and Competition"). EqualNet principally utilizes AT&T Corp. ("AT&T"),
Sprint Communications Company, L.P. ("Sprint") through its arrangement with The
Furst Group, Inc. ("Furst") a privately-held reseller of long-distance and
telecommunications services, Frontier Communications and MCI WorldCom Inc. ("MCI
WorldCom") to provide transmission of its customers' traffic. Sales related to
services provided utilizing the AT&T and Sprint networks accounted for
approximately 78.15% and 17.44%, respectively, of the Company's revenues for the
year ended June 30, 1998.

EqualNet, one of the Company's subsidiaries, and EqualNet Wholesale
Services, Inc. ("Wholesale") a non-operating wholly-owned subsidiary of
EqualNet, filed voluntary petitions for relief under Chapter 11 ("Chapter 11")
of the United States Bankruptcy Code (the "Bankruptcy Code") on September 10,
1998 (the "Petition Date") in the United States Bankruptcy Court for the
Southern District of Texas (the "Bankruptcy Court"), Houston, Texas. The cases
were conducted in such court as Cases No. 98-39561-H5-11 and 98-39560-H4-11.
Pursuant to Sections 1107 and 1108 of the Bankruptcy Code,

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EqualNet, managed its assets and operated its business as a debtor-in-
possession, pending the confirmation of its reorganization plan, which plan was
confirmed on April 28, 1999 and was consummated on May 28, 1999. At the time of
its bankruptcy filing, EqualNet reported total assets of $20.7 million and total
liabilities of $57.6 million. The largest individual creditor of EqualNet as of
the bankruptcy filing date was the Company, which was owed approximately $33.0
million at the time of EqualNet's bankruptcy filing. On October 2, 1998
Wholesale filed its motion to convert its bankruptcy proceeding from a Chapter
11 reorganization to a Chapter 7 liquidation, which motion was subsequently
granted.

EqualNet markets its services primarily to small business customers with
monthly long-distance bills of less than $500. For the year ended June 30,
1998, the monthly long-distance bill of EqualNet's average customer was
approximately $41. As of June 30, 1998, EqualNet had over 30,000 long-distance
customers. EqualNet is one of the several hundred "tier three" long distance
service providers. See "-Industry Background Structure and Competition."
EqualNet historically has used independent marketing agents and an internal
sales force to sell its services. Revenues derived from EqualNet's customers
introduced to EqualNet by independent marketing agents constituted approximately
85% of EqualNet's total revenue for the year ended June 30, 1998. The
independent marketing agents typically receive residual commissions based on
billed revenue.

The Company's revenues declined from a peak of $78.4 million in fiscal year
1996 to $46.6 million for the fiscal year ended June 30, 1997 and to $24.9
million for the fiscal year ended June 30, 1998. Pre-tax losses for the fiscal
years ended June 30, 1996, 1997 and 1998 were $11.1 million, $12.6 million and
$17.9 million, respectively.

During fiscal year 1998, the Company continued to experience financial and
operational difficulties. During the second half of fiscal 1998 the Company
focused on transitioning from being a switchless reseller to becoming a national
switch-based carrier by purchasing nine telecommunications switches ("Switches")
on March 6, 1998 through its subsidiary, Netco. During the process of
connecting network facilities to the Switches, the Company realized it lacked
adequate capital to support a national switched approach. The Company is
focusing upon a regional reseller approach, utilizing those Switches of Netco
located where the Company has the greatest potential for concentration of
traffic. In its effort to generate additional cash flow from under utilized
assets, the Company is currently investigating the possibility of liquidating
certain Switches or partitioning or leasing Switches to other carriers. The
Company plans to focus on offering bundled services to its customers, mainly
long-distance service, local service, wireless and paging, internet access and
web pages.

In October, 1998, the Company began to disconnect all of its Switches in
order to reduce fixed costs in areas in which the Company has little or no long-
distance traffic and simultaneously allow the Company to reconfigure its
circuits to increase its margins in areas where the Company has concentrations
of traffic. The Company intends to adopt a geographic focus in southern
California and the southwest where a significant portion of its customer base
currently resides. The Company believes that its Switches located in Houston
and Dallas, Texas and Los Angeles, California are well situated to service this
market area. The Company intends to seek to enter into wholesale agreements,
such as partitioning or leasing contracts, to turn its other Switches into
revenue generating assets.

INDUSTRY BACKGROUND, STRUCTURE AND COMPETITION

According to industry data, AT&T, together with MCI WorldCom and Sprint
constitute what generally is regarded as the first tier in the long distance
market. The second tier, generally defined as comprising companies generating
between $2 billion and $500 million in annual long distance revenue, such as
Frontier Corporation ("Frontier"), Cable & Wireless Communications, Inc. and
Qwest

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Communications, are believed to account for less than 5% of the more than $80
billion long-distance market cumulatively. The remaining market share is held by
several hundred smaller companies, known as third-tier carriers. Recent
legislative and regulatory activity is designed to foster a telecommunications
industry that encourages greater competition among providers of long-distance
and local telecommunications services, as well as data and network services.

Many first- and second-tier companies, most notably AT&T, Sprint, MCI
WorldCom and Frontier, have been providing long-distance products for resale for
a number of years to capture incremental traffic volume. In 1991, EqualNet
entered into the first of its agreements with AT&T to resell long distance
service over AT&T's network. In 1994, EqualNet entered into an agreement with
Sprint to resell long distance over Sprint's network. In 1996, EqualNet
replaced its direct contractual relationship with Sprint with its arrangement
with Furst to continue service to EqualNet's customers over Sprint's network.

Besides gross revenue, another significant distinction between long-
distance companies involves whether they maintain their own facilities.
Facilities-based companies own or lease transmission facilities, such as fiber
optic cable or digital microwave equipment. Profitability for facilities-based
carriers is highly dependent upon their ability to manage complex networking and
transmission costs. Substantially all of the first- and second-tier long
distance companies are facilities-based carriers and generally offer service
nationwide. Facilities-based carriers in the third-tier of the market generally
have facilities in a focused geographic area or lease facilities from first- or
second-tier carriers. Profitability for non-facilities based carriers is based
primarily on their ability to generate and retain sufficient revenue volume to
negotiate attractive pricing with one or more facilities-based carriers.
Pricing in such contracts typically is correlated inversely to minimum revenue
or volume commitment levels and term.

EqualNet began fiscal 1998 as a reseller utilizing such contracts to
provide service for its customers' long distance services, and still utilizes
these kinds of contractual arrangements to provide services to its historical
customer base. During fiscal 1998, EqualNet became a leased facilities-based
carrier as a result of its acquisition of Netco and the build out of network
facilities connecting these switch sites. While Netco owns the Switches used
for the routing of long distance traffic, all of the network facilities are
leased from other providers.

Another distinction among long-distance companies is that of switch-based
versus switchless carriers. Switch-based carriers have one or more switches,
computers that direct telecommunications traffic in accordance with programmed
instructions. All of the facilities-based carriers are switch-based carriers,
as are many non-facilities-based companies. Switchless carriers depend on one
or more facilities-based carriers to provide both transmission capacity and
switch facilities. In addition, switchless resellers enjoy the benefit of
offering their service on a nationwide basis, assuming that their underlying
carrier has a nationwide network. An "underlying carrier" is the carrier that
owns and is responsible for the management of the facilities needed to transmit
a customer's long-distance telephone call. Through fiscal 1997, EqualNet was a
switchless reseller. During the third quarter of fiscal 1998, Netco, a wholly-
owned subsidiary of the Company, acquired the Switches and associated network
assets for approximately $13.2 million. EqualNet entered into an agreement with
Netco to provide for operation of the Switches and build out of network
facilities in exchange for the right to carry traffic over the network and as a
result became a switch-based carrier.

The $95 billion local telecommunications industry is dominated by the
regional Bell operating companies ("RBOC"s) and GTE Communications Corporation
("GTE"). The RBOCs and GTE have the authority to provide interLATA (geographic
areas created by the AT&T divestiture known as local access transport areas)
long-distance service outside their service regions. The Telecommunications Act
of 1996 (the "Act") established procedures whereby the RBOCs can apply for
authority to provide interLATA

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long-distance service inside their respective service region. Similarly, certain
of the requirements governing GTE's provision of in-region long-distance service
were removed by the Act. The nature of competition in the telecommunications
industry is expected to change significantly as legislative, regulatory and
judicial activities progress. As barriers are removed for the RBOCs to provide
long distance services inside their geographic areas, and as telecommunications
mergers and consolidations occur, the Company would expect an increase in
competition for long-distance services which could result in the further loss of
market share, more price competition and/or a further decrease in operating
margins. The Company expects additional industry wide downward price pressure as
the RBOCs begin to compete more aggressively in the long distance market.

The Company's ability to compete and grow is subject to changing industry
conditions. Legislation and the resulting regulatory and judicial action have
had a significant impact on the current industry environment. These changes are
expected to continue to alter the nature and degree of competition in both the
local and long-distance segments of the industry and could directly impact the
Company's future growth opportunities.

Competitive factors in the long distance industry affecting the Company's
market share include brand recognition, pricing, customer service, network
quality, value-added services and regulatory and judicial developments. Non-
facilities-based carriers typically receive rates from underlying carriers in
inverse correlation with the amount of traffic that they can commit to the
underlying carrier - the larger the commitment, the lower the cost of service.
Subject to contract restrictions and customer brand loyalty, resellers may
competitively bid their traffic among various national long-distance carriers to
lower their cost of service. Non-facilities-based switchless carriers devote
their resources entirely to marketing, operations and customer service, leaving
the costs of network maintenance and management to the underlying carrier.
Conversely, facilities-based carriers concentrate on maximizing network
efficiency. In order to operate efficiently, facilities based carriers require
concentrations of their customer traffic where they have facilities to attempt
to maximize their network utilization and reduce the effective cost per minute.

The relationship between resellers and the major underlying carriers is
predicated primarily upon the pricing strategies of the first-tier companies,
which has resulted historically in higher rates for the small business customer
when compared to the rates paid by larger commercial customers. Small business
customers typically are not able to make the volume commitments necessary to
negotiate reduced rates under individualized contracts. The higher rates result
from the higher cost of credit, collection, billing and customer service per
revenue dollar associated with small billing level long-distance customers. By
committing to large volumes of traffic, the reseller is guaranteeing traffic to
the underlying carrier. The underlying carrier is also relieved of the
administrative burden of qualifying and servicing large numbers of relatively
small accounts. The successful reseller efficiently markets the long-distance
services, processes orders, verifies credit and provides customer service to
these large numbers of small accounts.

The Company believes that the rapid evolution of the communications
industry presents an opportunity for consolidation of third-tier companies in
general, and resellers and smaller, regionally focused switch based carriers, in
particular. Many of these companies are undercapitalized and may have
difficulty providing their services profitably, especially given that the level
of price competition among carriers has continued to increase. By growing
through consolidation, the Company believes that it can (i) generate increased
margins by securing better pricing from underlying carriers because of increased
volume commitments, (ii) justify the installation of switches in geographic
areas with concentrations of long distance traffic, and (iii) achieve economies
of scale in overhead allocation. Such economies are not certain and cannot be
precisely predicted. However, neither the amount of any increased margins nor
the

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ability to obtain such increased margins, nor the ability to concentrate
customer traffic of the Company, nor the economies of scale in overhead
allocation, are certain and cannot be precisely predicted.

SA TELECOM ACQUISITION

On January 21, 1998, the Company signed an agreement with SA Telecom, a
switch-based, long-distance telecommunications carrier serving customers
primarily in Texas and southern California to acquire certain assets and
customer bases in exchange for a combination of shares of the Company's
convertible preferred stock, cash and assumption of certain liabilities. The
transaction was subject to certain conditions, including approval of the
bankruptcy court supervising the reorganization of SA Telecom under Chapter 11
of the Bankruptcy Code. On March 9, 1998, the Company won approval from the
bankruptcy court for the transaction. The purchase of SA Telecom was approved
by the Company's shareholders on June 30, 1998 and the acquisition closed on
July 22, 1998 for consideration of approximately $3.47 million in cash,
approximately $5.4 million in convertible preferred stock and the assumption of
approximately $4.0 million in debt payable to Greyrock Business Credit. The
Company's newly formed wholly-owned subsidiary, USC Telecom, acquired the assets
of SA Telecom subject to final closing adjustments. Prior to the closing of
this transaction, EqualNet and SA Telecom entered into a management agreement
pursuant to which EqualNet managed the operations of SA Telecom until the
closing of the transaction. EqualNet assumed responsibility for any profits or
losses attributable to SA Telecom's operations between April 1, 1998 and the
closing of the transaction. SA Telecom has provided USC Telecom with notice
that it believes that the Company owes SA Telecom approximately $655,000 for
operating losses during the period the management agreement was in effect. The
determination of operating losses under the management agreement is subject to
interpretation and the Company has disputed the amount of operating losses as
alleged by SA Telecom. Additionally, SA Telecom is disputing certain other
elements of the final purchase price settlement. On December 28, 1998, the
court in which the SA Telecom bankruptcy proceedings are pending entered its
order that an additional amount of $812,772 is due to SA Telecom pursuant to the
terms of this transaction. In addition, Equalnet, EqualNet Corporation and USC
Telecom were ordered to pay $81,808 in vendor expenses incurred in operating the
assets of SA Telecom. A notice of appeal of this ruling has been filed. It is
not possible to estimate the outcome of these proceedings at this time. Any
additional amount paid by the Company, if any, is anticipated to be recorded as
additional purchase consideration. The Company has not included any losses
associated with SA Telecom operations in its Consolidated Statement of
Operations for the fiscal year 1998.

PRODUCTS AND SUPPLIERS

AT&T

EqualNet's principal provider of underlying outbound and inbound long-
distance services during fiscal year 1998 was AT&T. AT&T provided such services
to EqualNet pursuant to a long term contract which was rejected by EqualNet in
its Chapter 11 proceedings on October 31, 1998. Instead of renegotiating a new
contract with AT&T, EqualNet chose to acquire services on a wholesale basis from
another AT&T reseller to continue to provide service to those of its customers
whose long-distance service utilizes AT&T's network as the underlying carrier.
A major factor in EqualNet's decision to reject the AT&T contract was that it
felt that it would most probably continue to experience shortfalls in its MSARC
obligations throughout the remaining terms of the AT&T agreement which would
have expired in April 2000. The Company's Statement of Operations for the years
ended June 30, 1996, 1997 and 1998 do not include provisions for losses
associated with MSARC to AT&T. EqualNet and AT&T subsequently entered into a
stipulation that the total amount of AT&T's claim in the bankruptcy proceeding
was $5.8 million and that its administrative claim was $0.3 million.

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Sprint

EqualNet began purchasing long-distance services effective November 1,
1996, under Furst's contract with Sprint. This long-distance product was
negotiated at a rate less than that of EqualNet's AT&T contract rate and has
been marketed as EqualNet's private brand economy-priced product. During fiscal
year 1998, EqualNet incurred charges to Furst of $0.8 million under this
agreement with Furst. Charges due to Furst are based upon the amount of
EqualNet's customers' usage of services under Furst's contract with Sprint.
Initially, these charges were provided at Furst's cost of these services from
Sprint. Currently, these charges are incurred at a cost equal to 15% above
Furst's cost of these services. This long-distance product is available to
EqualNet's marketing network as an alternative to the AT&T products. EqualNet's
current agreement with Furst does not have a term and may be canceled by either
party at any time. No assurances can be made that EqualNet will continue to be
able to utilize Sprint through its contract with Furst. Termination of the
Furst contract could result in an increase in the cost Sprint charges EqualNet
to provide services. If EqualNet cannot use Furst's contract with Sprint or
negotiate its own agreement with Sprint, EqualNet could transfer these customers
to another carrier. Although EqualNet expects that such a transfer would cause
substantial one-time customer attrition, EqualNet would not expect a termination
of the agreement with Furst to have a material adverse effect on EqualNet's
results of operations.

Other Carriers

MCI WorldCom was one of the primary underlying carriers for SA Telecom.
EqualNet entered into an agreement with MCI WorldCom for the provision of
service in order to provide services over MCI WorldCom's network to new
customers located in an area not accessible by the Company's network. During
fiscal year 1998, approximately 1% of EqualNet's revenue was generated by
customers using MCI Worldcom as their underlying carrier.

In addition, the Company negotiated an agreement in August 1998 with
Frontier for the transport of traffic on its network facilities and switchless
resale traffic requiring a minimum of $250,000 monthly usage requirement after
the contract's initial six month term. The pricing under this contract is
superior to that available under the AT&T and Sprint contracts and can be
utilized for customers who are in areas where use of the Company's switches is
not economically advantageous. None of the Company's revenue during fiscal year
1998 were attributable to customers using Frontier as their underlying carrier.

The Company's diversity of carrier relationships may provide further
flexibility and alternatives for the Company in the event it is not able to
continue to contract with any one of the currently underlying carriers that
provide services for its customers.

CUSTOMER SERVICE AND CUSTOMER MANAGEMENT SYSTEM

The Company's operating subsidiaries' customer service function seeks to
develop long-term customer relationships by providing accurate billing
information and processing customer requests in a timely and efficient manner.
The responsibilities of the operations department include billing,
"provisioning" or processing orders with the underlying carriers, and supporting
independent marketing agents. The operations department receives orders from
independent marketing agents and from the sales department of EqualNet and USC
Telecom and then processes the orders for entry into the appropriate
subsidiary's database. Operations personnel interface with the underlying
carriers and billing companies for processing and procedural matters.

During the third quarter of fiscal year 1998, the Company abandoned the
improvements to the "NetBase" system in favor of "AMS", a customer management
and information system with billing

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capabilities, purchased from an independent telecom oriented software vendor,
Platinum Communications. The Company experienced difficulties converting from
the NetBase system to AMS. Unlike NetBase (the system used for most of fiscal
year 1998 prior to conversion), AMS purportedly had capabilities required for
switch-based data gathering, rating and billing. The conversion coincided with
the management of a new customer base (SA Telecom) and a migration to a switch
based environment, considerable billing errors and delays occurred.
Additionally, there were intricacies about AMS that placed the Company in
substantial reliance upon the vendor of this software. This reliance upon an
outside source for billing system troubleshooting has slowed the conversion
process. As of September 25, 1998, EqualNet began its conversion to CostGuard
ENTERPRISE ("CostGuard"), a more powerful cost rating, billing and customer care
system built on a Microsoft SQL Server database platform. This system is being
purchased from Info Directions, Inc., "IDI" and is expected to dramatically
improve rating speed and billing accuracy. Also, EqualNet expects to be able to
more readily extract meaningful data and management reports from CostGuard. The
CostGuard system design is flexible enough to respond to rapid changes in the
telecommunications marketplace. In fiscal year 1998, EqualNet recorded write
offs of $270,000 for NetBase and estimated the useful life of AMS to be
approximately one year until the CostGuard system can be implemented. The new
CostGuard system will cost $272,000 initially, and $68,000 per year thereafter
for ongoing support and software upgrades.

CUSTOMERS AND MARKETING

Customers

EqualNet markets its long-distance services primarily to small business
customers with monthly long-distance bills of less than $500. For the year
ended June 30, 1998, the monthly long-distance phone bill for an average
EqualNet customer was approximately $41. EqualNet does not have long term
contracts with its customers, but receives authorization from new customers in
connection with their order for service. In July, 1998, USC Telecom acquired
certain customers from SA Telecommunications. In January, 1999, USC Telecom and
EqualNet acquired certain customers formerly serviced by Brittan Communications
International Corporation ("BCI") at a foreclosure sale conducted by one of
BCI's secured creditors.

The SA Telecom customers are primarily located in southern California and
Texas. The BCI customers are more geographically diversified. The new USC
Telecom customers are comprised mainly of smaller commercial users, similar to
the customer base of EqualNet, but also include some larger, dedicated service
customers whose average monthly usage is larger than the average EqualNet
customer's usage. The average usage for the USC Telecom customers located
primarily in California historically has been $178 per month and the average
usage for the USC Telecom customers located primarily in Texas historically has
been $73 per month.

Marketing

Historically, EqualNet has relied on independent marketing agents to market
its long-distance products. In the bankruptcy proceedings, EqualNet rejected
the marketing contracts for virtually all of its authorized agents and sales
agents. Consequently, many of these agents may no longer be willing to continue
to market for EqualNet under new contractual arrangements. None of these former
agents have executed new agreements with EqualNet to continue as independent
marketing agents. Independent marketing agents sell EqualNet long-distance
products directly to business customers as authorized agents or sales agents of
Equalnet and may be entitled to receive a continuing commission based on the
monthly usage of the customer accounts that they have brought to EqualNet.
EqualNet provides independent marketing agents with promotional materials and
products and offers training programs by EqualNet employees. EqualNet solicits
independent marketing agents primarily through its personnel's industry

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contacts and relationships, supplemented by promotions through
telecommunications trade periodicals and trade shows.

TRADEMARKS AND PROPRIETARY RIGHTS

EqualNet has registered the trademark EqualNet(R) with the United States
Patent and trademark Office. The Company also has registered various trademarks
in connection with its product offerings.

REGULATION

Through the second quarter of fiscal 1998, as a non-facilities based
provider of long distance telecommunications services, EqualNet was subject to
many of the same regulatory requirements as facilities-based interexchange
carriers. EqualNet is regulated at the federal level by the FCC and is required
to file tariffs containing descriptions of its products, rates, terms and
conditions of service. In addition, EqualNet is required to maintain a
certificate, issued by the FCC, in connection with its international services.
EqualNet updates its tariffs to reflect any modifications to its existing rates
or terms and conditions of service, as well as to reflect any new products or
services developed for resale by EqualNet. USC Telecom, which commenced
operations in July, 1998 is subject to the same regulations and tariffing
requirements as EqualNet, and is currently in the process of filing tariffs and
obtaining the approvals necessary for it to provide services for the customer
bases acquired from SA Telecom. USC Telecom currently has a management
agreement in place with EqualNet under which EqualNet is providing those
services until USC Telecom receives the approvals necessary to provide those
services directly for its customers.

The intrastate long distance telecommunications operations of EqualNet and
USC Telecom are also subject to various state laws and regulations, including
prior certification, notification or registration requirements. EqualNet and
USC Telecom generally must obtain and maintain certificates of public
convenience and necessity from regulatory authorities in most states in which
they offer service. In most of these jurisdictions, EqualNet and USC Telecom
must also file and obtain prior regulatory approval of tariffs for intrastate
service. EqualNet can provide intrastate originating service to customers in
the contiguous 48 states, Hawaii, and the District of Columbia. EqualNet must
update and amend its tariffs when rates are adjusted or new products or services
are added to those it already offers.

The Telecommunications Act of 1996 (the "Act") is generally designed, among
other things, to stimulate the development of competition in local exchange
markets by permitting the RBOCs to enter the long distance arena only after they
comply with certain statutory requirements designed to eliminate their
monopolies over local exchange service. The RBOCs are permitted to offer long
distance services immediately in geographical areas other than the areas in
which they currently provide local exchange services. Before providing
interexchange services that originate in any state in their region, RBOCs must
petition the Federal Communications Commission ("FCC") for permission to provide
such services. The FCC must review such request within 90 days, but cannot
approve such request unless (i) such approval is consistent with the public
interest, convenience and necessity, (ii) the FCC has consulted with the
Department of Justice and given such Department's views substantial weight,
(iii) the RBOC has implemented the Act's checklist of conditions in the regions
where permission to provide interexchange services is sought, and (iv) either
the RBOC has entered into a binding interconnection agreement approved by the
state in question with one or more competing providers of local telephone
service to residential and commercial subscribers (which services are offered
either exclusively or predominately over such competitor's own facilities), or
the RBOC has received no such requests for interconnection within the
statutorily prescribed time period.

8
<PAGE>

Entry by long distance companies into the markets for local service is
governed by the public utility regulatory authorities of each state in which
such service is to be provided. While state public utility commissions are
responsible for regulating such entry, the Act prohibits state regulations that
could bar such entry.

The Act requires the FCC to promulgate regulations to implement the
requirements of the Act. Since the passage of the Act, the FCC has issued
rulings governing three major areas: (i) interconnection (the means by which a
facilities-based carrier connects its facilities to the equipment that handles a
local exchange carrier's local service lines), (ii) universal service (the
means by which local exchange carriers are subsidized in funding service to
areas or customers otherwise not economically feasible), and (iii) access charge
reform. Access charges are the fees that a long distance carrier pays to the
local exchange carrier to interconnect with the local exchange carrier's
facilities so that the long distance carrier may either originate or terminate
its customer's calls over the facilities of the local exchange carrier. Access
Charge Reform is the FCC's manner of modifying the amount of and the way in
which these expenses are assessed. Implementation of the Act is changing the
manner in which these areas are funded. The changes that most affect the
Company are in the areas of the funding of universal service (the fund to offset
the high cost of providing service in rural areas and to certain schools and
libraries) and local access (the charging by local exchange carriers to
interexchange carriers for their customers' accessing their networks to
originate or terminate long distance calls). Prior to the implementation of the
Act, both universal service and access charges were paid by EqualNet's
underlying carriers and presumably considered as a factor the underlying
carriers used to determine the rates for wholesale pricing charged to EqualNet.
With the competitive changes anticipated by the Act, funding for universal
service is now shared on the federal level by all communications carriers based
upon their proportionate share of revenue as compared with the budgeted funding
required to provide these services. In addition, many states have begun to
assess universal service charges on a state level to supplement the federal
funding of universal service.

Access charge reform has resulted in access charges in the form of the
Primary Interexchange Carrier Charge ("PIC-C"), an assessment to be paid by the
interexchange carrier that the end user customer has selected as its primary
interexchange carrier. The charge is assessed against each telephone line of
the customer, which for EqualNet's customers varies from $0.31 per line to $2.75
per line, depending upon the type of service.

Beginning in the third fiscal quarter, EqualNet began to be assessed both
universal service charges and PIC-C charges. Although the funding of universal
service and access charges are not new, the manner in which EqualNet is having
to pay for these items is new. Although EqualNet, and not its underlying
carriers, is now primarily responsible for the payment of these charges,
EqualNet has not experienced a lowering of its cost of service from its
underlying carriers in an amount equal to the increased amounts of the
assessments it has to pay for universal service and access charges. To the
extent EqualNet does not receive a lowering of its cost of service from its
underlying carriers equal in amount to its increased cost of business by virtue
of these assessments, its operating margins are diminished. EqualNet is
attempting to recoup at least a portion of the increase of these assessments by
passing these charges through, where permitted, to its end user customers. In
such circumstances, although the rates charged to the end user customers are not
increased, the effect is an increase to EqualNet's customers in their cost of
obtaining service.

EMPLOYEES

As of June 30, 1998, the Company had approximately 124 full time employees,
none of whom were subject to any collective bargaining agreement. As of June
14, 1999, the Company had 89 full time employees.

9
<PAGE>

Various members of management left the Company during fiscal 1998 and the
first quarter of fiscal 1999: Zane Russell, the Company's former President and
Chief Executive Officer, and Michael L. Hlinak, former Chief Financial Officer
and Chief Operating Officer resigned their positions as officers in April 1998,
as a result of the change in control of the Company that took place in March of
1998. Robert H. Turner replaced Mr. Russell as Chief Executive Officer of the
Company. In July 1998, the Board of Directors decided to remove Mr. Turner as
Chief Executive Officer. Bob Henson, who replaced Mr. Hlinak as the Chief
Operating Officer in March 1998, left the Company in July 1998. Maurie
Daigneau, who was appointed as the Company's Chief Operating Officer in July
1998, resigned that position in August 1998 to pursue other interests. Most of
the other members of management who were with the Company at the beginning of
fiscal 1998 have either resigned or been terminated since March 1998.

ITEM 2. PROPERTIES

EqualNet leases approximately 32,000 square feet of general and
administrative office space in Houston, Texas, under leases with unaffiliated
third parties that expire in 2004. EqualNet's monthly rental obligation for its
facilities is approximately $29,000. During its bankruptcy proceeding, EqualNet
amended its lease to reduce the number of square feet of lease space from 57,000
to 32,000, thereby reducing its monthly rental obligation from approximately
$54,000 to $29,000 per month.

ITEM 3. LEGAL PROCEEDINGS

In April, 1997, American Teletronics Long Distance, Inc. ("ATLD") and
MetroLink Communications, Inc. ("MetroLink") filed suit against EqualNet
Corporation and EqualNet Wholesale Services, Inc. in the United States District
Court for the Northern District of Illinois, Eastern Division (Cause No. 97-C-
2842) alleging damages based upon breach of contract, fraud and negligent
misrepresentation. Both defendants subsequently were served with process and
filed answers and counterclaims for damages. Plaintiffs allege damages for
EqualNet's failure to complete a purchase of ATLD's customer base, EqualNet's
failure to pay for long distance services provided by MetroLink to EqualNet's
customers through its contract with Unified Network Services LLC ("UNS") and for
damages arising out of EqualNet's alleged breach of contractual obligations to
UNS, a Delaware limited liability company of which EqualNet, Wholesale and
MetroLink were shareholders. It is anticipated that these matters will be
disposed of in the respective bankruptcy proceedings of EqualNet and Wholesale.
EqualNet's management denies any wrongdoing or liability in this matter.

On August 7,1998, Robert H. Turner ("Turner") filed suit against the
Company, Mark A. Willis and Willis Group, LLC in the 61st District Court of
Harris County, Texas in case number 98-37682 alleging an unspecified amount of
damages based upon an alleged breach of his employment contract and other
claims. The Company denies any wrongdoing or liability in the matter, and
intends to vigorously defend itself in this action. Since no discovery has
taken place in this matter, it is impossible to state with any degree of
certainty the amount of damages, if any, that the Company may incur, or if it
will be successful in asserting any cross claims or counterclaims it may have in
connection with the employment of Turner.

10
<PAGE>

On August 13, 1998, Steverson & Company, Inc. filed suit against the
Company in case number 704,244 in the County Civil Court at Law Number 2 of
Harris County Texas seeking damages in the amount of $22,892.78 plus attorneys
fees and court costs. The Company maintains that these charges were for
temporary services personnel utilized by EqualNet and not the Company. The
invoices are addressed to Equal Net Communications, the former name of EqualNet
Corporation before its name change on November 28, 1994. The dates on the
invoices run from June 16, 1998 through August 11, 1998; EqualNet Holding Corp.
did not formally change its name to Equalnet Communications Corp. until June
10, 1998. Due to the fact that these charges may be a claim in the bankruptcy
proceedings of EqualNet discussed below, it is impossible at this time to state
with any degree of certainty the ultimate exposure of either the Company or
EqualNet in this matter.

On August 13, 1998, Centillion Data Systems, Inc. filed suit against
EqualNet in case number 49DO29808CPOO1147 in the Superior Court of Marion
County, Indiana, seeking damages in the amount of $115,490.50 for billing and
other services allegedly provided to EqualNet, plus interest, attorneys fees and
court costs. The fact that these charges are a claim in the bankruptcy
proceedings of EqualNet discussed below make it impossible at this time to state
with any degree of certainty the ultimate exposure of EqualNet in this matter.

On September 3, 1998, the Company received a demand from New Boston Systems
through their attorneys, Steadman & Steele, for the payment of placement fees
for personnel hired by EqualNet. Although New Boston System's engagement letter
was with the Company, the personnel it placed were hired as employees of
EqualNet. It is the position of the Company that any payment due to New Boston
Systems would be due from EqualNet and not the Company. The amount claimed as
due to New Boston Systems is $10,526.25.

On September 15, 1998, Technigrafiks, Inc. filed suit against EqualNet dba
Creative Communications in case number 705,562 in the County Civil Court at Law
Number 1 of Harris County, Texas, seeking damages in the amount of $24,399 for
the printing of plastic cards for prepaid long-distance debit card-sales, plus
interest, attorneys fees and court costs. The fact that these charges are a
claim in the bankruptcy proceedings of EqualNet discussed below make it
impossible at this time to state with any degree of certainty the ultimate
exposure of EqualNet in this matter.

On September 17, 1998, KISS Catalog Ltd. filed suit against the Company as
assignee from Creative Communications International, Inc. of certain contract
rights from KISS Catalog Ltd. in case number 98 CIV. 6570 in the United States
District Court for the Southern District of New York, seeking payment of
$100,000 in license fees, attorneys fees, and any royalties which may be owing
under the license agreement. In 1996, the Company agreed to assume the
obligations under a merchandising license agreement, including the obligation to
make payments of royalties and license fees, with a minimum guarantee royalty
fee of $100,000 and a license fee of $150,000. Payments of the minimum
guarantee of $100,000 and $50,000 of the license fee were made. Payment of the
remaining $100,000 of the license fee has not been made.

On September 17, 1998, Comerica Leasing Corporation filed suit in the 270th
District Court of Harris County, Texas in case number 98-44481 against the
Company and EqualNet for breach of a settlement agreement arising out of
previous litigation for the enforcement of equipment and office furnishings
leases filed on February 12, 1998 in the 157th District Court of Harris County,
Texas in case number 98-06841. A settlement agreement was entered into by the
parties dismissing the earlier litigation and adding the Company as an obligor
for the payment of the settlement amounts. The remaining amounts due under the
settlement agreement and remaining lease obligations represent an amount in
excess of $1,000,000. Pursuant to an agreement reached in the bankruptcy
proceedings of EqualNet Corporation, Comerica Leasing agreed to release the
Company from any liability under the settlement and

11
<PAGE>

underlying agreements in exchange for payment of $265,000 plus the issuance of a
warrant for the purchase of up to 300,000 shares of Common Stock of the Company
at an exercise price of $1.50 per share for a period of five years from the date
of the agreement.

On September 21, 1998, Cyberserve, Inc., WSHS Enterprises, Inc. and
William Stuart (collectively "Bluegate") filed suit in the 215th District Court
of Harris County, Texas in case number 98-45115 against the Company, Willis
Group, LLC, Mark A. Willis, and Netco Acquisition LLC alleging damages for
breach of contract, breach of an employment agreement, fraud and fraud in the
inducement statutory fraud in a stock transaction, tortious interference with a
contract conspiracy, and quantum meruit. The matters complained of originated
with a letter of intent dated on or about October 28, 1997, wherein the Company
proposed the purchase of certain assets of Cyberserve, Inc. and WSHS
Enterprises, Inc. subject to the performance of due diligence by the parties.
Bluegate and certain of its shareholders had threatened to sue the Company in
the event the proposed transaction was not consummated substantially in
conformity with the terms set forth in the Letter of Intent. The damages
Bluegate alleges it incurred were as a result of, among other things, the
claimed modification of its business to its detriment in anticipation of the
integration of its operations with those of EqualNet. It is impossible to
determine with any degree of certainty what, if any, liability Equalnet or any
of its subsidiaries, may incur in this matter. The total amount of damages are
unspecified, but include a demand for a cash payment of $685,000, a sufficient
number of shares of Common Stock of the Company for the payment of $585,000, an
additional 525,000 shares of Common Stock, and other damages. The Company
denies any wrongdoing or liability in this matter and intends to vigorously
defend itself against all claims of the plaintiffs.

On September 29, 1998, SA Telecommunications Incorporated asserted claims
pursuant to the Purchase Agreement against USC Telecom, Inc. and the Company for
(i) $654,934 in operating losses for the period from April 1 through July 22,
1998, (ii) $278,377 for damages for delayed or unbillable revenue through
USBI/ZPDI, (iii) reimbursement of $8,149 for switch site leases, (iv) payment of
Specified Network Contracts Liabilities (amount not specified), (v) delivery of
5,358 shares of Series C Preferred escrowed at closing, and (vi) for return of
certain leased equipment not owned by SA Telecommunications but previously in
its possession and allegedly removed by Equalnet or USC Telecom. The Company
and USC Telecom dispute each of the claims asserted by SA Telecommunications in
its demand.

During the past several months, EqualNet and the Company have experienced
severe liquidity problems and have received numerous notices of default in
payment of trade creditors and other financial obligations. For example and
without providing an exhaustive list, EqualNet has received notice of default of
its agent agreements with Walker Direct Inc., Future Telecom Networks, Inc.,
Global Pacific Telecom, Inc. and others, making demand for the payment of
commissions due and for mediation pursuant to the terms of their agent
agreements. Netco Acquisition LLC presented a notice dated August 25, 1998
under the terms of the Tri-Party Agreement and Assignment dated January 20, 1998
between Netco Acquisition LLC, EqualNet Corporation and Cyberserve, Inc. that it
was enforcing its rights to foreclose on the web page customer base of EqualNet.
In addition, EqualNet defaulted in making timely payments under the $1,183,059
promissory note payable to Sprint Communications Company L.P., in the timely
payments to AT&T Corp., Premier Communications and MCI WorldCom for carrier
services. In addition, EqualNet received notice it was in default of its lease
agreement with Caroline Partners Ltd., the landlord for the office space
occupied by the Company and its subsidiaries, and that the landlord had
exercised its right to offset rents due against the letter of credit EqualNet
has provided as a security deposit for the landlord's benefit. Finova Capital
Corporation notified Netco of its failure to timely pay installments on its
promissory note in the original principal amount of $6.05 million. The payment
of such note is secured by the switches. Any liabilities for MSARC relating to
periods after the rejection date would likely be treated in the bankruptcy as
pre-petition unsecured indebtedness. Due to the amount

12
<PAGE>

of EqualNet's secured indebtedness (approximately $16.0 million), it is unlikely
AT&T would realize significant benefits even if it does assert its claim for
additional MSARC payments. Norwest Equipment Finance, Inc. has notified EqualNet
of its default in the payment for leased furniture currently being utilized by
EqualNet in the operation of its business. The remaining amount owed under such
lease is in excess of $100,000. The bankruptcy proceedings of EqualNet discussed
below make it impossible at this time to state with any degree of certainty the
ultimate exposure of EqualNet in these matters.

As a result of the liquidity problems listed in the foregoing paragraph and
other matters, on September 10, 1998, EqualNet filed for protection under
Chapter 11 of Title 11 of the United States Code, in case number 98-39561-H5-11
in the United States District Court for the Southern District of Texas and
Wholesale filed for protection under Chapter 11 of Title 11 of the United States
Code, in case number 98-39560-H4-11 in the United States District Court for the
Southern District of Texas. On October 2, 1998, Wholesale filed a motion
seeking to convert its Chapter 11 reorganization proceeding to a Chapter 7
liquidation proceeding.

During the last fiscal year, EqualNet settled disputed claims with the
attorneys general from eleven states alleging violations of consumer protection
statutes of those states. The settlement amount, which was paid in March, 1998,
totaled $225,000 plus the issuance of certain customer credits and adjustments.
The Company was either not included as a party or was dismissed as a party
before the entry of any final judgment in any of these proceedings.

From time to time the Company is involved in what it believes to be routine
litigation, or other legal proceedings that may be considered as part of the
ordinary course of its business. The Company does not believe that the adverse
determination of any such claims would have a material adverse effect on either
the results of operations or the financial condition of the Company.

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

Security holders voted upon the following matters in a special meeting held June
30, 1998:

1. Approval of an acquisition by the Company of certain assets of SA Telecom
in exchange for the payment of an aggregate of approximately $3,477,500 in
cash, the assumption of approximately $4,000,000 in liabilities and the
issuance of 196,553 shares of a newly designated series of the Company's
Preferred Stock.

<TABLE>
<CAPTION>
Votes:
----------
<S> <C>
For................. 17,513,748
Against............. 1,200
Abstain............. 3,300
Broker non-votes*... -
</TABLE>

2. Amendment of the Company's Employee Stock Option and Restricted Stock Plan
to increase the number of shares available for grant under that plan.

<TABLE>
<CAPTION>
Votes:
----------
<S> <C>
For................. 17,113,242
Against............. 393,306
Abstain............. 11,700
Broker non-votes*... -
</TABLE>

13
<PAGE>

3. Amendment of the Company's Non-Employee Director Stock Option Plan to
increase the number of shares available for grant under that Plan and to
increase the amounts granted under that plan.

<TABLE>
<CAPTION>
Votes:
----------
<S> <C>
For................. 17,200,442
Against............. 304,906
Abstain............. 12,900
Broker non-votes*... -
</TABLE>

4. Amendment of the Company's Articles of Incorporation to change the name of
the Company from EqualNet Holding Corp. to Equalnet Communications Corp.

<TABLE>
<CAPTION>
Votes:
----------
<S> <C>
For................. 17,509,048
Against............. 4,400
Abstain............. 4,800
Broker non-votes*... -
</TABLE>

5. Ratification of the issuance of 3,000 shares of the Company's Series B
Senior Convertible Preferred Stock on March 9, 1998.

<TABLE>
<CAPTION>
Votes:
----------
<S> <C>
For................. 17,475,852
Against............. 33,696
Abstain............. 8,700
Broker non-votes*... -
</TABLE>

6. Ratification of the issuance by the Company of warrants to two then current
directors of the Company in connection with the resignation of those
directors from offices of the Company to purchase an aggregate of up to
180,000 shares of Common Stock.

<TABLE>
<CAPTION>
Votes:
----------
<S> <C>
For................. 17,464,452
Against............. 49,496
Abstain............. 4,300
Broker non-votes*... -
</TABLE>

* Broker non-votes occur when a broker holding stock in street name does not
vote these shares.

PART II

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

During fiscal year 1998, the Company's Common Stock was traded on the
Nasdaq National Market ("Nasdaq") under the symbol "ENET". On May 7, 1999, the
Company's Common Stock was moved conditionally to The Nasdaq SmallCap Market
under the trading symbol "ENETC". Continued

14
<PAGE>

trading on The Nasdaq SmallCap Market is dependent upon the Company's meeting
certain conditions, including the maintenance of the minimum bid price of $1 per
share as required by both Nasdaq and The Nasdaq SmallCap Market. The table below
sets forth the high and low sales prices of the Common Stock for the fiscal
years 1997 and 1998, as reported by Nasdaq. The quotations reflect inter-dealer
prices, without retail mark-down or commission and may not represent actual
transactions.

<TABLE>
<CAPTION>
Fiscal Year Ended June 30,
Price Range
------------------------------------
High Low
---- ---
1997
<S> <C> <C>
First Quarter $ 4 7/8 $ 1 1/4
Second Quarter $ 3 1/8 $ 1 7/16
Third Quarter $ 2 13/16 $ 1
Fourth Quarter $ 2 3/32 $ 9/16

1998
First Quarter $ 2 7/16 $ 7/8
Second Quarter $ 2 1/8 $ 1 1/4
Third Quarter $ 2 31/32 $ 13/16
Fourth Quarter $ 3 $ 1 13/16
</TABLE>

On October 2, 1998, the last sales price per share of the Company's Common
Stock, as reported by Nasdaq, was $0.375.

On October 2, 1998, the Company's 18,385,832 shares of Common Stock
outstanding were held by approximately 2,100 shareholders of record.

The Company has never declared or paid a dividend on the Common Stock.
Holders of Common Stock are entitled to receive such dividends as may be
declared by the Board of Directors of the Company. The Company does not expect
to pay cash dividends in the foreseeable future. The Company is prohibited from
declaring dividends on the Common Stock unless and until the Company has paid
all accrued and outstanding dividends on the Company's Preferred Stock.
Furthermore, the Company's existing credit facility contains restrictions
relating to the payment of dividends and other distributions. The Company
intends to retain any future earnings to finance the expansion and development
of its business. The declaration and payment in the future of any Common Stock
cash dividends will be at the election of the Company's Board of Directors and
will depend upon the earnings, capital requirements and financial position of
the Company, existing or future loan covenants, general economic conditions' and
other pertinent factors.

The following table sets forth required information regarding all
securities sold without registration (and not previously reported) during fiscal
year 1998.

<TABLE>
<CAPTION>
Common
Stock Issuable
Date of Title of Upon Exercise of Aggregate Exercise Price
Sale Securities Warrant Name of Purchaser Offering Price Per Share
- ------- --------- --------------- ---------------- -------------- ---------------
<S> <C> <C> <C> <C> <C>
3/5/98 Warrant 400,000 Willis Group, LLC (1) $ 1.00
3/5/98 Warrant 500,000 Michael Willis (2) $ 1.00
3/6/98 Warrant 50,000 J. C. Bradford Co. (3) $ 1.50
4/15/98 Warrant 85,000 Mezzanine Telecom, Inc. (4) $ 7.50
4/15/98 Warrant 15,000 John Dalton (5) $ 7.50
</TABLE>

15
<PAGE>

<TABLE>
<S> <C> <C> <C> <C> <C>
4/15/98 Warrant 90,000 Zane Russell (6) $ 2.00
4/15/98 Warrant 90,000 Michael L. Hlinak (7) $ 2.00
6/27/98 Warrant 1,066,665 Pacific Global Networks, Inc. (8) $ 2.00
6/27/98 Warrant 1,650,000 Future Telecom Networks, Inc. (9) $ 2.00
10/1/97 Warrant 200,000 Willis Group, LLC (10) $ 1.00
Series A
3/5/98 Preferred 2,000,000 MCM Partners $2.0 million $1,000.00
Series B
3/9/98 Preferred 1,500,000 Furst Group $3.0 million $2,000.00
3/26/98 Warrants 33,334 First Sterling Ventures Corp. (11) $ 1.50
Common
3/26/98 Stock 666,667 First Sterling Ventures Corp. (12)
3/26/98 Warrants 33,333 Frank Hevrdejs (13) $ 1.50
Common
3/26/98 Stock 666,666 Frank Hevrdejs (14)
4/24/98 Warrants 170,000 James R. Crane (15) $ 1.00
Common
4/24/98 Stock 3,400,000 James R. Crane (16)
</TABLE>

The Company issued each warrant referenced above without registration in
reliance upon the exemption from registration afforded by Section 4(2) of the
Securities Act of 1933, as amended.

(1) Sold as partial consideration for the Switches.
(2) Sold in exchange for the delivery of a guarantee.
(3) Exchanged for investment advisory services.
(4) Sold as partial consideration for the exchange of one of the Company's
outstanding warrants.
(5) Sold as partial consideration for the exchange of one of the Company's
outstanding warrants.
(6) Issued as compensation to a resigning executive.
(7) Issued as compensation to a resigning executive.
(8) Exchanged for marketing services to be performed prior to vesting.
(9) Exchanged for marketing services to be performed prior to vesting.
(10) Sold as partial consideration for bridge loan financing.
(11) Sold for cash consideration.
(12) Sold for cash consideration of $ 1.0 million for stock plus warrants
described in (11) above.
(13) Sold for cash consideration.
(14) Sold for cash consideration of $1.0 million for stock plus warrants
described in (13) above.
(15) Sold for cash consideration.
(16) Sold for cash consideration of $3.4 million for stock plus warrants
described in (15) above.

ITEM 6. SELECTED FINANCIAL DATA

The following table sets forth certain selected consolidated financial data
from the audited consolidated financial statements of the Company for each of
the five years ended June 30, 1998. This information should be read in
connection with and is qualified in its entirety by the more detailed
information and consolidated financial statements, including the notes thereto,
under Item 8 of this Annual Report on Form 10-K/A . The earnings per share
amounts prior to 1997 have been restated as required to comply with Statement of
Financial Accounting Standards No. 128 "Earnings Per Share." For further
discussion of earnings per share and the impact of Statement of Financial
Accounting Standards No. 128, see the notes to the consolidated financial
statements under Item 8 of this Annual Report on Form 10-K/A .

16
<PAGE>

<TABLE>
<CAPTION>
FISCAL YEAR ENDED JUNE 30,
----------------------------------------------------------------------------
1994 1995 1996 1997 1998
---- ---- ---- ---- ----
INCOME STATEMENT DATA:
<S> <C> <C> <C> <C> <C>
Sales $35,397,331 $67,911,405 $ 78,354,858 $ 46,588,496 $ 24,876,242
Cost of sales 28,801,516 54,655,313 61,807,113 34,481,128 21,991,680
Selling, general and
administrative expenses 5,297,710 8,936,102 13,719,573 12,453,814 14,139,010
Depreciation and amortization 271,679 1,355,832 5,933,890 5,999,898 4,734,741
Write down of assets ---- ---- 6,882,661 4,400,000 1,134,666
----------- ----------- ------------ ------------ ------------
Operating income(loss) 1,026,426 2,964,158 (9,988,379) (10,746,344) (17,123,855)
Other income (expense) 742,916 (92,856) (1,088,887) (1,888,889) (819,533)
----------- ----------- ------------ ------------ ------------
Income (loss) before federal
income taxes and extraordinary
item 1,769,342 2,871,302 (11,077,266) (12,635,233) (17,943,388)
-----------
Provision (benefit) for federal income taxes ---- 507,057 (2,659,853) 2,345,311 ----
----------- ----------- ------------ ------------ ------------
Net income (loss) $ 1,769,342 $ 2,364,245 $ (8,417,413) $(14,980,544) $(17,943,388)
----------- ----------- ------------ ------------ ------------
Net loss per share - basic and diluted $(1.40) $(2.46) $(1.64)
------------ ------------ ------------
Pro forma net income(1) $ 1,079,299 $ 1,751,494
----------- -----------
Pro forma net income per share $0.27 $0.38
----------- -----------
Weighted average number of shares(2) 4,000,000 4,618,043 6,017,332 6,096,932 10,943,630
----------- ----------- ------------ ------------ ------------
Cash dividends per share(3) $0.22 $0.61 $ ---- $ ---- $ ----
----------- ----------- ------------ ------------ ------------
Balance Sheet Data:
Cash and equivalents $ 194,571 $ 3,526,543 $ 381,849 $ 828,478 $ 459,581
Working capital (deficiency) 230,448 7,772,366 (3,161,437) (4,667,109) (13,559,609)
Total assets 9,044,595 39,315,569 34,595,832 19,162,160 27,760,447
Total long-term debt and capital leases, net
of current portion 512,914 1,142,640 45,000 ---- ----
Total shareholders' equity (deficit) 1,350,698 20,705,724 12,383,998 (1,688,539) 2,957,782
</TABLE>
_______________
(1) From July 1, 1992 to March 7, 1995, the Company had reported for federal
income tax purposes as an S corporation. Accordingly, all taxable earnings
of the Company during that time have been taxed directly to the
shareholders of the Company at their individual tax rates. A pro forma
adjustment to reflect federal and state income taxes as if the Company were
a C corporation is presented for the respective periods at an estimated
effective rate of 39%.

(2) Shares used to compute pro forma net income per share are based upon the
actual weighted-average shares outstanding giving retroactive effect to the
Company's reorganization which occurred March 8, 1995.

(3) Shares used to compute cash dividends per share are based upon 4,000,000
shares outstanding beginning in 1993 and for the remaining periods as a
result of the reorganization. On March 7, 1995, the Company declared a
final dividend of $0.53 per share to the shareholders of record on such
date. The dividend was paid on March 24, 1995, to the shareholders of
record on March 7, 1995.

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

The following discussion of operations and financial condition of the
Company should be read in conjunction with the Consolidated Financial Statements
and Notes thereto included elsewhere in this Annual Report on Form 10-K/A.
Special Note: Certain statements set forth below constitute "forward-looking
statements" within the meaning of Section 27A of the Securities Act and Section
21E of the Exchange Act. See "Special Note Regarding Forward-Looking
Statements".

OVERVIEW

Because of the continued erosion of market share and continuing declines in
cash flow, EqualNet Corporation ("EqualNet"), one of the Company's wholly-owned
subsidiaries, and EqualNet Wholesale Services, Inc. ("Wholesale"), a non-
operating wholly-owned subsidiary of EqualNet, filed voluntary petitions for
relief under Chapter 11 ("Chapter 11") of the United States Bankruptcy Code (the

17
<PAGE>

"Bankruptcy Code") on September 10, 1998 (the "Petition Date") in the United
States Bankruptcy Court for the Southern District of Texas (the "Bankruptcy
Court"), Houston, Texas. The cases are not being jointly administered at this
time and are pending in such Court as Cases No. 98-39561-H5-11 and 98-39560-H4-
11. Pursuant to Sections 1107 and 1108 of the Bankruptcy Code, EqualNet, as
debtor and debtor-in-possession, managed and operated EqualNet's assets and
business pending the confirmation of the plan of reorganization subject to the
supervision and orders of the Bankruptcy Court. On April 27, 1999, EqualNet
received confirmation of its plan of reorganization. On May 28, 1999, EqualNet
consummated its plan of reorganization. On October 2, 1998, Wholesale filed its
motion to convert its bankruptcy proceeding from a Chapter 11 reorganization to
a Chapter 7 liquidation.

During fiscal year ended June 30, 1998, the approximate number of billable
minutes declined to 85 million from 168 million minutes for the fiscal year
ended June 30, 1997. The approximate number of customers declined to 30,000 in
June 1998 from 59,000 customers in June 1997. EqualNet's long-distance volume
declined from 10.6 million monthly minutes in June 1997 to 6.4 million monthly
minutes in June 1998. Substantially all of EqualNet's revenues have been
derived from the sale of long-distance services to small business customers.
The source of these accounts is primarily independent marketing agents and the
acquisition of customer accounts of other resellers. Many of these agents
previously marketed EqualNet's long-distance products via telemarketing. The
reduction in minutes can be partially attributed to AT&T becoming much more cost
competitive. Many of these customers have been offered and accepted lower
prices from other long distance vendors as well as AT&T. EqualNet's revenue per
minute averaged approximately $0.22 in June 1998, whereas AT&T and other long-
distance vendors currently market the same service for $0.10 or less per minute.
EqualNet does not intend to market its services to new customers until a plan of
reorganization is approved.

During the first three quarters of fiscal 1998, EqualNet's primary costs,
its costs of sales, were variable and consisted of the underlying "wholesale"
cost of long-distance services from its underlying providers, commissions to
independent agents and billing costs. During the fourth quarter of fiscal year
1998, EqualNet entered into an agreement with Netco to provide for operation of
Netco's nine switches ("switches") and build out of network facilities in
exchange for the right to carry traffic over the network: thus EqualNet became a
switch-based carrier with new fixed costs (primarily maintenance and network
management). Since EqualNet did not have the customer density to support the
costs associated with the network facilities, EqualNet incurred losses which
created even larger cash flow deficits.

EqualNet generated revenue through orders received from independent
marketing agents and by acquiring the customer accounts of several other
resellers. EqualNet historically acquired customer accounts from independent
marketing agents on an individual price per order basis, with some agents
receiving an initial payment to help defer the cost of acquiring the orders
which would be offset by future commissions earned (agent advances) and others
receiving a higher initial payment with no future commission owed (deferred
acquisition costs). This allowed EqualNet to use the agents as a vehicle to
outsource telemarketing activities. Expenditures associated with individually
acquired orders, both advanced and purchased, totaled approximately $3.2 million
and $0.6 million in fiscal years 1997 and 1998, respectively.

The operational problems encountered as a result of the attempted
conversion from the NetBase system to AMS kept EqualNet from being able to
calculate and pay its marketing agents the commissions due them on either a
timely or regular basis. In addition, these operational problems resulted in
delays in provisioning new customer orders from some of these agents, causing
delays in generating revenues from these customers, and in some instances, the
loss of new customer orders. These delays also adversely impacted revenues and
cash flows for the Company. As a result, the Company's and EqualNet's
relationships with marketing agents have deteriorated. See Liquidity and
Capital Resources.

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<PAGE>

The Company's selling, general and administrative costs are primarily the
costs of back office operations including billing, provisioning and customer
service. The Company also has devoted significant resources to the information
technology necessary to support customer service and the network of independent
marketing agents. The Company is currently purchasing its third information
system, either purchased or internally developed, within eighteen months.

The Company reported for federal income tax purposes as an S corporation
under the Internal Revenue Code of 1986, as amended, until its reorganization in
connection with its initial public offering in March 1995, and was similarly
treated for state income tax purposes under comparable state laws.

REORGANIZATION OF EQUALNET CORPORATION

On September 10, 1998, EqualNet, a wholly-owned subsidiary of the Company
and Wholesale, a non-operating subsidiary of EqualNet filed for protection under
Chapter 11 of the United States Bankruptcy Code. In the initial bankruptcy
filing, EqualNet reported total assets of $20.7 million and total liabilities of
$57.6 million. As of that date, the largest individual creditor of EqualNet was
the Company, which was owed approximately $33.0 million, representing
approximately 57.3% of EqualNet's total recorded liabilities. On October 2,
1998 Wholesale filed its motion to convert its bankruptcy proceeding from a
Chapter 11 reorganization to a Chapter 7 liquidation. EqualNet's bankruptcy may
make it difficult for the Company to obtain services from vendors of EqualNet or
otherwise maintain those vendor relationships or relationships with EqualNet's
marketing agents. Consequently, there can be no assurance that the bankruptcy
of EqualNet will not have a material adverse effect on the Company.

Although EqualNet's filing was a voluntary petition, it was in default on
its debt and was in arrears on most of its vendor payables. Other than the
Company, the largest creditor of EqualNet is AT&T, which was owed approximately
$9.0 million. This amount did not include any claims of AT&T arising from
EqualNet's MSARC obligations pursuant to its contract with AT&T. EqualNet
rejected its contract with AT&T in the bankruptcy proceeding and entered into an
agreement as to the amount of AT&T's claim for prepetition liabilities as being
$5.8 million as well as the amount of its administrative claim as being $0.3
million. Although it did not own them, EqualNet was the entity that operated
the network of nine switches, and it has incurred a substantial amount of
additional indebtedness to vendors associated with those operations.

EqualNet intends to seek to reorganize its business under bankruptcy
protection. The goal is to stabilize its operations and substantially improve
its balance sheet. Through the reorganization, EqualNet hopes to retain a
substantial portion of its customer base, reduce its liabilities, improve the
efficiency of its operations, and reduce its operating and administrative costs.

EqualNet's customer base represented substantially all of the Company's
consolidated group's revenue in the fiscal year ended June 30, 1998. However,
as a result of the acquisition of SA Telecom's customer base and assets on July
23, 1998, EqualNet's revenues are currently approximately one-half of the
consolidated group's revenues. As of June 30, 1998, EqualNet's non-affiliate
liabilities of approximately $18.0 million represented 75% of the consolidated
group's liabilities, and the book basis of its assets, approximately $11.0
million, represented approximately 41% of the consolidated group's assets.

In order for EqualNet to successfully reorganize, it must successfully
negotiate new carrier agreements, arrange adequate assurance with its vendors
during the pendency of the reorganization, improve the efficiency of its back
office operations and reduce overhead to generate positive cash flow,

19
<PAGE>

retain a substantial portion of its customer base and obtain the approval of
creditors of a plan of reorganization. Failure to achieve any of these items
could lead to a liquidation of EqualNet.

RESULTS OF OPERATIONS

The following table sets forth for the fiscal periods indicated the
percentages of total sales represented by certain items reflected in the
Company's consolidated statements of income and expenses:

<TABLE>
<CAPTION>
Percentage of Total Revenues
Fiscal Year Ended June 30,
-----------------------------------------------
1994 1995 1996 1997 1998
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Total sales 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of sales 81.4 80.5 78.9 74.0 88.4
----- ----- ----- ----- -----
Gross margin 18.6 19.5 21.1 26.0 11.6
Selling, general and administrative expenses 14.9 13.1 17.5 26.7 56.8
Depreciation and amortization 0.8 2.0 7.6 12.9 19.0
Write down of long term assets - - 8.8 9.4 4.6
----- ----- ----- ----- -----
Operating income (loss) 2.9 4.4 (12.8) (23.0) (68.8)
Other income (expense):
Interest income 0.1 0.7 0.1 0.0 0.1
Interest expense (0.4) (0.8) (0.9) (2.2) (4.6)
Miscellaneous 2.4 (0.1) (0.6) (1.9) 1.2
----- ----- ----- ----- -----
Income (loss) before federal income taxes 5.0 4.2 (14.2) (27.1) (72.1)
and extraordinary item
Provision (benefit) for federal income taxes - 0.7 (3.4) 5.0 0.0
----- ----- ----- ----- -----
Net income (loss) 5.0% 3.5% (10.8)% (32.1)% (72.1)%
===== ===== ===== ===== =====
</TABLE>

YEAR ENDED JUNE 30, 1998, COMPARED TO YEAR ENDED JUNE 30, 1997

Total Sales. Long distance sales decreased 46.6% from $46.6 million for
fiscal year 1997 to $24.9 million in fiscal year 1998. The decrease was due
primarily to a decrease in the number of customer accounts and a corresponding
decrease in billable minutes. The decline in revenues in fiscal year 1998 was
the result of an increased rate of attrition on existing customers and a decline
in completed order activity. The company's average price to its AT&T customer
base was approximately $0.27 per minute. This is considerably higher than
competitors who have intensely marketed these customers. To counter this
attrition, EqualNet focused the efforts of its independent marketing agents to
utilize the underlying networks of carriers other than AT&T, but the Company
experienced considerable difficulty provisioning these new customers because of
the conversion problems with the AMS system.

Total Cost of Sales. Long distance cost of sales decreased 36.2% from
$34.5 million for fiscal year 1997 to $22.0 million in fiscal 1998. The
decrease was due primarily to a decrease in the company's total sales. The
Company's cost of sales as a percentage of revenue deteriorated from 74.0% in
fiscal year 1997 to 88.4% in fiscal year 1998. If the same percentage of
revenue would have been maintained throughout fiscal year 1998, the cost of
sales would have been approximately $18.4 million. The additional $3.4 million
in cost of sales is due primarily to fixed and variable costs associated with
the network which were not incurred in fiscal year 1997. With the acquisition
of Netco, the Company decided to provision a nationwide network which could
originate, transport, and terminate the new traffic generated by the independent
marketing agents.

Commission expense as a percentage of total sales increased from 5.6% to
9.5%. Commission expense includes advances to agents that are not expected to
be recovered through future commissions

20
<PAGE>

earned by those agents. These advances were made because of provisioning
problems. In order to retain the agents, the Company advanced funds to the
agents based on estimated revenues that could have been generated by them if the
provisioning problems had not occurred. Because of provisioning problems and
high attrition rates among these new customers, the revenue expected from the
agents was never attained.

Billing expense increased from 7.3% of total sales in fiscal year 1997 to
9.5% of total sales in fiscal year 1998 because of the transition to the AMS
billing system. The need to generate the same invoice multiple times and high
consulting costs were problems with this system. Bad debt expense increased
from 3.7% of total sales to 6.7% due primarily to the billing problems.
Customers routinely received their invoices late, (in some cases two months
late), especially in the fourth quarter and many were unwilling to pay the
amount due.

Selling, General and Administrative Expenses. Selling, general, and
administrative expenses increased from $12.5 million in fiscal year 1997 to
$14.1 million in fiscal year 1998. Selling, general, and administrative
expenses increased as a percentage of sales from 26.7% to 56.8% for the years
ended 1997 and 1998, respectively. The increase in this ratio was due to a
decline in total sales without a corresponding reduction in selling, general and
administrative expenses. Until late in fiscal year 1998, the Company's
infrastructure continued to be more appropriate for a substantially larger
company. Payroll expenses in fiscal year 1998 increased as a percentage of
total revenues from 12% in fiscal year 1997 to 20%. This was due to the
acquisition of personnel knowledgeable in switch technology and computer
programming related to the new billing system which accounted for an increase in
costs of approximately $0.5 million. During fiscal year 1998, there were two
proxies. This resulted in an increase in accounting, professional and legal
fees of $0.9 million.

During the fourth quarter of fiscal year 1998, management re-evaluated the
value of certain assets. The Netbase billing system ($269,155), accounts
receivable from Cyberserve, Inc. and WSHS Enterprises, Inc. ("Bluegate")
($167,000), accounts receivable from UNS ($364,000) and agent advances
($300,000) were written down to net realizable values.

Depreciation and Amortization. Depreciation and amortization decreased
21.1% as the Company recorded $6.0 million in fiscal year 1997 compared to $4.7
million in fiscal year 1998.

The Company wrote down assets of approximately $4.8 million and $1.1
million during the years ended June 30, 1997 and 1998, respectively. During
fiscal year 1997, the Company recorded a charge to earnings for $4.4 million to
reduce the carrying value of purchased customer accounts to an estimate of
future discounted cash flows from the purchased accounts.

Operating Loss. The operating loss increased 59.3% from $10.7 million in
fiscal year 1997 to $17.1 million in fiscal year 1998.

Other Income (Expense). Other expenses decreased by $1.1 million or 56.6%
from fiscal year 1997 to fiscal year 1998. This reduction is primarily due to
the payment of penalties, settlement costs, and legal fees which were accrued in
fiscal year 1997. These accruals were associated with complaints against the
Company by various state regulatory agencies on behalf of customers. In fiscal
year 1997, there was also a $195,000 expense recorded in this account for the
failed Unified Network Services joint venture; these expenses were not incurred
during fiscal year 1998.

YEAR ENDED JUNE 30, 1997, COMPARED TO YEAR ENDED JUNE 30, 1996

Total Sales. Long-distance sales decreased 40.5%, from $78.4 million in
fiscal 1996 to $46.6 million for the year ended June 30, 1997. The decrease was
due primarily to a decrease in the number of

21
<PAGE>

customer accounts and a corresponding decrease in billable minutes. The decline
in revenues in fiscal year 1997 was the result of an increased rate of attrition
on existing customers and a decline in order activity beginning in the last half
of fiscal year 1996. The Company began reducing order activity in early calendar
1996 to reduce the incidence of loss due to delayed provisioning times at AT&T
and because it discovered a new customer management system was severely
hampering the Company's ability to provision and service new customers. The
Company slowly began increasing order activity once it had reverted to the
original Netbase system and provisioning times had returned to acceptable
levels; however, the Company began experiencing liquidity problems during this
time frame and has been unable to fund agent advances that stimulate order
activity as significant as those experienced prior to January 1996.

Total Cost of Sales. The Company's cost of sales, which are variable,
decreased from $61.8 million in fiscal 1996 to $34.5 million for the year ended
June 30, 1997, a decrease of 44.2%. This decrease was a result of a decrease in
the Company's sales. The Company's cost of long distance (which is a component
of cost of sales) improved as a percentage of sales, decreasing from 63.6% to
55.6% for the years ended June 30, 1996 and 1997, respectively. The improvement
in the percentage is the result of the renegotiation of the company's contracts
with its carriers and from the recognition of a one-time credit from AT&T. The
Company negotiated an 8% improvement in the interstate rate it receives from
AT&T in May 1996 followed by an 8% improvement again in November 1996 and
another 8% improvement in May 1997. Additionally, the Company was granted a
one-time credit of $1.2 million as part of the new contract with AT & T,
effective May 1, 1997 and a $400,000 backlog of carrier disputes being processed
by the Company and credited by the Company's carriers in March 1997. The
carrier dispute backlog was the result of difficulties AT & T encountered in
processing the Company's disputed long distance usage which had accumulated over
an extended period of time.

Commission expense as a percentage of sales decreased from 6.5% to 5.6%.
Commission expense included a $1.0 million charge and $400,000 charge for fiscal
years 1996 and 1997, respectively, to expense advances to agents that are not
expected to be recovered through future commissions earned by those agents.
Commissions as a percentage of revenues without these charges would be 5.2% and
4.7% for fiscal years 1996 and 1997, respectively. The decrease relates in part
to a payment in the second quarter of fiscal 1996 to a principal agent to reduce
the agent's commission rate by approximately 4%. Of the Company's total sales
during fiscal years 1996 and 1997, 28% and 23%, respectively, were derived from
customers introduced to the Company from this agent. The Company shifted its
sales strategy from that of purchasing customer accounts and bases of customer
accounts, which have very little associated commission expense, to one of
advancing commissions to independent marketing agents for individual customer
accounts.

Billing expense as a percentage of sales increased from 4.0% to 7.3% for
the fiscal years ending 1996 and 1997, respectively, as a result of the Company
beginning to bill a significant portion of its customers through Local Exchange
Carriers ("LECs"). Billings through the LECs represented 26.8% of the Company's
revenues for the year ended June 30, 1997. The cost of billing through LECs is
generally greater than billing customers through independent billing companies;
however, the Company believed that by billing customers through the LECs,
savings would also be recognized by decreased bad debt expense and reduced
customer attrition. In addition, because the majority of customer service was
performed by the LECs, the Company had been able to reduce overhead related to
the cost of servicing these customers directly. Bad debt expense decreased from
4.9% of sales in fiscal year 1996 to 3.7% of sales in fiscal year 1997. The
Company's collection efforts were hindered in fiscal 1996 by the failure of a
new customer management system to produce the necessary information to allow for
the most effective method of collection, resulting in a higher than normal
incident of uncollected accounts.

22
<PAGE>

Selling, General and Administrative Expenses. Selling, general and
administrative expenses decreased 9.2% from $13.7 million for the year ended
June 30, 1996, to $12.5 million for the same period in fiscal 1997. Selling,
general and administrative expenses increased as a percentage of sales from
17.5% to 26.7% for the years ended June 30, 1996 and 1997, respectively. The
decrease in this expense was a result of cost reduction efforts by the Company.
Total staff decreased from an average of 204 temporary and permanent employees
during the year ended June 30, 1996 (183 permanent employees at June 30, 1996)
to an average of 163 temporary and permanent employees in fiscal 1997 (151
permanent employees at June 30, 1997). Salary related expense decreased $1.5
million from fiscal 1996 to fiscal 1997 as a result of the decrease in
personnel. Administrative expense was down $404,000 for fiscal 1997 compared to
fiscal 1996 as the result of decreasing supplies and office expense by $135,000
and due to a reduction in corporate long-distance and telephone related expenses
by $259,000. The decrease in long-distance and phone related expenses was
related to the acquisition of a new telephone system in January 1996 which
allowed the Company to significantly reduce hold times, thereby reducing long-
distance costs, and due to the decrease in the number of customers, resulting in
fewer calls. Additionally, the Company incurred $246,000 in acquisition related
costs in early fiscal 1996 which were not present in fiscal 1997. These savings
were offset somewhat by an increase in bank fees, marketing fees, lease expense
and the addition of Creative and its related overhead. The Company incurred
approximately $170,000 in additional legal and professional fees in fiscal 1997
as compared to fiscal 1996. Included in professional fees are fees paid to
third party verification companies which the Company utilized to verify customer
orders. These fees totaled approximately $151,000 in fiscal 1997 as compared to
$1,500 in fiscal 1996. Bank fees increased as a result of the cost of obtaining
an amendment to the Company's loan agreement. Marketing fees increased as the
Company conducted an aggressive campaign related to the placement of long-
distance calling cards with all of its customers. Lease expense increased
$422,000 from fiscal 1996 to fiscal 1997 due to the Company entering into two
significant leases beginning in January 1996 for a new telephone system and for
computer equipment to support the Company's information system network.
Creative Communications, an operating division of the Company, resulted in an
additional $450,000 in selling, general and administrative expenses to support
its operations, which were acquired by the Company in fiscal 1997.

Depreciation and Amortization. Depreciation and amortization increased
slightly as the company recorded $5.9 million and $6.0 million in expense during
1996 and 1997, respectively. The Company expended very little on capital
equipment during fiscal 1997 and returned to compensating agents through
commissions and advances on commissions.

The Company wrote down assets of approximately $6.9 million and $4.4
million during the years ended June 30, 1996 and 1997, respectively. During
fiscal 1997 the Company recorded a charge to earnings for $4.4 million to reduce
the carrying value of purchased customer accounts to an estimate of future
discounted cash flows from the purchased accounts. Included in the write down
in fiscal 1996 was a similar $4.6 million non-cash charge to reduce the carrying
value of acquired customer bases to the present value of the expected future
cash flows associated with the underlying customer accounts and a $2.2 million
write off of capitalized software development costs associated with the NetBase
system. The write down of deferred acquisition costs was necessitated by a
greater than expected turnover of acquired customer bases which resulted from
difficulties in billing and servicing the underlying customer accounts.

Operating Loss. The operating loss increased 7.6% from $10.0 million for
the year ended June 30, 1996, to $10.7 million for the year ended June 30, 1997.

Other Income (Expense). Other expense increased from $1.1 million for the
year ended June 30, 1996 to $1.9 million for the year ended June 30, 1997. This
increase was primarily attributable to an increase in interest expense of
$343,000 from fiscal 1996 to fiscal 1997 and an increase in miscellaneous
expense of $406,000 from fiscal 1996 to fiscal 1997. The increase in interest
expense was the result of

23
<PAGE>

the increase in the interest rate under the Company's bank line of credit and
the addition of the note payable to Furst. Other expense in fiscal 1996 includes
a $250,000 accrual for possible penalties, settlement costs and legal expenses
associated with the resolution of pending complaints against the Company by
various state regulatory agencies with regard to customer complaints. Fiscal
1997 includes an additional $390,000 for settlements reached in fiscal 1998. See
Item 3, "Legal Proceedings". Other expense also included $135,000 and $195,000
in fiscal 1996 and fiscal 1997, respectively, in losses related to the failed
Unified Network Services joint venture, which the Company entered into in
February 1996.

LIQUIDITY AND CAPITAL RESOURCES

The Company recorded net losses of $8.4 million, $15.0 million and $17.9
million for the years ended June 30, 1996, 1997 and 1998, respectively. The
Company funded its operations during the year ended June 30, 1998 through
extension of payment terms from the Company's suppliers, fundings under
EqualNet's receivables purchase agreement, from investments totaling $9.4
million from private placements with several accredited investors and through
operating cash flows. EqualNet's funding availability under a receivables
purchase arrangement declined principally as a result of declining revenues and
billing and collections difficulties experienced as a result of EqualNet's
conversion to the AMS billing system. At current levels of operations and with
a declining revenue base, the Company may seek additional capital and continued
concessions from its vendors and may need to continue to reduce expenses to
bring them in line with current levels of revenues. There can be no assurances
that the Company can reduce its expenses enough to achieve a break even in cash
flow.

To date, the external funds necessary to fund the Company's capital
requirements arising from capital expenditures, acquisitions and working capital
have been provided primarily from asset based financing, third-party sources of
capital and the proceeds from the Company's initial public offering. Maximum
borrowings under the Company's line of credit increased from $100,000 in 1992 to
$7.5 million in 1997. EqualNet replaced the credit facility under which
borrowings at June 30, 1997 were outstanding with a new facility with RFC
Capital Corporation ("RFC") effective June 18, 1997 and which funded July 7,
1997. RFC purchases EqualNet's receivables and unbilled call detail records and
periodically remits back to EqualNet excess collections over amounts funded less
financing fees. The maximum allowable amount of funding under the RFC facility
originally was $8.0 million and was increased to $10.0 million in July 1998.
EqualNet's receivables purchase agreement at June 30, 1998 provided for a
funding base that was dependent upon the amount and aging of accounts receivable
and unbilled call detail records. RFC may cease funding of new receivables
without prior written notice at its option. Financing charges on the
outstanding balance was prime plus 4.5% per annum (currently prime plus 7.0%).
Should RFC cease to provide financing in accordance with its option, EqualNet
would be forced to seek immediate replacement of the facility to provide working
capital. Current sources of funds from operations and working capital would be
insufficient to provide funds adequate to continue funding operations. On
September 16, 1998, the bankruptcy court approved an interim order approving a
debtor-in-possession ("DIP") financing through RFC for EqualNet which allows
EqualNet to continue to finance its receivables on the same basis as the pre-
petition financing. A hearing to consider the final approval of the DIP
financing is scheduled on October 15, 1998. If the DIP financing is not
approved, it is unlikely EqualNet will have the working capital needed to
continue business.

EqualNet's contract with AT&T, which was rejected in EqualNet's bankruptcy
proceeding, specified the pricing of the services provided to EqualNet by AT&T
and established minimum semi-annual revenue commitments ("MSARC") which had to
be met to receive the contractual price and to avoid shortfall penalties. At
June 30, 1998, EqualNet had not reached the completion of the term of the third
MSARC; however, EqualNet was substantially below the cumulative pro rata monthly
commitment. The total shortfall for this MSARC is estimated to be $11.6
million. AT&T provides such services to

24
<PAGE>

EqualNet pursuant to a long term contract which may be rejected in bankruptcy
proceedings. If the existing contract with AT&T is terminated, either by
EqualNet through a rejection of the existing contract pursuant to the bankruptcy
proceedings or by AT&T for non-payment, prior to the expiration of the full term
without execution of a new contract, EqualNet could be liable for the total
amount of the unsatisfied MSARC for the period in which the discontinuance
occurs and for 50% of the MSARCs for each semi-annual period remaining in the
contract tariff term. The MSARCs for year two of the contract are $15.0 million
each. The MSARCs for year three are $10.0 million each. Historically, EqualNet
has been able to negotiate a settlement of such shortfalls with AT&T which has
resulted in no penalty being incurred by EqualNet. EqualNet rejected its
contract with AT&T and acquired replacement services for its customers whose
long-distance service utilized AT&T's network as the underlying carrier by
contracting for these services through another large customer of AT&T.

Cash Flow From Operations. The Company generated (used) net cash of
$3,974,000 and ($4,870,000) in operating activities in fiscal 1997 and fiscal
1998, respectively. Cash from net losses adjusted for non-cash expenses
decreased from a use of cash of $1.7 million in fiscal 1997 to a use of cash of
$9.8 million in fiscal 1998. This use in fiscal 1998 was offset by the change
in operating assets and liabilities, including a $1.5 million change in accounts
receivable, a $3.5 million change in accounts payable and a $389,000 decrease in
prepaid expenses and other. Accounts receivable decreased as revenues continued
to decline throughout fiscal 1998. Accounts payable, particularly the payable
to providers of long-distance, increased as a result of EqualNet's inability to
pay its vendors on a timely basis.

Cash Flow From Investing Activities. Net cash used in investing activities
in fiscal 1997 of $344,000 increased to $10.1 million in fiscal 1998. The
Company invested $6.8 million in property, plant and equipment. Most of the
investment related to the purchase of the Switches.

Financing Activities. Financing activities used $3.2 million in fiscal
1997 and generated $14.5 million in fiscal 1998. In fiscal 1997 due to
increased restrictions imposed upon the Company by its primary lender and due to
the declining revenue base, the Company experienced a decline in the borrowing
base available under the line of credit. This resulted in a net reduction in
borrowings under the line in fiscal 1997 of $6.1 million and further reductions
in fiscal 1998 of $4.5 million. In fiscal 1997, the Company sought to offset a
portion of the loss of funds under the line of credit and issued subordinated
debt in February 1997 which resulted in $3.0 million in proceeds. In fiscal
year 1998, the Company generated $9.4 million from the issuance of Common Stock
and warrants and $6.05 million from the securing of debt.

The Company closed several recapitalization transactions during fiscal
1998.

On October 1, 1997, the Company issued to the Willis Group a $1.0 million
Convertible Secured Note, bearing interest at the rate of 12% per year and
maturing April 1, 1998 (the "Note"), and a warrant for the purchase of up to 0.2
million shares of Common Stock at an exercise price of $1.00 per share, subject
to adjustment (the "October Warrant"). The October Warrant is exercisable for
five years. The outstanding balance of the Note was convertible into a number
of shares of Common Stock determined by dividing the outstanding balance by the
lesser of $1.00 or 85% of the market price of the Common Stock. As of the date
of issuance of the convertible debt the Company recorded an interest charge of
$0.15 million to record the impact of the debt being convertible at a discount
to market. On March 5, 1998, the Note and accrued interest were exchanged for
1.05 million shares of Common Stock.

On December 2, 1997, EqualNet entered into several related agreements, (as
amended, the "Agreements") involving the Willis Group, LLC, a privately held
investment partnership ("the Willis Group"), and other third parties.
Collectively, these Agreements provided for a recapitalization of the

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Company and for the Company to acquire certain telecommunications network assets
and switches (collectively the "Transactions".) Under the terms of the
Agreements the Company acquired nine telecommunications switches (the
"Switches") from the Willis Group for $7.6 million of aggregate consideration,
consisting of $5.85 million in cash, 1.4 million shares of Common Stock, and
warrants to purchase an additional 0.4 million shares of Common Stock. The
Company secured financing of $6.05 million for the cash portion of the
consideration through an unaffiliated third party lender, which loan is secured
by the Switches, bears interest at a rate per year of 6.42% above an index rate
based on U. S. Treasury Notes (the loan interest rate currently is 12.1%) and is
payable in 36 consecutive monthly payments. In addition, an affiliate of the
Company was granted 0.5 million warrants for guaranteeing a portion of this
financing.

Under the terms of the Agreements, the Company acquired Netco Acquisition
Corp. ("Netco"), a Delaware corporation controlled by the Willis Group, which
held certain intangible rights and assets previously acquired by the Willis
Group and formerly held by Total National Telecommunications. These assets
consisted of intangible rights to use certain software and codes necessary to
operate the Switches. The Company acquired Netco for $5.6 million in aggregate
consideration, including 3.58 million shares of Common Stock and 2,000 shares of
the Company's Series A Convertible Preferred Stock ("Series A Preferred".) The
Series A Preferred is non-voting, has a stated value of $1,000 per share and is
entitled to receive dividends at the rate of $80.00 per year, payable quarterly.
Holders of Series A Preferred have the right to convert their shares into Common
Stock initially at the rate of 1,000 shares of Common Stock per share of Series
A Preferred (or the stated value divided by $1.00), or an aggregate of 2.0
million shares of Common Stock, subject to adjustment pursuant to certain anti-
dilution provisions. The Series A Preferred has a $1,000 per share liquidation
preference over the Company's Common Stock. Dividends are payable at the
determination of the Board of Directors. Dividends when not paid are cumulative
and bear interest at a rate of 12.0%. Cumulative dividends in arrears at June
30, 1998 were $52,000 or $26.00 per Series A Preferred share. Under the
instrument defining the rights of the holders of the Series A Preferred, the
Company is prohibited from declaring or paying dividends on the Common Stock
unless all accrued dividends on the Series A Preferred have been paid.

Under the terms of the Agreements, the Company also issued and sold to the
Willis Group 4.0 million shares of Common Stock at a price of $1.00 per share in
cash for total aggregate consideration of $4.0 million in cash.

On March 6, 1998, the Company entered into an exchange agreement ("Exchange
Agreement") with The Furst Group, ("Furst"), a New Jersey corporation, an
accredited investor and the holder of the Company's $3.0 million subordinated
debt, pursuant to which Furst exchanged the $3.0 million 10% subordinated note
due December 31, 1998 and warrants to purchase 1.5 million shares of Common
Stock for 3,000 shares of Series B Senior Convertible Preferred Stock ("Series B
Preferred") along with 0.3 million shares of the Company's Common Stock to
satisfy the accrued interest due on the notes. Each share of the Series B
Preferred has a stated value of $1,000 and is entitled to share with the Common
Stock in any dividends declared based upon the number of shares of Common Stock
the Series B is convertible into at the time such dividend is declared. Each
share of Series B Preferred is convertible initially into 500 shares of Common
Stock subject to certain anti-dilution provisions. The Series B Preferred has a
$1,000 per share liquidation preference over the Series A Preferred and the
Common Stock. Each share of Series B Preferred also entitles the holder thereof
to one vote, voting as a single class with the Common Stock, on matters
submitted to the shareholders of the Company.

On March 26, 1998, the Company issued to First Sterling Ventures, a Texas
corporation, and an individual, both accredited investors, an aggregate of 1.33
million shares of Common Stock and warrants to purchase an additional 0.67
million Common Stock shares for an aggregate of $2.0 million in cash. The
Willis Group was granted a 1.0% facilitation fee for these transactions totaling
$0.02 million.

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On April 24, 1998, the Company entered into an agreement with an individual
investor to issue 3.4 million shares of par $.01 per share Common Stock of the
Company which constitute approximately 15.9% of the outstanding Common Stock and
warrants for the purchase of 0.17 million shares of Common Stock in exchange for
$3.4 million. The Willis Group was granted a 1.0% facilitation fee for this
transaction totaling $0.03 million.

During the quarter ended March 31, 1998, EqualNet obtained a cash flow
bridge loan of $0.4 million from Netco Acquisition, LLC, an entity owned 50% by
the Willis Group. This note was payable on March 31, 1998 and had an interest
rate of 10% which escalates to 18% after an event of default occurs. This note
is secured by the web page customers. As of June 30, 1998, the Company was in
default on this note as no principal or interest payments have been made.

Effective July 31, 1998, the Company issued two 6% Senior Secured
Convertible Notes due in 2001 (the "2001 Notes") in the amount of $1.5 million
each to the Willis Group and Genesee Fund Limited-Portfolio B ("Genesee"), a
British Virgin Islands corporation, both accredited investors. The 2001 Notes
are convertible into a variable number of shares of the Company's Common Stock.
Ownership percentage upon conversion is currently limited to no more than 4.9%
of the outstanding shares of Common Stock. The 2001 Notes bear interest at 6%
and interest payments are due each February 15, May 15, August 15 and November
15 commencing on November 15, 1998.

The 2001 Notes rank equally with all other unsubordinated debt obligations
of the Company. The Company's obligations under the 2001 Notes are secured by
certain collateral pursuant to security agreements. A holder of the 2001 Note
may require the Company to repurchase the 2001 Note if an event of default
occurs. Events of default include, among other things, the Nasdaq delisting of
the Common Stock. A default under either of these 2001 Notes could have a
material adverse effect on the Company's ability to raise additional capital and
on the results of operations or financial condition.

In connection with the issuance of the 2001 Notes, the Company issued to
each of the Willis Group and Genesee a warrant ("Warrant") to purchase 333,116
shares of Common Stock at a purchase price of $0.9006 per share. In addition,
the Company issued to the Willis Group and Advantage Fund Limited 3,750 shares
of its Series D Convertible Preferred Stock ("Series D Preferred") in exchange
for 3.0 million shares of its Common Stock and $0.2 million. The Warrants
expire on September 4, 2003.

Any holder of a 2001 Note may convert the 2001 Note, in whole or in part,
into shares of Common Stock at a conversion price per share equal to the lesser
of:

. the product of (1) the average of the lowest sales price of the
Company's Common Stock on Nasdaq for the five days immediately
preceding the date of conversion and (2) 85% (subject to reduction
pursuant to the terms of the 2001 Notes); and

. $0.9006 (subject to reduction pursuant to the terms of the 2001
Notes).

Each share of Series D Preferred will be entitled to receive dividends at a
rate of $60.00 per share per year, payable if declared by the Board of
Directors. Any dividends that accrue on the Series D Preferred may be paid, at
the Company's option (subject to certain limitations), in cash or, in whole or
in part, by issuing additional shares of Series D Preferred. Under the terms of
the Series D Preferred, the Company cannot declare or distribute any dividends
to holders of Common Stock unless all dividends on the Series D Preferred have
been paid.

Holders of shares of Series D Preferred will have the right to convert each
of their shares into a number of shares of Common Stock equal to the quotient
of:

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<PAGE>

. the sum of (1) $1,000 (subject to adjustment pursuant to the Series D
Preferred documents), (2) accrued but unpaid dividends to the
applicable conversion date on the share of Series D Preferred being
converted and (3) accrued but unpaid interest on the dividends on the
share of Series D Preferred being converted; and

. an amount equal to the lesser of:

. the product of (1) the average of the lowest sales price of the
Common Stock on Nasdaq for any five trading days during the 25
trading days immediately preceding the conversion date and (2)
85% (subject to downward adjustment, if applicable, pursuant to
the Series D Preferred documents); and

. $1.2281 (subject to reduction pursuant to the Series D Preferred
documents), subject to adjustment pursuant to the anti-dilution
provisions.

Working Capital and Long Cash Cycle.

Customer billings for long distance services are generated from detailed
calls records which are generally available from the carriers on a weekly basis
following the previous week's customer usage, and from the switches on a daily
basis following the day of customer usage. Customer invoices usually are
generated; on a monthly basis for the direct-billed customers and weekly for the
LEC billed customers and are due upon receipt by the customer. However, the
Company historically collects a large portion of receivables after the scheduled
due date, resulting in an average cash cycle of in excess of 90 days. Since the
Company's underlying carriers typically have required payment within 35 days
following the month of usage, delays in receipt of customer payments have
resulted in significant working capital needs. During the fourth fiscal
quarter, EqualNet was not able to continue to pay AT&T either installments under
its payment plan for usage in arrears or for current usage on or before 35 days
from the date of invoice, and did not make some payments when due. In order to
avoid termination of service, EqualNet agreed in the first fiscal quarter of
1999 to send daily payments to AT&T in amounts approximating the costs EqualNet
would incur from AT&T for providing such services. As noted above, on September
10, 1998, EqualNet and Wholesale filed petitions for relief under Chapter 11 of
the Bankruptcy Court. On October 2, 1998 Wholesale filed its motion to convert
its bankruptcy proceeding from a Chapter 11 reorganization to a Chapter 7
liquidation.

During fiscal 1998, the Company had expenditures of $6.8 million on capital
items, including $6. 05 million to purchase the Switches. The Company has
minimal planned capital expenditures budgeted for fiscal year 1999 other than
expenditures associated with the CostGuard billing system.

Management's Plans to Return to Profitability

The Company's management is taking the following actions to strengthen the
financial position of the Company. New products are being developed to
significantly enhance sales and revenue, including (i) bundled minute long
distance products resembling cellular offerings, (ii) wholesale international
rates for retail customers and (iii) advertiser sponsored long distance, where
customers are offered the opportunity to make a limited duration long-distance
call if they will first listen to an advertisement targeted to the subscribed
customer's demographics.

The Company's management believes these products and services will not
require significant capital investment to test and implement. The technology
for and development of the advertiser sponsored long distance will substantially
be paid for by utilizing the Company's common stock through an acquisition. The
Company expects to utilize its internal resources and the personnel already
involved
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with the development of these product offerings to assist in addressing
marketing and technology issues in bringing these products to market.

The Company believes that new product offerings such as advertiser
sponsored long distance are particularly significant to overcoming its financial
difficulties. The Company's management believes that in order to become
competitive, the Company must remain innovative, and not attempt to depend on
competitive pricing alone.

In order to provide financing to support operations during the next twelve
months, the Company must also generate revenue from its existing resources. The
switch network is being employed to generate revenue by (i) placing dedicated
customers on the network via connectivity to a local switch, (ii) port leasing
of switch assets and (iii) international product offerings accessed through the
switches.

In addition, the Company is continuing to reduce its primary carrier costs
for its existing customer base. These actions are expected to lower monthly
carrier costs by 15% to 20% beginning in May 1999.

The Company continues to make improvements in its billing and MIS systems
to more accurately bill customers, maximize customer revenue and ensure proper
audit of vendor invoices related to the cost of service.

Management believes that the plans discussed above are critical to
returning the Company to profitability. Additionally, the Company intends to
seek possible strategic alliances and business combinations in order to more
rapidly implement its plans for increasing the service offerings or for reducing
costs of the Company. As noted above, management believes that its plans can be
achieved without additional significant capital resources and intends to use the
Company's common or preferred stock to pursue strategic alliances and business
combinations. Management is attempting to balance the cash flows from operations
to meet current needs, and is continuously seeking additionally capital
resources to fund the expansion of service offerings of the Company. Should
capital resource requirements to achieve the management's plan to return to
profitability significantly exceed management's ability to meet those needs, the
Company's ability to return to profitability could be significantly delayed or
impaired.

TAXES

Sales Taxes. An improper treatment of sales taxes arose from the Company's
failure to remit the sales tax due to various taxing authorities on the
incremental component of revenue in excess of the cost of the underlying service
(for which taxes were properly paid). At June 30, 1998 EqualNet had an accrual
of $339,500 for resolution of this matter. The Company believes that the amount
accrued is adequate for the satisfaction of this tax liability, including any
interest payable.

During the fiscal year, EqualNet was audited for sales taxes for the period
of July 1, 1991 through December 31, 1996. On April 20, 1998, the Texas
Comptroller's office assessed EqualNet with $465,876 in additional sales taxes
plus interest for these tax periods. EqualNet has paid $168,466 as the
undisputed portion of this assessment. EqualNet has disputed the basis for the
remaining assessment, timely filed its notice of appeal, and is currently
proceeding through the appeals process. EqualNet has accrued the full amount of
the remaining assessment plus interest incurred through June 30, 1998.

Federal Excise Taxes. During fiscal 1998, the Company had an installment
agreement with the Internal Revenue Service for payment of under payment of
second quarter fiscal 1994 federal excise taxes which allowed for the Company to
satisfy the amount outstanding in equal payments of $25,000 per month. During
fiscal 1998, the Company paid a total of $225,000 to the Internal Revenue
Service satisfying this obligation.

Income Taxes. The Company has gross deferred tax assets of $15.6 million
for which a valuation allowance of $15.6 million has been established. The
deferred tax assets arise from deductible temporary

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<PAGE>

differences of $5.9 million and a net operating loss carry forward of $9.7
million. In assessing the need for and amount of a valuation allowance, the
Company considered its inability to generate taxable income in recent periods,
the facts and circumstances which led to the significant operating loss incurred
in the years ended June 30, 1997 and 1998, and projections of future taxable
income. Financial Accounting Standards Board Statement No. 109, "Accounting for
Income Taxes", allows for the recognition of deferred tax assets by considering,
among other things, the ability of the Company to generate future taxable
income. A valuation allowance is required to reduce tax assets to their expected
realizability if it is more likely than not that some portion or all of the
deferred tax assets will not be realized. Statement 109 explicitly provides that
reaching a conclusion that a valuation allowance is not required is difficult
when there is negative evidence such as cumulative losses in recent years. The
Company has been in a cumulative loss position at June 30, 1998. The Company
does not believe that positive evidence of the ability to generate future
taxable income is sufficient to counteract the negative evidence, the cumulative
losses, and accordingly has recorded a valuation allowance for the full amount
of the deferred tax.

LEGAL LIABILITIES

In April, 1997, American Teletronics Long Distance, Inc. ("ATLD") and
MetroLink Communications, Inc. ("MetroLink") filed suit against EqualNet
Corporation and EqualNet Wholesale Services, Inc. in the United States District
Court for the Northern District of Illinois, Eastern Division (Cause No. 97-C-
2842) alleging damages based upon breach of contract, fraud and negligent
misrepresentation. Both defendants subsequently were served with process and
filed answers and counterclaims for damages. Plaintiffs allege damages for
EqualNet's failure to complete a purchase of ATLD's customer base, EqualNet's
failure to pay for long distance services provided by MetroLink to EqualNet's
customers through its contract with Unified Network Services LLC ("UNS") and for
damages arising out of EqualNet's alleged breach of contractual obligations to
UNS, a Delaware limited liability company of which EqualNet Corporation,
EqualNet Wholesale Services, Inc. and MetroLink were shareholders. It is
anticipated that these matters will be disposed of in the respective bankruptcy
proceedings of EqualNet and Wholesale. EqualNet's management denies any
wrongdoing or liability in this matter.

EqualNet has committed to make certain payments to AT&T for usage incurred
in prior periods. EqualNet defaulted in the timely payment of those payments
during the fourth fiscal quarter of 1998, and began to enter into a series of
short term, alternative payment agreements with AT&T for the payment of amounts
due to AT&T for current usage with any surplus to be applied to the arrearage
amounts. The failure to make any payments due to AT&T could result in the
termination of service to EqualNet's customers whose long distance service is
provided over AT&T's networks. The pending bankruptcy proceeding discussed
below could have a substantial affect on this obligation. EqualNet Corporation
is negotiating with another AT&T reseller as a potential supplier of these
services instead of dealing with AT&T directly. If so, management would
anticipate negotiating payment terms superior to those available directly from
AT&T.

On August 7, 1998, Robert H. Turner ("Turner") filed suit against the
Company, Mark A. Willis and Willis Group, LLC in the 61st District Court of
Harris County, Texas in case number 98-37682 alleging an unspecified amount of
damages based upon an alleged breach of his employment contract and other
claims. The Company denies any wrongdoing or liability in the matter, and
intends to vigorously defend itself in this action. Since no discovery has
taken place in this matter, it is impossible to state with any degree of
certainty the amount of damages, if any, that the Company may incur, or if it
will be successful in asserting any cross claims or counterclaims it may have in
connection with the employment of Turner.

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<PAGE>

On August 13, 1998, Steverson & Company, Inc. filed suit against the
Company in case number 704,244 in the County Civil Court at Law Number 2 of
Harris County Texas seeking damages in the amount of $22,892.78 plus attorneys
fees and court costs. The Company maintains that these charges were for
temporary services personnel utilized by EqualNet, and not the Company. The
invoices are addressed to Equal Net Communications, the former name of EqualNet
Corporation before its name change on November 28, 1994. The dates on the
invoices run from June 16, 1998 through August 11, 1998. EqualNet Holding Corp.
did not formally change its name to Equalnet Communications Corp. until June
30, 1998. Due to the fact that these charges may be a claim in the bankruptcy
proceedings of EqualNet discussed below, it is impossible at this time to state
with any degree of certainty the ultimate exposure of either the Company or
EqualNet in this matter.

On August 13, 1998, Centillion Data Systems, Inc. filed suit against
EqualNet in case number 49D029808CP001147 in the Superior Court of Marion
County, Indiana, seeking damages in the amount of $115,490.50 for billing and
other services allegedly provided to EqualNet, plus interest, attorneys fees and
court costs. The fact that these charges are a claim in the bankruptcy
proceedings of EqualNet discussed below make it impossible at this time to state
with any degree of certainty the ultimate exposure of EqualNet in this matter.

On September 15, 1998, Technigrafiks, Inc. filed suit against EqualNet dba
Creative Communications in case number 705,562 in the County Civil Court at Law
Number 1 of Harris County, Texas, seeking damages in the amount of $24,399 for
the printing of plastic cards for debit card sales, plus interest, attorneys
fees and court costs. The fact that these charges are a claim in the bankruptcy
proceedings of EqualNet discussed below make it impossible at this time to state
with any degree of certainty the ultimate exposure of EqualNet in this matter.

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On September 21, 1998, Cyberserve, Inc., WSHS Enterprises, Inc. and
William Stuart (collectively "Bluegate") filed suit in the 215th District Court
of Harris County, Texas in case number 98-45115 against the Company, Willis
Group, LLC, Mark A. Willis, and Netco Acquisition LLC alleging damages for
breach of contract, breach of an employment agreement, fraud and fraud in the
inducement, statutory fraud in a stock transaction, tortious interference with a
contract, conspiracy, and quantum meruit. The matters complained of originated
with a letter of intent dated on or about October 28, 1997, wherein the Company
proposed the purchase of certain assets of Cyberserve, Inc. and WSHS
Enterprises, Inc. subject to the performance of due diligence by the parties.
Bluegate and certain of its shareholders had threatened to sue the Company in
the event the proposed transaction was not consummated substantially in
conformity with the terms set forth in the Letter of Intent. The damages
Bluegate alleges it incurred were as a result of, among other things, the
claimed modification of its business to its detriment in anticipation of the
integration of its operations with those of EqualNet. It is impossible to
determine with any degree of certainty what, if any, liability Equalnet, or any
of its subsidiaries, may incur in this matter. The total amount of damages are
unspecified, but include a demand for a cash payment of $685,000, a sufficient
number of shares of Common Stock of the Company for the payment of $585,000, an
additional 525,000 shares of Common Stock, and other damages. The Company
denies any wrongdoing or liability in this matter and intends to vigorously
defend itself against all claims of the plaintiffs.

On September 29, 1998, SA Telecommunications Incorporated asserted claims
pursuant to the Purchase Agreement against USC Telecom, Inc. and the Company for
(i) $654,934 in operating losses for the period from April 1 through July 22,
1998, (ii) $278,377 for damages for delayed or unbillable revenue through
USBI/ZPDI, (iii) reimbursement of $8,149 for switch site leases, (iv) payment of
Specified Network Contracts Liabilities (amount not specified), (v) delivery of
5,358 shares of Series C Preferred escrowed at closing, and(vi) for return of
certain leased equipment not owned by SA Telecommunications but previously in
its possession and allegedly removed by Equalnet or USC Telecom. The Company
and USC Telecom dispute each of the claims asserted by SA Telecommunications in
its demand.

During the past several months, EqualNet and the Company have experienced
severe liquidity problems and have received numerous notices of default in
payment of trade creditors and other financial obligations. For example and
without providing an exhaustive list, EqualNet has received notice of default of
its agent agreements with Walker Direct, Inc., Future Telecom Networks, Inc.,
Global Pacific Telecom, Inc. and others, making demand for the payment of
commissions due and for mediation pursuant to the terms of their agent
agreements. Netco Acquisition LLC presented a notice dated August 25, 1998
under the terms of the Tri-Party Agreement and Assignment dated January 20, 1998
between Netco Acquisition LLC, EqualNet Corporation and Cyberserve, Inc. that it
was enforcing its rights to foreclose on the web page customer base of EqualNet.
In addition, EqualNet defaulted in making timely payments under the
$1,183,059.03 promissory note payable to Sprint Communications Company L.P., in
the timely payments to AT&T Corp., Premier Communications and MCI WorldCom for
carrier services. In addition, EqualNet received notice it was in default of
its lease agreement with Caroline Partners Ltd., the landlord for the office
space occupied by the Company and its subsidiaries, and that the landlord had
exercised its right to offset rents due against the letter of credit EqualNet
has provided as a security deposit for the landlord's benefit. Finova Capital
Corporation notified Netco of its failure to timely pay installments on its
promissory note in the original principal amount of $6.05 million. The payment
of such note is secured by the switches. Norwest Equipment Finance, Inc. has
notified EqualNet of its

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default in the payment for leased furniture currently being utilized by EqualNet
in the operation of its business. The remaining amount owed under such lease is
in excess of $100,000.

From time to time the Company is involved in what it believes to be routine
litigation or other legal proceedings that may be considered as part of the
ordinary course of its business. The Company does not believe that the adverse
determination of any such claims would have a material adverse effect on either
the results of operations or the financial condition of the Company.

SEASONALITY

The Company's long distance revenue is subject to seasonal variations.
Because most of the Company's revenue is generated by non-residential customers,
the Company traditionally experiences decreases in long-distance usage and
revenue in those periods with holidays. In past years the Company's long-
distance traffic, which is primarily non-residential, has declined slightly
during the quarter ending December 31 due to the November and December holiday
periods.

INFLATION

Inflation has not had a significant impact on the Company's operations to
date.

YEAR 2000

The Year 2000 problem arises from the fact that due to early limitations on
memory and disk storage many computer programs indicate the year by only two
digits, rather than four. This limitation can cause programs (both system and
application) that perform arithmetic operations, comparisons, or sorting of data
fields to yield incorrect results when working outside the year range of 1900
through 1999.

The Company has anticipated potential Year 2000 issues and has
substantially completed all in-house preparation for the upcoming event. The
Company is still in the process of accessing vendors and customer's capabilities
in dealing with Year 2000 issues. The Company owns nine switches which were
manufactured by Siemens Telecom Network ("Siemens"). Siemens has agreed to
provide software patches which will ensure the switches are Year 2000 compliant.
Siemens represents these patches to be provided free of charge, and will be
installed in fiscal year 1999.

The Info Directions CostGuard billing system to be implemented by the
Company currently is represented as Year 2000 compliant. However, the
underlying operating system upon which the

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CostGuard system operates, Microsoft Windows NT 4.0, has not been represented as
being Year 2000 compliant.

The Company intends to poll vendors and customers about Year 2000 issues.
This process should be completed by the end of fiscal year 1999. The cost for
polling will be immaterial. The Company's major vendors: AT&T, Sprint and MCI
WorldCom are Fortune 500 companies which have disclosure requirements for Year
2000 issues. The risk of these vendors not minimizing their risk should be
minimal. The Company has two major concerns with Year 2000 issues as it applies
to customers. First, the customer phone equipment should be Year 2000
compliant. If it is not, the customers will not be able to utilize all of the
capabilities of the phone systems, thus possibly reducing the revenues of the
Company. The Info Directions CostGuard billing system will allow the Company to
provide billing information to customers in electronic data formats. If the
customer's computer systems are not Year 2000 compliant, they will not be able
to utilize this service.

CAUTIONARY STATEMENTS

In addition to the other information in this Annual Report on Form 10-K/A, the
following factors should be considered carefully when evaluating the likelihood
of the Company's realization of expectations with respect to operating results
and other matters described in this Annual Report on Form 10-K/A. See "Special
Note Regarding Forward-Looking Statements" on page 1.

ADDITIONAL NECESSARY CAPITAL - EqualNet and Wholesale filed for Chapter 11
protection in September of 1998. The Company needed additional capital to
obtain the creditor's approval of a plan of reorganization for EqualNet. In
addition, it is likely that additional capital may be needed to fund operating
deficits of the Company's other subsidiaries during the foreseeable future.
Although the Company has no current funding sources, it believes it can attract
additional funding if it is able to reduce the liabilities of EqualNet through
the plan of reorganization. There can be no assurances that the Company will be
able to obtain the necessary capital or sufficiently reduce EqualNet's
liabilities to continue to operate the Company.

ATTRITION RATES - In the event that the Company experiences attrition rates in
excess of those anticipated either as a result of increased provisioning times
by its underlying carrier, the purchase of poorly performing traffic, or the
inability to properly manage the existing customer base, additional charges that
affect earnings may be incurred.

DEPENDENCE ON INDEPENDENT MARKETING AGENTS - USC Telecom has a small internal
sales force and obtains the majority of its new customers from independent
marketing agents ("Agents"). USC Telecom's near-term ability to expand its
business depends upon whether it can continue to maintain favorable
relationships with existing Agents and recruit and establish new relationships
with additional Agents. No assurances can be made as to the willingness of the
existing Agents to continue to provide new orders to USC Telecom or as to USC
Telecom's ability to attract and establish relationships with new Agents.

DEPENDENCE ON FACILITIES-BASED CARRIERS - The Company, even though it now owns
nine switches, depends upon other carriers to provide the telecommunications
services that it resells to its customers and the detailed information upon
which it bases its customer billings. The Company's near-term ability to expand
its business partially depends upon whether it can continue to maintain
relationships with AT&T and Sprint. The loss of the telecommunications services
that the Company receives from AT&T or Sprint could have a material adverse
effect on the Company's results of operations and financial condition.

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CARRIER COMMITMENTS - EqualNet has significant commitments with certain carriers
to resell long-distance services. EqualNet's contracts with its carriers
contain clauses that could materially and adversely impact EqualNet should
EqualNet incur a shortfall in meeting its commitments. Although EqualNet has
from time to time failed to meet its commitment levels under a particular
contract and in each case has been able to negotiate a settlement with the
carrier which resulted in no penalty being incurred by EqualNet, there can be no
assurances that EqualNet will be able to reach similar favorable settlements
with its carriers in the event that EqualNet should fail to meet its future
commitments.

To the extent that these carriers are considered to be utilities in EqualNet's
bankruptcy proceeding, these carriers will be entitled to adequate assurance of
payment for carrier services after September 10, 1998, the Bankruptcy Filing
Date. Adequate assurance may be in the form of cash deposits or advance
payments in an amount determined by the court as sufficient to provide these
carriers with adequate assurance of payment. The failure to provide adequate
assurance of payment for future services would give these carriers the right to
discontinue to provide such services. Current sources of funds from operations
and working capital may not be sufficient to provide the amount of adequate
assurance of payment required by these carriers. There can be no assurance that
EqualNet would be able to secure funding for the amount of any adequate
assurance that may be required of EqualNet. See Note 2. Chapter 7 and 11
Filing and Note 4. Liquidity and Working Capital Deficit.

In recent years, AT&T, MCI WorldCom and Sprint have consistently followed one
another in pricing their long-distance products. If MCI WorldCom and Sprint
were to lower their rates for long-distance service and AT&T did not adopt a
similar price reduction, adverse customer reaction could affect the Company's
ability to meet its commitments under the AT&T contract which could have a
material adverse affect on the Company's financial position and results of
operations.

To the extent that these carriers are considered to be utilities in EqualNet's
bankruptcy proceedings, these carriers will be entitled to adequate assurance of
payment for carrier services after September 10, 1998, the Petition Date.
Adequate assurance may be in the form of cash deposits or advance payments in an
amount determined by the court as sufficient to provide these carriers with
adequate assurance of payment.

BILLING SYSTEM PROBLEMS EqualNet converted to a new customer management,
billing and rating system - AMS, purchased from Platinum Communications in March
1998. Unlike NetBase (the system used for most of fiscal year 1998 prior to
conversion), AMS has capabilities required for switch-based data gathering,
rating and billing. The conversion coincided with the acquisition of a new
customer base (SA Telecom) and a migration to a switch based environment,
considerable billing errors and delays occurred. Additionally, there are
aspects of AMS that could require continuing support from Platinum
Communications. This reliance upon an outside source for billing system
troubleshooting has slowed the conversion recovery process. As of September 25,
1998, EqualNet is making plans to convert to CostGuard ENTERPRISE, an industrial
class rating, billing and customer care system built on a Microsoft SQL Server
database platform. This system is being purchased from Info Directions, Inc.,
"IDI" and is expected to dramatically improve rating speed and billing accuracy.
Also, EqualNet expects to be able to more readily extract meaningful data and
management reports from CostGuard. The system design is flexible enough to
respond to rapid changes in the telecommunications marketplace. In fiscal year
1998, EqualNet recorded a write-off of $270,000 for NetBase and estimated the
useful file of AMS to be approximately one year until the CostGuard system can
be implemented. The new system, CostGuard, will cost $272,000 initially, then
$68,000 per year in subsequent years for ongoing support and software upgrades.
There can be no assurance that the IDI billing system will fully meet EqualNet's
current and on going needs. If the IDI system fails to provide the expected
results, EqualNet may need to invest in other alternative billing systems.

35
<PAGE>

RELATIONSHIPS WITH STATE REGULATORY AGENCIES - EqualNet's and USC Telecom's
intrastate long-distance telecommunications operations are subject to various
state laws and regulations, including prior certification, notification or
registration requirements. EqualNet and USC Telecom must generally obtain and
maintain certificates of public convenience and necessity from regulatory
authorities in most states in which it offers service. Any failure to maintain
proper certification in jurisdictions in which either of these companies provide
a significant amount of intrastate long-distance service could have a material
adverse effect on the Company's business.

VOLATILITY OF SECURITIES PRICES - Historically, the market price of the Common
Stock has been highly volatile. During all of fiscal 1998, the market price for
the Common Stock as reported by the Nasdaq has ranged from a high of $3.00 per
share to a low of $0.875 per share. There can be no assurance that the market
price of the Common Stock will remain at any level for any period of time or
that it will increase or decrease to any level. Changes in the market price of
the Common Stock may bear no relation to EqualNet's actual operational or
financial results. In addition, if the Company fails to maintain the minimum
bid price ($1.00 per share) or the minimum net tangible assets ($4.0 million)
requirements of Nasdaq, the Common Stock would be subject to delisting by
Nasdaq. On September 30, 1998, Nasdaq notified the Company that it would be
delisted if the closing bid price for its Common Stock is not equal to or
greater than $1.00 for a minimum of ten consecutive trading days during the
period from October 1, 1998 to December 29, 1998. On October 8, 1998, Nasdaq
also notified the Company that it would be delisted if the market value of its
public float was not equal to or greater than $5.0 million for a minimum of ten
consecutive trading days during the period from October 9, 1998 to January 6,
1999.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Company is subject to market risk exposure related to changes in interest
rates on its borrowing and receivable sales facilities. These instruments carry
interest at a pre-agreed upon percentage point spread over the prime interest
rate. At June 30, 1998, the Company had $8.1 million outstanding under its debt
facilities. Based on this balance, an immediate change of one percent in the
interest rate would cause a change in interest expense of approximately $81,000
on an annual basis. The Company's objective in maintaining these variable rate
borrowings is the flexibility obtained regarding lower overall cost as compared
with fixed-rate borrowings.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The financial statements and supplementary financial information required
to be filed under this Item are presented on pages 55 through 90 of this Annual
Report on Form 10-K/A, and are incorporated herein by reference.

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

The following table sets forth the names, ages and titles of the Company's
directors and executive officers as of October 2, 1998.

36
<PAGE>

Year Term As
Director Will
Name Age Position(s) Expire
---- --- ----------- -------------
<S> <C> <C> <C>
Mark A. Willis 30 Chairman of the Board , Director 2000

Mitchell H. Bodian 47 President, Chief Executive Officer, 1998
Director

Dean H. Fisher 47 Senior Vice President, General
Counsel and Secretary

David L. Kerr 45 Chief Financial Officer

James T. Harris 39 Director 2000

John Isaac "Ike" Epley 32 Director 1999

Ronald J. Salazar 50 Director 1998

Zane Russell 33 Director 1999

Robert H. Turner 50 Director 1998
</TABLE>

Mark A. Willis has served as Chairman of the Board and a director of the
Company since March 1998. Mr. Willis founded the Willis Group, an investment
fund, in 1997 and serves as its President. The fund has made investments in
industries such as offshore oil platform equipment, geophysical services, oil
and gas production, telecommunications, and an aircraft parts supplier. Before
forming the Willis Group, Mr. Willis worked at Eagle USA Airfreight, an air
freight forwarder, for two and a half years, where he rose to the position of
Regional Sales and Marketing Manager. Before that, Mr. Willis served as a
marketing and sales representative for Talent Tree, a temporary help agency
providing primarily clerical and office staffing services. Dr. Salazar, a
director, is married to Mr. Willis' aunt.

Mitchell H. Bodian has served as President and Chief Executive Officer
since July 1998 and as a director of the Company since March 1998. Mr. Bodian
has been the Managing Director of Bodian Associates, an investment banking firm
providing financial advisory services to middle market companies, since 1990.
Bodian Associates specializes in providing merger and acquisition services to
niche telecommunications services providers. In October 1996, Mr. Bodian was
appointed as Chapter 11 Trustee for Conectco, a switchless reseller that sold
telephone debit cards and provided one plus telecommunications services, and
that filed for the protection under the United States bankruptcy laws in August
1996. Mr. Bodian has approximately twenty years of experience in management
consulting and investment banking with Kearney Management Consultants, Warburg
Paribas Becker and Merrill Lynch. Mr. Bodian holds an MBA from Stanford
Business School.

Dean H. Fisher became Vice President and General Counsel of EqualNet in May
1993, Senior Vice President in November 1994 and Secretary in January 1995. In
January 1995 Mr. Fisher was elected Senior Vice President, Secretary and General
Counsel of the Company. He has also served as director of EqualNet from July
1991 to April 1998. From May 1976 to June 1993, Mr. Fisher was engaged in the
private practice of law in Houston, Texas, serving as President of Fisher &
Readhimer, P. C. from April 1985 to June 1993.

37
<PAGE>

David L. Kerr has been an officer of the Company since September 1998. Mr.
Kerr holds an Accounting and Business Administration degree from Mississippi
State University and is a licensed general securities representative. Mr. Kerr
was a partner with KPMG from 1987 to 1995 serving clients primarily in the
energy industry, providing tax consultation services and consulted on merger and
acquisition transactions. In 1995, Mr. Kerr co-founded Omni Ventures, LLC
("Omni"), a venture capital and investment banking firm. Mr. Kerr joined
Equalnet Communications in September 1998 as interim Chief Financial Officer.

James T. Harris, C.P.A. has served as a director of the Company since March
1998. Mr. Harris has specialized in assisting high net worth individuals as
well as small and medium sized business owners through his own firm, James T.
Harris, C.P.A., since 1992. Mr. Harris is the Treasurer of the Willis Group.
Before beginning his own firm, Mr. Harris served as Manager of Management
Consulting with the firm of Hein + Associates, where he specialized in
consulting in the areas of profit improvement, management, mergers and
acquisitions, incentive plans, systems and implementation, financial planning
and tax planning and compliance.

John Isaac "Ike" Epley has served as a director of the Company since March
1998. Mr. Epley has been a Managing Director of Omni Ventures, L. L. C., a
venture capital and investment banking firm, since August 1995. He also has
been a Managing Director of Omni Securities, L. L. C. , a registered
broker/dealer, since its inception in November 1997. He is a registered
Principal and General Securities Representative. Mr. Epley served as Vice
President of Alex Brown & Sons, an investment banking firm in Houston, from
January 1993 to 1995 where Mr. Epley focused on institutional fixed income
sales. His clients included large multinational companies, financial
institutions, insurance companies and money management firms.

Ronald J. Salazar, Ph.D. has served as a director of the Company since
March 1998. Dr. Salazar received his Ph.D. in business administration from the
University of Texas in 1990 in the area of Strategic Management and Competitive
Strategy. Since 1995, Dr. Salazar has been a partner in the management
consulting firm of Palladian Analysis & Consulting, L. L. C. in Houston, Texas.
Prior to that Dr. Salazar was an assistant professor at the University of
Houston and Idaho State University since 1988 teaching management courses. Dr.
Salazar is married to Mr. Mark Willis' (Chairman of the Board of Directors)
aunt.

Zane Russell has served as a director of the Company since January 1995.
Mr. Russell co-founded EqualNet in July 1990 and served as President and
director since that time until November 1994 when he assumed the position of
Chairman of the Board and Chief Executive Officer until March 1998. He has also
served as the President of the Company from January 1995 until March 1998.
Prior to the formation of EqualNet, from January to July 1990, he was a
commercial accounts manager for American Telco Long Distance, a regional long
distance carrier From November 1989 to November 1990, Mr. Russell served as
project manager for Natkin Mechanical, a construction company.

Robert H. Turner has served as a director of the Company since March 1998
and as President and Chief Executive Officer of the Company from March 1998 to
July 1998. Mr. Turner was removed as President and Chief Executive Officer for
cause by the Board of Directors of the Company in July 1998. Mr. Turner served
as President and Chief Executive Officer of EON Corporation, a U.S. national and
international wireless data services provider, from 1996 to 1998. Mr. Turner
further served as President and Chief Executive Officer of Telezone Inc., a
Canadian national wireless services provider, from 1994 to 1995. From 1991 to
1993 Mr. Turner also served as President and Chief Executive Officer of PTT
Telecom Netherlands US, Inc., the American subsidiary of Holland's Post and
Telephone Company providing international long distance, carrier transit,
calling card, private line, facilities management and information management
services.

38
<PAGE>

Section 16(a) Beneficial Ownership Reporting Compliance

Based solely on a review of reports on Forms 3 and 4 and amendments thereto
furnished to the Company during its most recent fiscal year and written
representations from certain reporting persons that no report on Form 5 was
required, the Company believes that during the fiscal year ended June 30, 1998,
all officers, directors and greater than 10% shareholders complied with all
filing requirements applicable to them, except that Messrs. Dean Fisher and
James Harris failed to file timely form 5's. Delinquent form 5's were completed
and filed on October 12, 1998.

ITEM 11. EXECUTIVE COMPENSATION

SUMMARY COMPENSATION TABLE

The following table summarizes compensation information concerning the
Chief Executive Officer and each of the Company's most highly compensated
executive officers as to whom the total annual salary and bonus for the fiscal
year ended June 30, 1998 exceeded $100,000 (the "Named Executive Officers").

<TABLE>
<CAPTION>
Annual Compensation
Name and Fiscal Common Stock All Other
Principal Position Year Salary Bonus Underlying Options Compensation(1)

<S> <C> <C> <C> <C> <C>
Hal Turner 1998 $100,961 - - $3,076
former Chief Executive Officer 1997 -
1996 -

Zane Russell 1998 142,931 - 90,000 6,073
former Chairman of the Board and 1997 178,000 - 90,000 3,498
former President 1996 178,000 - - 4,249

Michael L. Hlinak 1998 175,182 - 90,000 6,434
former Executive Vice President, 1997 155,000 - 90,000 3,607
Chief Financial Officer and Chief 1996 128,000 - - 6,576
Operating Officer

Dean H. Fisher 1998 129,800 - - 6,059
Senior Vice President, General 1997 129,000 - 35,000 3,451
Counsel and Secretary 1996 128,000 - - 6,097
</TABLE>

- ----------------------
(1) Represents contributions in 1996 by the Company under the Company's 401(k)
Plan for Messrs. Russell, Hlinak and Fisher of $1,676, $2,477 and $1,676,
respectively, and health insurance premiums paid by the Company for Messrs.
Russell, Hlinak and Fisher of $4,572, $4,100 and $4,421, respectively.
Represents contributions in 1997 by the Company under the Company's 401(k)
Plan for Messrs. Russell, Hlinak and Fisher of $1,676, $1,785, and $1,676,
respectively, and health insurance premiums paid in 1997 by the Company for
Messrs. Russell, Hlinak and Fisher of $1,823, $1,823, and $1,775,
respectively. Represents contributions in 1998 by the Company under the
Company's 401(k) Plan for Messrs. Russell, Hlinak and Fisher of $2,651,
$661, and $3,894, respectively, and health insurance premiums paid in 1998
by the Company for Messrs. Turner, Russell, Hlinak and Fisher of $3,076,
$3,422, $5,773, and $2,165, respectively.

39
<PAGE>

OPTION GRANTS IN FISCAL 1998

Equalnet did not grant options to any of the Named Executive Officers during
fiscal 1998. The following table sets forth information regarding the value of
unexercised warrants and options held by the Named Executive Officers. None of
the Named Executive Officers exercised any warrants or options in fiscal year
1998.

<TABLE>
<CAPTION>
NUMBER OF SHARES OF
COMMON STOCK UNDERLYING UNEXERCISED WARRANTS AND VALUE OF UNEXERCISED
OPTIONS AT JUNE 30, 1998 IN THE MONEY WARRANTS AND OPTIONS AT JUNE 30, 1998 (1)
NAME EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
------------------- ----------------------- ------------------- -------------------------
<S> <C> <C> <C> <C>
Robert H. Turner --- --- --- ---

Zane Russell 90,000 --- $5,400 ---
Michael L. Hlinak 90,000 --- $5,400 ---
Dean H. Fisher 35,000 --- --- ---
</TABLE>
(1) The value of each unexercised in-th e-money warrant or option is equal to
the difference between the closing price of the common stock on the Nasdaq
National Market on June 30, 1998 of $2.06 per share and the exercise price
of the warrant or option.

COMPENSATION OF DIRECTORS

Each non-employee director is paid $20,000 per year, plus $1,500 for each
meeting of the Board which he personally attends, $1,500 for each meeting of a
committee of the Board which he personally attends and $500 for each meeting in
which he participates by telephone. All non-employee directors of the Company
are reimbursed for ordinary and necessary expenses incurred in attending Board
or committee meetings. The Company has adopted the Director Plan, as amended in
May 1998, pursuant to which each non-employee director receives options to
purchase a number of shares of Common Stock equal to $60,000 divided by the
average of the highest and lowest price of the Common Stock the day before the
date of his election as a director ("Fair Market Value") and options to purchase
a number of shares of Common Stock equal to $30,000 divided by the Fair Market
Value of the Common Stock the day before each annual meeting of the Company's
shareholders for each year thereafter. These options have an exercise price
equal to the Fair Market Value of the Common Stock and the initial grants vest
over three years in 33-1/3% increments and the annual grants vest in six months
from the date of grant. Employee directors of the Company do not receive any
additional compensation from the Company for their services as directors.

SEVERANCE AGREEMENTS

Employment agreements with Mr. Zane Russell and Mr. Michael Hlinak were
terminated during the second half of fiscal 1998. Payments due to Mr. Russell
and Mr. Hlinak are described in Note 15 to the consolidated financial
statements.

40
<PAGE>

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The following table sets forth information as of October 2, 1998 (unless
indicated otherwise), with respect to the beneficial ownership of the Common
Stock and the Series A, Series B, Series C and Series D Preferred of the Company
by (1) persons known to the Company to be the beneficial owners of more than 5%
of any class of capital stock of the Company, (2) each director and Named
Executive Officer of the Company and (3) all directors and executive officers of
the Company as a group.

<TABLE>
<CAPTION>
COMMON STOCK (1) SERIES A PREFERRED(2) SERIES B PREFERRED SERIES C PREFERRED(2)
----------------------- --------------------- ------------------- ---------------------
DIRECTORS, EXECUTIVE NUMBER PERCENT NUMBER PERCENT NUMBER PERCENT NUMBER PERCENT
OFFICERS AND 5.0% OF OF OF OF OF OF OF OF
STOCKHOLDERS SHARES CLASS(3) SHARES CLASS SHARES CLASS SHARES CLASS
- -------------------- ------ -------- ------ ------- ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C> <C>
Michael T. Willis 25,031,082 (4) 68.2% - - - - -
5005 Woodway,
Suite 350
Houston, Texas 77056
James T. Harris 24,831,082 (4)(7) 68.6% - - - - -
5005 Woodway,
Suite 350
Houston, Texas 77056
Willis Group, LLC 24,531,082 (4) 67.8% - - - - -
5005 Woodway, Suite 350
Houston, Texas 77056
Mark A. Willis 24,531,082 (4) 67.8% - - - - -
5005 Woodway,
Suite 350
Houston, Texas 77056
James R. Crane 3,570,000 (5) 19.2% - - - - -
15350 Vickery Drive
Houston, Texas 77032
MCM Partners 2,082,000 (6) 10.2% 2,000 100% - - -
10500 NE 8th, Suite 1920
Bellevue, Washington
98004
Genesee Fund Limited 7,833,116 (8) 29.9% - - - - -
Portfolio B
10500 NE 8th, Suite 1920
Bellevue, Washington
98004
Advantage Fund Limited 9,397,500 (9) 33.9% - - - - -
10500 NE 8th, Suite 1920
Bellevue, Washington
98004
SA Telecommunications, 1,950,730 (10) 9.7% - - - - 196,533 100%
Inc
1600 Promenade Center,
15th Floor
Richardson, Texas 75080
The Furst Group, Inc 1,822,000 (11) 9.2% - - 3,000 100% -
459 Oakshade Road
Shamong, New Jersey
08088
James D. Kaylor 1,822,000 (11) 9.2% - - - - -
916 P Street, Suite 200
Lincoln, Nebraska 68508
John S. Streep 1,822,000 (11) 9.2% - - - - -
15841 Kilmarnock Drive
Ft. Myers, Florida 33912
Mitchell H. Bodian - - - - - - -
1250 Wood Branch Park Dr.
Houston, Texas 77079
Robert H. Turner - - - - - - -
1250 Wood Branch Park Dr.
Houston, Texas 77079
Zane Russell 1,047,556 (7)(12) 5.7% - - - - -
20607 Shadow Mill Court
Houston, Texas 77450
Dean H. Fisher 267,602 (13) 1.5% - - - - -
1250 Wood Branch Park Dr.
Houston, Texas 77079
Michael L. Hlinak 90,000 (15)* - - - - - -
1250 Wood Branch Park Dr.
Houston, Texas 77079
John Isaac "Ike" Epley - - - - - - -
1250 Wood Branch Park Dr.
Houston, Texas 77079
Ronald J. Salazar, Ph.D. - - - - - - -
1250 Wood Branch Park Dr.
Houston, Texas 77079
Frank Hevrdejs 1,400,000 (14) 7.6% - - - - -
8 Greenway Plaza
Houston, Texas 77046
Current directors and 25,846,240 (16) 71.2% - - - - -
executive officers as a
group (9 persons)

SERIES D PREFERRED(2)
---------------------
DIRECTORS, EXECUTIVE NUMBER PERCENT
OFFICERS AND 5.0% OF OF
STOCKHOLDERS SHARES CLASS
-------------------- ------ -------
<S> <C> <C>
Michael T. Willis 1,875 50%
5005 Woodway,
Suite 350
Houston, Texas 77056
James T. Harris 1,875 50%
5005 Woodway,
Suite 350
Houston, Texas 77056
Willis Group, LLC 1,875 50%
5005 Woodway, Suite 350
Houston, Texas 77056
Mark A. Willis 1,875 50%
5005 Woodway,
Suite 350
Houston, Texas 77056
James R. Crane - -
15350 Vickery Drive
Houston, Texas 77032
MCM Partners - -
10500 NE 8th, Suite 1920
Bellevue, Washington
98004
Genesee Fund Limited - -
Portfolio B
10500 NE 8th, Suite 1920
Bellevue, Washington
98004
Advantage Fund Limited 1,875 50%
10500 NE 8th, Suite 1920
Bellevue, Washington
98004
SA Telecommunications, - -
Inc
1600 Promenade Center,
15th Floor
Richardson, Texas 75080
The Furst Group, Inc - -
459 Oakshade Road
Shamong, New Jersey
08088
James D. Kaylor - -
916 P Street, Suite 200
Lincoln, Nebraska 68508
John S. Streep - -
15841 Kilmarnock Drive
Ft. Myers, Florida 3391
Mitchell H. Bodian - -
1250 Wood Branch Park Dr
Houston, Texas 77079
Robert H. Turner - -
1250 Wood Branch Park Dr
Houston, Texas 77079
Zane Russell - -
20607 Shadow Mill Court
Houston, Texas 77450
Dean H. Fisher - -
1250 Wood Branch Park Dr
Houston, Texas 77079
Michael L. Hlinak - -
1250 Wood Branch Park Dr
Houston, Texas 77079
John Isaac "Ike" Epley - -
1250 Wood Branch Park Dr
Houston, Texas 77079
Ronald J. Salazar, Ph.D. - -
1250 Wood Branch Park Dr
Houston, Texas 77079
Frank Hevrdejs - -
8 Greenway Plaza
Houston, Texas 77046
Current directors and - -
executive officers as a
group (9 persons)
</TABLE>

41
<PAGE>

(1) Except as otherwise noted, each shareholder has sole voting and dispositive
power with respect to the shares of Common Stock.
(2) Except under limited circumstances, the holders of the Series A Preferred,
Series C Convertible Preferred Stock and Series D Preferred are not
entitled to vote.
(3) For purposes of calculating the beneficial ownership of each stockholder,
it was assumed (in accordance with the Securities and Exchange Commission's
definition of "beneficial ownership") that such stockholder had exercised
all options or warrants, or converted any convertible securities, by which
such stockholder had the right, within 60 days following October 2, 1998,
to acquire shares of Common Stock. It was further assumed that in each
case, such exercise or conversion occurred on October 2, 1998.
(4) Includes warrants exercisable for an aggregate of 933,116 shares of Common
Stock, 1,875 shares of Series D Convertible Preferred Stock convertible in
the aggregate into approximately 9,375,000 shares of Common Stock and a
Note convertible in the aggregate into approximately 7,500,000 shares of
Common Stock. Michael T. Willis holds directly a warrant for the purchase
of 500,000 shares of Common Stock and James T. Harris holds 300,000 shares
of Common Stock directly as the result of a transfer from Willis Group,
LLC. None of such shares was outstanding as of October 2, 1998.
Information relating to ownership by Willis Group, LLC and

42
<PAGE>

Messrs. Michael T. Willis, Mark A. Willis and James T. Harris is based on
reports on Schedule 13D filed with the Securities and Exchange Commission
on October 10 and October 14, 1997. Michael T. Willis and Mark A. Willis
each own 48.5% of the membership interest in Willis Group, LLC and Mr.
Harris owns the remaining 5% membership interest. Michael T. Willis is the
Secretary of Willis Group, LLC, Mark A. Willis is the President of Willis
Group, LLC and Mr. Harris is the Treasurer of Willis Group, LLC. According
to the report, Willis Group, LLC has sole voting and dispositive power with
respect to all shares other than shares or warrants held directly and
Messrs. Michael T. Willis, Mark A. Willis and Harris have shared voting and
dispositive power with respect to all shares other than shares or warrants
held directly.
(5) Includes a warrant exercisable for an aggregate of 170,000 shares of Common
Stock, none of which had been issued as of October 2, 1998. Information
relating to ownership by James R. Crane is based on reports on Schedule 13D
filed with the Securities and Exchange Commission on May 6, 1998.
(6) Consists of 2,000 shares of Series A Preferred currently convertible in the
aggregate into approximately 2,082,000 shares of Common Stock..
(7) Excludes 5,000 shares of Common Stock issuable upon exercise of stock
options awarded under the Director Plan that are not exercisable within 60
days.
(8) Includes a warrant exercisable for an aggregate of 333,116 shares of Common
Stock and a Note convertible into an aggregate of approximately 7,500,000
shares of Common Stock.
(9) Includes 1,875 shares of Series D Convertible Preferred Stock convertible
in the aggregate into approximately 9,375,000 shares of Common Stock.
(10) Includes 196,553 shares of Series C Convertible Preferred Stock
convertible in the aggregate into 1,965,530 shares of Common Stock.
(11) Includes 3,000 shares of Series B Convertible Preferred Stock convertible
in the aggregate into 1,500,000 shares of Common Stock. Information
relating to ownership by TFG, James D. Kaylor and John S. Streep is based
on management's information regarding the transactions. Messrs. Kaylor and
Streep each own 45% of the Common Stock of TFG. Mr. Kaylor is the Chairman
of the Board of TFG and Mr. Streep is the Chief Executive Officer of TFG.
(12) Includes a warrant exercisable for an aggregate of 90,000 shares of Common
Stock.
(13) Includes options exercisable for an aggregate of 35,000 shares of Common
Stock. Excludes 40,000 shares of Common Stock held by trusts for the
benefit of Mr. Fisher's children. Mr. Fisher has disclaimed any beneficial
ownership of these shares.
(14) Includes beneficial ownership of warrants exercisable for an aggregate of
66,667 shares of Common Stock.
(15) Includes a warrant exercisable for an aggregate of 90,000 shares of Common
Stock.
(16) See Notes 3, 4, 7, 12 and 13 above.

* Less than 1%.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

In February 1997, the Company issued to The Furst Group, Inc. ("TFG") (i)
a subordinated note in the principal amount of $3 million, bearing interest at
10% per annum, due December 31, 1998 (the "TFG Note"), (ii) warrants exercisable
for the purchase of 1.5 million shares of Common Stock at $2.00 per share (the
"TFG Warrants") and (iii) a Right in the Event of a Change of Control (the "TFG
Right"), all for an aggregate consideration of approximately $2,210,000 in cash
and $790,000 in credit towards the purchase of long-distance services from
Sprint Communications Company, L. P. ("Sprint"). In connection with this
transaction, the Company began utilizing, effective November 1, 1996, TFG's
contract with Sprint for the purchase of long-distance services. TFG
beneficially owns more than five percent of the Company's voting securities.
During fiscal 1997, the Company purchased approximately $1.5 million of long-
distance services from Sprint under this contract. During fiscal 1998, the
Company purchased approximately $2.2 million of long-distance services from
Sprint under this contract. The TFG Note is secured by all of the accounts and
general intangibles of the Company. As of October 27, 1997, the TFG Warrants
had not been exercised. The TFG Right provides that TFG will receive
approximately 11.5% of the fair market value of consideration provided in the
event Equalnet engages in certain significant transactions within two years of
the date of the TFG Right. Transactions that would trigger

43
<PAGE>

the TFG Right include Equalnet's consolidation with, or merger with or into
another person other than TFG and the sale by Equalnet or its subsidiaries of a
significant portion of the Company's assets.

On March 6, 1998, the shareholders of the Company approved certain
transactions detailed below:

On March 6, 1998 as a result of various transactions, the Willis Group and its
affiliates gained control of the Board of Directors of the Company, having
nominated for shareholder approval four of the seven members of the Board of
Directors. Willis Group, LLC beneficially owns more than five percent of the
Company's voting securities. Mark A. Willis, the Chairman of the Board of
Directors of the Company, owns a 48.5% membership interest in Willis Group, LLC.

Under the terms of the Agreements the Company acquired nine telecommunications
switches (the "Switches") from the Willis Group for $7.6 million of aggregate
consideration, consisting of $5.85 million in cash, 1.4 million shares of Common
Stock, and warrants to purchase an additional 0.4 million shares of Common
Stock. The Company secured financing of $6.05 million for the cash portion of
the consideration through an unaffiliated third party lender, which loan is
secured by the Switches, bears interest at a rate per year of 6.42% above an
index rate based on U.S. Treasury Notes (the loan interest rate currently is
12.1%) and is payable in 36 consecutive monthly payments. In addition, Mike
Willis, a member of the Willis Group and father to Mark Willis, was granted 0.5
million warrants for guaranteeing a portion of this financing.

Under the terms of the Agreements, the Company acquired Netco Acquisition Corp.
("Netco"), a Delaware corporation controlled by the Willis Group, which held
certain intangible rights and assets previously acquired by the Willis Group and
formerly held by Total National Telecommunications. These assets consisted of
intangible rights to use certain software and codes necessary to operate the
Switches. The Company acquired Netco for $5.6 million in aggregate
consideration, including 3.58 million shares of Common Stock and 2,000 shares of
the Company's Series A Convertible Preferred Stock ("Series A Preferred".) MCM
Partners, the holder of all 2,000 shares of series A Preferred stock,
beneficially owns more than five percent of Equalnet's voting securities.
Mitchell H. Bodian, President, Co-Chief Executive Officer, principal financial
officer and a director of Equalnet, has been a consultant, on a fee basis, for
MCM Partners and its affiliates for several years. The Series A Preferred is
non-voting and has a stated value of $1,000 per share and is entitled to
received dividends at the rate of $80.00 per share per year, payable quarterly.
Holders of Series A Preferred have the right to convert their shares into Common
Stock initially at the rate of 1,000 shares of Common Stock per share of Series
A Preferred (or the stated value divided by $1.00), or an aggregate of 2.0
million shares of Common Stock, subject to adjustment pursuant to certain anti-
dilution provisions. The Series A Preferred has a $1,000 per share liquidation
preference over the Company's Common Stock. Dividends are payable at the
determination of the Board of Directors. Dividends when not paid are cumulative
and bear interest at a rate of 12.0%. Cumulative dividends in arrears at June
30, 1998 were $52,000 or $25.78 per Series A Preferred share. Under the
instrument defining the rights of the holders of the Series A Preferred, the
Company is

44
<PAGE>

prohibited from declaring or paying dividends on the Common Stock unless all
accrued dividends on the Series A Preferred have been paid.

Under the terms of the Agreements, the Company also issued and sold to the
Willis Group 4.0 million shares of Common Stock at a price of $1.00 per share in
cash.

On March 6, 1998, the Company entered into an exchange agreement ("Exchange
Agreement") with The Furst Group, ("Furst"), a New Jersey corporation, an
accredited investor and the holder of the Company's $3.0 million subordinated
debt, pursuant to which Furst exchanged the $3.0 million 10% subordinated note
due December 31, 1998 and warrants to purchase 1.5 million shares of Common
Stock for 3,000 shares of Series B Senior Convertible Preferred Stock ("Series B
Preferred") along with 0.3 million shares of the Company's Common Stock to
satisfy the accrued interest due on the notes. Each share of the Series B
Preferred has a stated value of $1,000 and is entitled to share with the Common
Stock in any dividends declared based upon the number of shares of Common Stock
the Series B is convertible into at the time such dividend is declared. Each
share of Series B Preferred is convertible into 500 shares of Common Stock,
subject to certain anti-dilution provisions. The Series B Preferred has a
$1,000 per share liquidation preference over the Series A Preferred and the
Common Stock. Each share of Series B Preferred also entitles the holder thereof
to one vote, voting as a single class with the Common Stock, on matters
submitted to the shareholders of the Company.

Effective July 31, 1998, the Company issued two 6% Senior Secured
Convertible Notes due in 2001 (the "2001 Notes") in the amount of $1.5 million
each to the Willis Group and Genesee Fund Limited-Portfolio B ("Genesee"), a
British Virgin Islands corporation, both accredited investors. The 2001 Notes
are convertible into a variable number of shares of the Company's Common Stock.
Ownership percentage upon conversion is currently limited to no more than 4.9%
of the outstanding Common Stock. The 2001 Notes bear interest at 6% and
interest payments are due each February 15, May 15, August 15 and November 15
commencing on November 15, 1998.

The 2001 Notes rank equally with all other unsubordinated debt obligations
of the Company. The Company's obligations under the 2001 Notes are secured by
certain collateral pursuant to security agreements. A holder of the 2001 Note
may require the Company to repurchase the 2001 Note if an event of default
occurs. Events of default include among other things, the Nasdaq delisting of
the Common Stock. A default under either of these 2001 Notes could have a
material adverse effect on the Company's ability to raise additional capital and
on the results of operations or financial condition.

In connection with the issuance of the 2001 Notes, the Company issued to each of
the Willis Group and Genesee a warrant ("Warrant") to purchase 333,116 shares of
Common Stock at a purchase price of $0.9006 per share. In addition, the Company
issued to the Willis Group and Advantage Fund Limited 3,750 shares of its Series
D Convertible Preferred Stock ("Series D Preferred") in exchange for 3.0 million
shares of its Common Stock and $0.2 million. The Warrants expire on September
4, 2003.

Any holder of a 2001 Note may convert the 2001 Note, in whole or in part,
into shares of Common Stock at a conversion price per share equal to the lesser
of:

45
<PAGE>

. $0.9006 (subject to reduction pursuant to the terms of the 2001
Notes).

Holders of shares of Series D Preferred will have the right to convert each
of their shares into a number of shares of Common Stock equal to the quotient
of:

. an amount equal to the lesser of:

. the product of (1) the average of the lowest sales price of the Common
Stock on Nasdaq for any five trading days during the 25 trading days
immediately preceding the conversion date and (2) 85% (subject to
downward adjustment, if applicable, pursuant to the Series D Preferred
documents); and

. $1.2281 (subject to reduction pursuant to the Series D Preferred
documents),

subject to adjustment pursuant to the anti-dilution provisions.

46
<PAGE>

PART IV

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

(A) DOCUMENTS INCLUDED IN THIS REPORT:

1. FINANCIAL STATEMENTS PAGE

<TABLE>
<S> <C>
Report of Independent Auditors...................... 54
Consolidated Balance Sheets as of June 30, 1997 and
1998............................................... 55
Consolidated Statements of Operations for the years
ended June 30, 1996, 1997 and 1998................ 57
Consolidated Statements of Shareholders' Equity
(Deficit) for the years ended June 30, 1996, 1997
and 1998........................................... 58
Consolidated Statements of Cash Flows for the years
ended June 30, 1996, 1997 and 1998................. 60
Notes to Financial Statements....................... 61
2. FINANCIAL STATEMENT SCHEDULES
</TABLE>

Schedule II

(B) REPORTS ON FORM 8-K:

On March 10, 1998, the Company filed with the Securities and Exchange Commission
a Current Report on Form 8-K reporting, under Items 1, 5 and 7, the change of
control of the Company and the Transactions described in this report. The
Company included a pro forma balance sheet as of January 31, 1998 after giving
effect to the Transactions, in that report.

On September 21, 1998, the Company filed with the Securities and Exchange
Commission a Current Report on Form 8-K reporting, under Item 3, the filing for
protection under Chapter 11 of the Bankruptcy Code for EqualNet Corporation and
Wholesale Services Inc.

Exhibits designated by the symbol * were filed with the Company's Annual
Report on Form 10-K filed on October 13, 1998. All exhibits not so
designated are incorporated by reference to a prior filing as indicated,
unless otherwise noted.

The Company undertakes to furnish to any shareholder so requesting a copy
of any of the following exhibits upon payment to the Company of the
reasonable costs incurred by the Company in furnishing any such exhibit.

47
<PAGE>

EXHIBIT NO. DESCRIPTION

3.1 Articles of Incorporation of the Registrant (incorporated by reference to
Exhibit 3.1 to Amendment No. 1 to the Registrant's Registration
Statement on Form S-1 (Registration No. 33-88742); filed on February
13, 1995).

3.2 Bylaws of the Registrant (incorporated by reference to Exhibit 3.2 to the
Registrant's Registration Statement on Form S-1 (Registration No. 33-
88742); filed on January 24, 1995).

4.1 $1,000,000 Note dated October 1, 1997, issued by the Company to the Willis
Group (incorporated by reference to exhibit 4.1 of the Company's
Quarterly Report on Form 10-Q for the quarter ended 12/31/97).

4.2 Loan and Security Agreement, dated March 6, 1998, between the Company and
Finova Capital Corporation (incorporated by reference to exhibit 4.2
of the Company's Quarterly Report on Form 10-Q for the quarter ended
3/31/98).

10.1 Lease Agreement dated June 28, 1994, between EqualNet and Caroline
Partners, Ltd., as amended by First Amendment dated August 15, 1994,
and Second Amendment dated September 8, 1994 (incorporated by
reference to Exhibit 10.6 to Registrant's Registration Statement on
Form S-1 (Registration No. 33-88742) filed on January 24, 1995).

10.2 Financing agreement between Receivables Funding Corporation and EqualNet
Holding Corporation, dated June 18, 1997 (incorporated by reference to
Exhibit 10.17 to Amendment 2 to the Registrant's Annual Report on Form
10-K for the year ended June 30, 1997, filed on October 28, 1997)

10.3 Carrier Agreement between AT & T and EqualNet Corporation, dated May 13,
1997 (certain confidential portions of this exhibit have been omitted
pursuant to a request for confidential treatment pursuant to Rule 246-
2 under the Securities Exchange Act of 1934, incorporated by reference
to Exhibit 10.18 to Amendment 2 to the Registrant's Annual Report on
Form 10-K for the year ended June 30, 1997, filed on October 28, 1997)

10.4 Subscription Agreement, dated as of July 1, 1997, among the Company and
Lexus Commercial Enterprises, Ltd. (incorporated by reference to
exhibit 10. 1 of the Company's Quarterly Report on Form 10-Q for the
quarter ended 9/30/97).

10.5 Secured Promissory Note, dated as of July 1, 1997, made by Lexus
Commercial Enterprises, Ltd. In favor of the Company (incorporated by
reference to exhibit 10.2 of the Company's Quarterly Report on Form
10-Q for the quarter ended 9/30/97).

10.6 Note and Warrant Purchase Agreement, dated October 1, 1997, by and among
the Company and the Willis Group, as amended February 12, 1998
(incorporated by reference to exhibit 10.1 of the Company's Quarterly
Report on Form 10-Q for the quarter ended 12/31/97).

10.7 Switch Agreement, dated December 2, 1997, between the Company and the
Willis Group, as amended by the First Amendment dated December 19,
1997, and Second Amendment dated February 12, 1998 (incorporated by
reference to exhibit 10.2 of the Company's Quarterly Report on Form
10-Q for the quarter ended 12/31/97).

48
<PAGE>

10.8 Agreement of Merger and Plan of Reorganization, dated December 2, 1997,
between the Company and EQ Acquisition Sub. Inc., Netco Acquisition,
LLC and Netco Acquisition Corp., as amended by the First Amendment
dated December 19, 1997, and Second Amendment dated February 12, 1998
(incorporated by reference to exhibit 10.3 of the Company's Quarterly
Report on Form 10-Q for the quarter ended 12/31/97).

10.9 Stock Purchase Agreement, dated December 2, 1997, by and among the Company
and the Willis Group., as amended by the First Amendment dated
December 19, 1997, (incorporated by reference to exhibit 10.4 of the
Company's Quarterly Report on Form 10-Q for the quarter ended
12/31/97).

10.10 Exchange Agreement, dated March 6, 1998 between the Company and The Furst
Group, Inc. (incorporated by reference to exhibit 10.5 of the
Company's Quarterly Report on Form 10-Q for the quarter ended
3/31/98).

10.11 Stock and Warrant Purchase Agreement dated March 26 1998, between the
Company and First Sterling Ventures Corp. and Frank Hevrdejs
(incorporated by reference to exhibit 10.6 of the Company's Quarterly
Report on Form 10-Q for the quarter ended 3/31/98).

10.12 Stock Purchase Warrant dated March 26 1998, between the Company and First
Sterling Ventures Corp. (incorporated by reference to exhibit 10.7 of
the Company's Quarterly Report on Form 10-Q for the quarter ended
3/31/98).

10.13 Stock Purchase Warrant dated March 26 1998, between the Company and Frank
Hevrdejs (incorporated by reference to exhibit 10.8 of the Company's
Quarterly Report on Form 10-Q for the quarter ended 3/31/98).

10.14 Stock and Warrant Purchase Agreement dated April 24, 1998, between the
Company and James R. Crane (incorporated by reference to exhibit 10.9
of the Company's Quarterly Report on Form 10-Q for the quarter ended
3/31/98).

10.15 Registration Rights Agreement dated April 24, 1998, between the Company
and James R. Crane (incorporated by reference to exhibit 10.10 of the
Company's Quarterly Report on Form 10-Q for the quarter ended
3/31/98).

10.16 Warrant Agreement dated April 24, 1998, between the Company and James R.
Crane (incorporated by reference to exhibit 10.11 of the Company's
Quarterly Report on Form 10-Q for the quarter ended 3/31/98).

10.17 Purchase Agreement dated January 15, 1998 between the Company and SA
Telecommunications, Inc. and Certain of its Subsidiaries as amended by
Amendment dated March 10, 1998 (incorporated by reference to exhibit
10.12 of the Company's Quarterly Report on Form 10-Q for the quarter
ended 3/31/98).

10.18 Management Services Agreement dated March 12, 1998 between the Company
and SA Telecommunications, Inc. (incorporated by reference to exhibit
10.13 of the Company's Quarterly Report on Form 10-Q for the quarter
ended 3/31/98).

10.19 *Secured Convertible Note, dated September 4, 1998, issued by the Company
to Genesee Fund Limited-Portfolio B.

49
<PAGE>

10.20 *Secured Convertible Note, dated September 4, 1998, issued by the Company
to the Willis Group, LLC.

10.21 *Common Stock Purchase Warrant, dated September 4, 1998 between the
Company and Genesee Fund Limited-Portfolio B.

10.22 *Common Stock Purchase Warrant, dated September 4, 1998 between the
Company and the Willis Group, LLC.

10.23 *Note Purchase and Exchange Agreement, effective as of July 31, 1998,
between the Company and Advantage Fund Limited.

10.24 *Note Purchase and Exchange Agreement, effective as of July 31, 1998,
between the Company and the Willis Group, LLC.

10.25 *Form of 6% Senior Secured Convertible Note due 2001 attached as Annex I
to Note Purchase and Exchange Agreement in exhibits 10.23 and 10.24
above.

10.26 *Form of Series D Preferred documents of Board of Directors Establishing
and Designating Series D Convertible Preferred Stock and Fixing the
Rights and Preferences of such Series attached as Annex II to Note
Purchase and Exchange Agreements in exhibits 10.23 and 10.24 above.

10.27 *Form of Common Stock Purchase Warrant attached as Annex III to Note
Purchase and Exchange Agreements in exhibits 10.23 and 10.24 above.

10.28 *Form of Registration Rights Agreement attached as Annex V to Note
Purchase and Exchange Agreements in exhibits 10.23 and 10.24 above.

10.29 *Form of Notice of Conversion of Series D Preferred Stock of Equalnet
Communications Corp. attached as Annex VII to Note Purchase and
Exchange Agreements in exhibits 10.23 and 10.24 above.

10.30 *Form of Opinion of Counsel to be Delivered on Closing Date attached as
Annex VIII to Note Purchase and Exchange Agreements in exhibits 10.23
and 10.24 above.

10.31 *Form of Opinion of the Company's General Counsel attached as Annex IX to
Note Purchase and Exchange Agreements in exhibits 10.23 and 10.24
above.

10.32 *Form of Opinion in Connection with Security Agreement attached as Annex
X to Note Purchase and Exchange Agreements in exhibits 10.23 and 10.24
above.

10.33 *Note Purchase Agreement, effective as of July 31, 1998 between the
Company and Genesee Fund Limited-Portfolio B.

10.34 *Form of 6% Senior Secured Convertible Note due 2001 attached as Annex I
to Note Purchase Agreements in exhibits 10.33 above.

10.35 *Form of Common Stock Purchase Warrant attached as Annex II to Note
Purchase Agreements in exhibits 10.33 above.

50
<PAGE>

10.36 *Form of Registration Rights Agreement attached as Annex IV to Note
Purchase Agreements in exhibits 10.33 above.

10.37 *Form of Opinion of Counsel to be Delivered on Closing Date attached as
Annex VI to Note Purchase Agreements in exhibits 10.33 above.

10.38 *Form of Opinion of the Company's General Counsel attached as Annex VII
to Note Purchase Agreements in exhibits 10.33 above.

10.39 *Form of Opinion in Connection with Security Agreement attached as Annex
X to Note Purchase Agreement in exhibit 10.33 above.

10.40 *Letter Agreement regarding net proceeds interest dated September 4, 1998
between the Company, Netco, Genesee Fund Limited-Portfolio B and the
Willis Group, LLC.

10.41 *Master Purchase Agreement dated as of July 31, 1998 by and between the
Company, Genesee Fund Limited-Portfolio B, the Willis Group, LLC and
Advantage Fund Limited.

10.42 *Security Agreement dated as of July 31, 1998 by and among the Company,
USC Telecom, Netco, EqualNet, the Willis Group, LLC and Genesee Fund
Limited-Portfolio B.

10.43 *Assignment of Rights and Obligations Under Purchase Agreement, dated
July 21, 1998 between the Company and SA Telecom, making reference to
the Purchase Agreement in exhibit 10.18 above.

10.44 *Receivables Sales Agreement dated July 23, 1998 between USC Telecom and
RFC.

10.45 *Carrier Services Switchless Agreement, dated June 30, 1998 between
Frontier Communications of the West, Inc. and the Company, (certain
confidential portions of this exhibit have been omitted pursuant to a
request for confidential treatment pursuant to Rule 246-2 under the
Securities Exchange Act of 1934, incorporated by reference to Exhibit
10.52 to the Registrant's Annual Report on Form 10-K for the year
ended June 30, 1998, filed on October 13, 1998).

10.46 *Stock Purchase Warrant dated October 1, 1997 from the Company to the
Willis Group, LLC.

10.47 *Stock Purchase Warrant dated as of December 2, 1997 between the Company
and Netco Acquisition, LLC.

10.48 *Stock Purchase Warrant dated March 5, 1998 from the Company to the
Willis Group, LLC.

10.49 *Stock Purchase Warrant dated March 5, 1998 from the Company to Mike
Willis.

10.50 *Stock Purchase Warrant dated March 6, 1998 from the Company to J. C.
Bradford.

10.51 *Stock Purchase Warrant dated April 15, 1998 from the Company to
Mezzanine Telecom, Inc.

10.52 *Stock Purchase Warrant dated April 15, 1998 from the Company to John
Dalton.

51
<PAGE>

10.53 *Stock Purchase Warrant dated April 15, 1998 from the Company to Zane
Russell.

10.54 *Stock Purchase Warrant dated April 15, 1998 from the Company to Michael
L. Hlinak.

10.55 *Stock Purchase Warrant dated June 27, 1998 from the Company to Pacific
Global Networks, Inc.

10.56 *Stock Purchase Warrant dated June 27, 1998 from the Company to Future
Telecom Networks, Inc.

10.57 *Stock Purchase Warrant dated July 23, 1998 from the Company to RFC
Capital Corporation.

10.58 *Stock Purchase Warrant dated August 19, 1998 from the Company to Lance
Hack.

10.59 *Stock Purchase Warrant dated September 10, 1998 from the Company to RFC
Capital Corporation.

10.60 *Registration Rights Agreement dated November 12, 1996 between the
Company and Creative Communications International, Inc.

23.1 Consent of Independent Auditors.

23.2 Consent of Independent Auditors (filed herewith).

27.1 *Financial Data Schedule.

52
<PAGE>

INDEX TO FINANCIAL STATEMENTS
PAGE
----
<S> <C>
Report of Independent Auditors........................................................... 54

Consolidated Balance Sheets as of June 30, 1997 and 1998................................. 55

Consolidated Statements of Operations for the years ended

June 30, 1996, 1997 and 1998............................................................. 57

Consolidated Statements of Shareholders' Equity (Deficit) for the
years ended June 30, 1996, 1997 and 1998................................................. 58

Consolidated Statements of Cash Flows for the years ended June 30, 1996, 1997 and 1998... 60

Notes to Consolidated Financial Statements............................................... 61
</TABLE>

53
<PAGE>

REPORT OF INDEPENDENT AUDITORS

Board of Directors and Shareholders
Equalnet Communications Corp.

We have audited the accompanying consolidated balance sheets of Equalnet
Communications Corp., formerly EqualNet Holding Corp., and subsidiaries as of
June 30, 1997 and 1998, and the related consolidated statements of operations,
shareholders' equity (deficit), and cash flows for each of the three years in
the period ended June 30, 1998. Our audit also included the financial statement
schedule listed in the Index at Item 14(a). These financial statements and
schedule are the responsibility of the Company's management. Our responsibility
is to express an opinion on these financial statements and schedule based on our
audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards 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. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Equalnet
Communications Corp. and subsidiaries at June 30, 1997 and 1998, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended June 30, 1998, in conformity with generally
accepted accounting principles. Also, in our opinion, the related financial
statement schedule, when considered in relation to the basic financial
statements taken as a whole, presents fairly in all material respects the
information set forth therein.

The accompanying financial statements have been prepared assuming Equalnet
Communications Corp. and subsidiaries will continue as a going concern. As more
fully described in Notes 2 and 4, the Company has incurred recurring operating
losses, has a working capital deficiency, debt in default and an operating
subsidiary has filed for protection under Chapter 11 of the Federal Bankruptcy
Court. These conditions raise substantial doubt about the Company's ability to
continue as a going concern. Management's plans in regard to these matters are
also described in Note 4. The financial statements do not include any
adjustments to reflect the possible future effects on the recoverability and
classification of assets or the amounts and classification of liabilities that
may result from the outcome of this uncertainty.

ERNST & YOUNG LLP

Houston, Texas
October 8, 1998

54
<PAGE>

EQUALNET COMMUNICATIONS CORP.
CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>
JUNE 30, 1997 JUNE 30, 1998
------------- -------------
<S> <C> <C>
ASSETS
Current assets
Cash and equivalents $ 828,478 $ 459,581
Accounts receivable, net of allowance for doubtful accounts of
$1,450,954 at June 30, 1997 and $1,034,253 at June 30, 1998 9,048,961 5,839,284

Receivable from officers 28,367 -
Due from agents 2,907,922 1,596,590
Advance on acquisition purchase price - 3,014,000
Prepaid expenses and other 285,516 109,684
----------- -----------
Total current assets 13,099,244 11,019,139
----------- -----------
Property and equipment
Computer equipment 3,435,121 17,824,993
Office furniture and fixtures 1,209,032 1,209,032
Leasehold improvements 1,174,777 1,177,592
----------- -----------
5,818,930 20,211,617
Accumulated depreciation and amortization (3,028,768) (4,837,626)
----------- -----------
2,790,162 15,373,991
Customer acquisition costs, net of accumulated amortization of
$13,050,667 at June 30, 1997 and $13,957,622 at June 30, 1998 1,262,939 355,984

Other assets 1,027,507 1,011,333
Goodwill, net of accumulated amortization of $46,020 at June 30, 1997 982,308 -
----------- -----------
Total assets $19,162,160 $27,760,447
=========== ===========
</TABLE>

See accompanying notes.

55
<PAGE>

EQUALNET COMMUNICATIONS CORP.
CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>
June 30, 1997 June 30, 1998
------------- -------------
<S> <C> <C>
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
Current Liabilities
Payable to providers of long distance services $ 7,977,531 $ 6,627,711
Accounts payable 1,858,065 4,237,310
Accrued expenses 1,398,319 3,799,315
Accrued sales taxes 591,182 205,108
Brokerage commissions payable 151,755 39,000
Current maturities of capital lease obligations 51,000 -
Notes payable to long distance provider 1,183,059 1,183,059
Debt in default - 5,752,535
Debt in default to an affiliate - 400,000
Contractual obligations with regard to receivable sales agreement - 2,334,710
Revolving line of credit 4,555,442 -
------------ ------------
Total current liabilities 17,766,353 24,578,748
------------ ------------
Subordinated note payable 2,864,058 -
Deferred rent 220,288 223,917
Commitments and contingencies
Shareholders' equity (deficit)
Preferred stock, $0.01 par value Authorized shares - 1,000,000 at
June 30, 1997 and 5,000,000 at June 30, 1998
Series A Convertible Preferred Stock (non-voting) aggregate - 2,000,000
liquidation preference of $2.1 million at June 30, 1998: Issued
and outstanding shares - 0 at June 30, 1997 and 2,000 at June
30, 1998.
Series B Senior Convertible Preferred Stock (voting), aggregate - 3,000,000
liquidation preference of $3.0 million at June 30, 1998: Issued
and outstanding - 0 at June 30, 1997 and 3,000 at June 30, 1998.
Common stock, $.01 par value 61,738 217,935
Authorized shares - 20,000,000 at June 30, 1997 and 50,000,000 at
June 30, 1998 Issued and outstanding shares - 6,173,750 at June
30, 1997 and 21,793,517 at June 30, 1998
Treasury stock at cost: 21,750 shares at June 30, 1997 and (104,881) (817,153)
400,447 at June 30, 1998
Additional paid in capital 20,390,927 37,063,468
Stock warrants 368,000 1,763,240
Deferred compensation (245,829) (115,826)
Retained deficit (22,158,494) (40,153,882)
------------ ------------
Total shareholders' equity (deficit) (1,688,539) 2,957,782
------------ ------------
Total liabilities and shareholders' equity (deficit) $ 19,162,160 $ 27,760,447
============ ============
</TABLE>

See accompanying notes.

56
<PAGE>

EQUALNET COMMUNICATIONS CORP.
CONSOLIDATED STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
YEAR ENDED JUNE 30,
-----------------------------------------------------
1996 1997 1998
------------ ------------ ------------
<S> <C> <C> <C>
Sales $ 78,354,858 $ 46,588,496 $ 24,876,242
Cost of sales 61,807,113 34,481,128 21,991,680
------------ ------------ ------------
Gross profit 16,547,745 12,107,368 2,884,562
Selling, general and administrative expenses 13,719,573 12,453,814 14,139,010
Depreciation and amortization 5,933,890 5,999,898 4,734,741
Write down of assets 6,882,661 4,400,000 1,134,666
------------ ------------ ------------
Operating loss (9,988,379) (10,746,344) (17,123,855)
Other income (expense)
Interest income 55,546 3,685 37,006
Interest expense (679,745) (1,022,284) (1,145,262)
Other income (expense) (464,688) (870,290) 288,723
------------ ------------ ------------
(1,088,887) (1,888,889) (819,533)
Loss before federal income taxes (11,077,266) (12,635,233) (17,943,388)

Provision (benefit) for federal income taxes (2,659,853) 2,345,311 -
------------ ------------ ------------
Net loss $ (8,417,413) $(14,980,544) $(17,943,388)
============ ============ ============
Preferred stock dividends - - $ 52,000

Net loss available to common shareholders $ (8,417,413) $(14,980,544) $(17,995,388)

Net loss per share basic and diluted $(1.40) $(2.46) $(1.64)
============ ============ ============
</TABLE>

See accompanying notes.

57
<PAGE>

EQUALNET COMMUNICATIONS CORP.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT)

<TABLE>
<CAPTION>
ADDITIONAL
PREFERRED COMMON TREASURY PAID-IN
STOCK STOCK STOCK CAPITAL WARRANTS
--------- -------- --------- ----------- ---------
<S> <C> <C> <C> <C> <C>
Balance, June 30, 1995 $ - $ 60,237 $ - $20,065,199 $ -
Forfeiture of 18,182 shares of stock granted to
key employees (77,229) (122,771)
Forfeiture of 3,568 shares of stock granted to
key employees for tax withholdings payable (27,652)
Amortization of deferred compensation
Net loss $(1.40 per share)
---------- -------- --------- ----------- ----------
Balance, June 30, 1996 - 60,237 (104,881) 19,942,428 -
Common stock and warrants issued in acquisition 1,501 448,499 199,000
Stock warrants issued with debt 169,000
Amortization of deferred compensation
Net Loss $(2.46 per share)
---------- -------- --------- ----------- ----------

Balance, June 30, 1997 - 61,738 (104,881) 20,390,927 368,000
Forfeiture of 5,454 shares of stock granted to
key employees (12,272) (47,728)
Proceeds-issuance common stock & warrants 87,334 9,042,667 270,000
Preferred stock dividends
Common stock shares reacquired (700,000)
Issuance of warrants with debt 42,740
Conversion of convertible debt 3,000,000 13,733 1,528,600
Interest charge on convertible debt 150,000
Exchange of warrants for common stock (169,000)
Issuance of stock and warrants for equipment 2,000,000 50,040 4,954,092 950,000
Warrants issued under severance agreement 301,500
Issuance of stock for note receivable 5,090 1,044,910
Amortization of deferred compensation
Net loss $(1.64 per share)
---------- -------- --------- ----------- ----------

Balance, June 30, 1998 $5,000,000 $217,935 $(817,153) $37,063,468 $1,763,240
========== ======== ========= =========== ==========
</TABLE>

58
<PAGE>

<TABLE>
<CAPTION>
Retained
Deferred Earnings
Compensation (Deficit) Total
------------ --------- -----
<S> <C> <C> <C>
Balance, June 30, 1995 $(659,175) $ 1,239,463 $ 20,705,724
Forfeiture of 18,182 shares of stock granted to
key employees 200,000 -
Forfeiture of 3,568 shares of stock granted to (27,652)
key employees for tax withholdings payable
Amortization of deferred compensation 123,339 123,339
Net loss $(1.40 per share) (8,417,413) (8,417,413)
--------- ------------ ------------
Balance, June 30, 1996 (335,836) (7,177,950) 12,383,998
Common stock and warrants issued in acquisition
649,000
Stock warrants issued with debt 169,000
Amortization of deferred compensation 90,007 90,007
Net Loss $(2.46 per share) (14,980,544) (14,980,544)
--------- ------------ ------------
Balance, June 30, 1997 (245,829) (22,158,494) (1,688,539)
Forfeiture of 5,454 shares of stock granted to
key employees 60,000 -
Proceeds-issuance common stock & warrants 9,400,000
Preferred stock dividends (52,000) (52,000)
Common stock shares reacquired (700,000)
Issuance of warrants with debt 42,740
Conversion of convertible debt 4,542,334
Interest charge on convertible debt 150,000
Exchange of warrants for common stock (169,000)
Issuance of stock and warrants for equipment 7,954,132
Warrants issued under severance agreement 301,500
Issuance of stock for note receivable 1,050,000
Amortization of deferred compensation 70,003 70,003
Net loss $(1.64 per share) (17,943,388) (17,943,388)
--------- ------------ ------------
Balance, June 30, 1998 $(115,826) $(40,153,882) $ 2,957,782
========= ============ ============
</TABLE>

See accompanying notes.

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<PAGE>

EQUALNET COMMUNICATIONS CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
YEARS ENDED JUNE 30,
---------------------------------------
1996 1997 1998
------- ------ ------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net loss $ (8,417,413) $(14,980,544) $(17,943,388)
Adjustments to reconcile net loss to cash provided by
(used in) operating activities:
Depreciation and amortization 5,933,890 5,999,898 4,734,741
Provision for bad debt 3,820,701 1,726,929 1,660,594
Provision for due from agents 1,000,000 - -
Provision (benefit) for deferred income taxes (3,486,686) 2,228,077 -
Loss on sale of assets 1,508 341 -
Imputed interest on note payable - 33,058 -
Compensation expense recognized for common stock issue 123,339 90,007 70,003
Interest charge on convertible debt issued at discount - - 150,000
Warrants issued under severance agreements - - 301,500
Write down of long term assets 6,882,661 4,400,000 1,134,666
Credit from carrier - (1,200,000) -
Change in operating assets and liabilities:
Accounts receivable 2,068,102 3,596,968 1,549,082
Due from agents (3,104,424) (1,765,853) 922,042
Prepaid expenses and other (519,802) 1,467,672 (251,905)
Other assets (562,786) (479,207) (654,609)
Accounts payable and accrued liabilities (4,911,888) 2,856,222 3,457,235
------------ ------------ ------------
Net cash provided by (used in) operating activities (1,172,798) 3,973,568 (4,870,039)

INVESTING ACTIVITIES
Purchase of property and equipment (4,404,531) (272,010) (6,834,245)
Proceeds from sale of equipment 1,010 4,331 -
Advance on acquisition purchase price - - (3,014,000)
Deferred acquisition costs - - (281,417)
Purchase of customer accounts (8,468,472) (76,457) -
------------ ------------ ------------
Net cash used in investing activities (12,871,993) (344,136) (10,129,662)

FINANCING ACTIVITIES
Proceeds from long-term debt - 3,000,000 7,800,000
Repayments on long-term debt - - (297,465)
Net proceeds from (repayments on) revolving line of credit 9,601,605 (6,098,803) (4,555,441)
Net proceeds from receivable sales agreement - - 2,334,710
Proceeds from sale leaseback transaction 1,434,144 - -
Repayments on capital lease obligations (108,000) (84,000) (51,000)
Proceeds from issuance of stock - - 9,400,000
Acquisition of treasury stock (27,652) - -
------------ ------------ ------------
Net cash provided by (used in) financing activities 10,900,097 (3,182,803) 14,630,804
------------ ------------ ------------
Net increase (decrease) in cash and equivalents (3,144,694) 446,629 (368,897)
Cash and equivalents, beginning of year 3,526,543 381,849 828,478
------------ ------------ ------------
Cash and equivalents, end of year $ 381,849 $ 828,478 $ 459,581
============ ============ ============
</TABLE>

See accompanying notes.

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<PAGE>

EQUALNET COMMUNICATIONS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1998

1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

ORGANIZATION AND BUSINESS

Equal Net Communications, Inc. was incorporated in Texas on July 18, 1990.
On November 28, 1994, Equal Net Communications, Inc. changed its name to
EqualNet Corporation. Prior to its initial public offering of common stock in
1994, EqualNet formed EqualNet Holding Corp. (the "Company") as a newly
organized holding company. Subsequent to the reorganization, EqualNet
Corporation ("EqualNet") became a wholly-owned subsidiary of the Company. On
June 30, 1998, the Company changed its name from EqualNet Holding Corp. to
Equalnet Communications Corp.

The Company is a national long-distance telephone company comprised of two
operating subsidiaries, EqualNet and Netco Acquisition Corp., ("Netco"). On
March 6, 1998 the Company purchased, through Netco, nine switches and became a
switch-based reseller with leased line facilities. EqualNet utilizes AT&T Corp.
("AT&T") and Sprint Communications Company, L. P. ("Sprint"), through its
arrangement with The Furst Group, Inc. ("Furst") a privately-held reseller of
long-distance and telecommunications services, and Frontier Communications and
MCI WorldCom, to provide transmission of its customers' traffic.

Customers placed by one independent marketing agent accounted for
approximately 28%, 23% and 19% of sales in 1996, 1997 and 1998, respectively.

On July 23, 1998, the Company acquired certain assets and customer bases
from SA Telecommunications, Inc. ("SA Telecom") and formed a third operating
company, USC Telecom, Inc. ("USC Telecom"), to absorb the purchased assets.
(See also Note 19.)

On September 10, 1998, EqualNet, one of the Company's wholly-owned
subsidiaries, and Wholesale Services, Inc. ("Wholesale"), a non-operating
wholly-owned subsidiary of EqualNet, filed for protection under Chapter 11 of
the Bankruptcy Code. On October 2, 1998 Wholesale filed its motion to convert
its bankruptcy proceeding from a Chapter 11 reorganization to a Chapter 7
liquidation (See also Note 2.)

PRINCIPLES OF CONSOLIDATION

The consolidated financial statements include the accounts of Equalnet
Communications Corp. and all majority-owned subsidiaries. All significant
intercompany transactions have been eliminated.

PROPERTY AND EQUIPMENT

Computer equipment, office furniture and fixtures, and leasehold
improvements are carried at cost, less accumulated depreciation and
amortization. Depreciation and amortization are provided for by the straight-
line method over the estimated useful lives of the depreciable assets which
range from four to ten years. Leasehold improvements are amortized over the
shorter of their useful lives or the term of the lease.

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<PAGE>

CUSTOMER ACQUISITION COSTS

Customer acquisition costs represent the direct costs of an acquired
billing base of customer accounts and orders bought on an individual basis from
certain agents or telemarketers. These costs are amortized by applying the
Company's attrition rate associated with the acquired customers each month
against the unamortized balance of the previous month (declining balance method)
over a five-year period, switching to the straight-line method when the
straight-line method results in greater amortization. During fiscal year 1996,
the attrition rate used to amortize customer acquisition costs was 3.0% through
March 31, 1996 and 5.0% thereafter. The attrition rate used during fiscal years
1997 and 1998 was 9.0%. The attrition rate used by the Company in amortizing
customer acquisition costs is an estimate of the attrition rate of the acquired
customer bases, and actual attrition may differ from the estimates used. The
Company evaluates the attrition rate of the acquired customer base each quarter
and adjusts the attrition rate as necessary. The Company periodically evaluates
the unamortized balance of customer acquisition costs to determine whether there
has been any impairment by comparing the undiscounted future cash flows of the
acquired customer base to the net book value of the associated customer base.
If it appears that an impairment has been incurred, management will write the
unamortized balance down to its fair value.

During the years ended June 30, 1996 and 1997, the Company wrote off $4.6
million and $4.4 million of customer acquisition costs as a result of higher
than expected attrition associated with those accounts.

PREPAID COMMISSIONS

During the year ended June 30, 1996, the Company modified the agreement
with one of its principal agents to reduce the commission rate the Company pays
to the agent on existing customers in exchange for $1.2 million from the
Company. The Company paid $710,000 in cash, with the remainder from the
transaction being utilized to offset advances due from the agent to the Company.
The prepaid commissions are amortized by applying the Company's attrition rate
associated with the underlying customers each month against the unamortized
balance of the previous month (declining balance method) over a two year period,
switching to the straight-line method when the straight-line method results in
greater amortization. Prepaid commissions were fully amortized as of June 30,
1998.

CASH AND CASH EQUIVALENTS

Highly liquid investments with a maturity of three months or less are
considered cash equivalents.

GOODWILL

Goodwill represents the excess cost over the net assets of an acquired
business and is being amortized on a straight line basis over 10 years. During
the fourth quarter of fiscal year 1998, the Company wrote-off the remaining
goodwill associated with the prior acquisition of Creative Communications
International, Inc. (See also Note 12.)

REVENUE RECOGNITION

Revenue is recognized in the month in which the Company's customers
complete the telephone call.

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<PAGE>

INCOME TAXES

The Company accounts for deferred income taxes using the liability method.
Under this method, deferred tax assets and liabilities are determined based on
differences between financial reporting and tax bases 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.

USE OF ESTIMATES

The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.

CONCENTRATION OF CREDIT RISK

Financial instruments that potentially subject the Company to
concentrations of credit risk are accounts receivable. The Company continuously
evaluates the credit worthiness of its customers' financial conditions and
generally does not require collateral. The Company's allowance for doubtful
accounts is based on current market conditions and management's expectations.
Write-offs of accounts receivable, net of recoveries, were $2.46 million, $5.57
million and $1.97 million for the years 1996, 1997, and 1998, respectively.

EARNINGS PER SHARE

In 1997, the Financial Accounting Standards Board issued Statement No. 128
("Statement 128"), "Earnings Per Share". Statement 128 replaced the calculation
of primary and fully diluted earnings per share with basic and diluted earnings
per share. Unlike primary earnings per share, basic earnings per share excludes
any dilutive effects of options, warrants and convertible securities. Diluted
earnings per share is very similar to the previously reported fully diluted
earnings per share. All earnings per share amounts for all periods have been
presented, and where appropriate, restated to conform to the Statement 128
requirements.

TREASURY STOCK

Treasury stock is accounted for using the cost method. During fiscal years
1996 and 1998, 18,182 shares and 5,454 shares of Common Stock, respectively,
which had been granted to employees upon future service was forfeited (See Note
16). As a result, $77,229 and $60,000 in deferred compensation was recorded in
fiscal years 1996 and 1998, respectively, as the cost of these treasury shares.
The cost of the treasury shares was determined by the closing price per share of
common stock on the date of forfeiture which ranged from $3.84 to $5.88 and was
$2.25 per share for fiscal years 1996 and 1998, respectively. In addition, upon
the vesting of stock grants by certain employees, the employees elected to
reduce the number of shares received to satisfy federal income tax withholding
liabilities to be paid by the Company on the employee's behalf. In fiscal year
1996, the Company received 3,568 treasury shares required to satisfy the
liability based on the market value of the exchanged shares on the date of the
exchange, resulting in a total increase in treasury stock of $27,652.
Additionally, during fiscal year 1998, the Company received 373,244 treasury
shares upon default of a note receivable from a shareholder to satisfy the
outstanding principal, resulting in an increase in treasury stock of $700,000.

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<PAGE>

ACCOUNTING FOR EMPLOYEE STOCK BASED COMPENSATION

The Company accounts for employee stock based compensation in accordance
with APB Opinion 25 and expects to continue doing so.

NEW ACCOUNTING PRONOUNCEMENTS

In 1997, the FASB issued Statement No. 130, Reporting Comprehensive Income,
and Statement No. 131, Disclosures About Segments of an Enterprise and Related
Information, and Statement No. 132, Employers' Disclosures About Pensions and
Other Post-Retirement Benefits. These statements, which are effective for
periods beginning after December 15, 1997, expand and modify disclosures and,
accordingly, will have no impact on the Company's reported financial position,
results of operations, or cash flows.

ACCOUNTING CHANGES

In March 1995, the FASB issued Statement No. 121, Accounting For the
Impairment of Long-Lived Assets and For Long-Lived Assets to be Disposed of
("Statement No. 121"), which requires impairment losses to be recorded on long-
lived assets used in operations when indicators of impairment are present and
the undiscounted cash flows estimated to be generated by those assets are less
than the assets carrying amount. Statement No. 121 also addresses the
accounting for long-lived assets that are expected to be disposed of. The
Company adopted Statement No. 121 in the first quarter of fiscal 1998. Prior to
the adoption of Statement 121, the Company determined any impairment write-downs
of long-lived assets in a manner generally consistent with Statement No. 121.
At the date of adoption, there was no impact to the financial statements. The
Company reviews its long-lived assets for impairment on a quarterly basis.

The FASB issued Statement No. 125, Accounting for Transfers and Servicing
of Financial Assets and Extinguishment of Liabilities, which requires an entity
to recognize the financial and servicing assets it controls and the liabilities
it has incurred and to derecognize financial assets when control has been
surrendered in accordance with the criteria provided in the Statement. The
Company adopted the new rules beginning in the first quarter of fiscal 1998.
The application of the new rules did not have a material impact on the financial
statements.

In 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 128 ("Statement No. 128"), Earnings per
Share. Statement 128 replaced the previously reported primary and fully diluted
earnings per share. Unlike primary earnings per share, basic earnings per share
excludes any dilutive effect of options, warrants, and convertible securities.
Diluted earnings per share is very similar to the previously reported fully
diluted earnings per share. Upon adoption of No. 128 in the quarter ended
December 31, 1997, all earnings per share amounts for all periods have been
presented, and where necessary, restated to conform to the Statement 128
requirements.

FAIR VALUE OF FINANCIAL INSTRUMENTS

The carrying amounts of accounts receivable, accounts payable and other
payables approximate fair values due to the short term maturities of these
instruments. The carrying value of the Company's notes payable to a long
distance carrier revolving line of credit, and contractual obligations with
regard to its receivable sales agreement approximate fair value because the rate
on such debt is variable, based on the current market.

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<PAGE>

RECLASSIFICATION

Certain balances from the years ending June 30, 1996 and 1997 have been
reclassified to be consistent with June 30, 1998 classifications.

2. CHAPTER 7 AND 11 FILING

EqualNet, one of the Company's operating subsidiaries, and Wholesale, a
wholly-owned non-operating subsidiary of EqualNet filed voluntary petitions for
relief under Chapter 11 ("Chapter 11") of the United States Bankruptcy Code (the
"Bankruptcy Code") on September 10, 1998 (the "Petition Date") in the United
States Bankruptcy Court for the Southern District of Texas (the "Bankruptcy
Court"), Houston, Texas. The cases were conducted in such court as Cases No.
98-39561-H5-11 and 98-39560-H4-11. On October 2, 1998 Wholesale filed its
motion to convert its bankruptcy proceeding from a Chapter 11 reorganization to
a Chapter 7 liquidation. Pursuant to Sections 1107 and 1108 of the Bankruptcy
Code, EqualNet managed its assets and operated its business as a as debtor-in-
possession pending confirmation of its reorganization plan.

The Company's consolidated financial statements have been prepared on a
going concern basis, which contemplates continuity of operations, realization of
assets and liquidation of liabilities and commitments in the normal course of
business. The Chapter 11 filing by EqualNet, as well as related circumstances
and the losses from operations, continue to raise substantial doubt about the
Company's ability to continue as a going concern. The appropriateness of
reporting on the going concern basis is dependent upon, among other things,
confirmation of a plan of reorganization for EqualNet, future operations, and
the ability to generate sufficient cash from operations and financing sources to
meet obligations. The consolidated financial statements included herein do not
include any adjustments relating to the commencement of EqualNet's bankruptcy
case or to reflect the possible future effects on the recoverability and
classification of assets or the amounts and classification of liabilities that
may result from the outcome of the uncertainty of the Company's ability to
continue as a going concern.

3. DIP FINANCING AND EXIT FACILITY

Prior to filing for bankruptcy protection, EqualNet and Receivables Funding
Corporation ("RFC") entered into an agreement whereby RFC agreed to amend
certain financing agreements with EqualNet to eliminate EqualNet's bankruptcy
filing as an event of default and, subject to bankruptcy court approval, to
continue to finance EqualNet's receivables under a debtor in possession ("DIP")
facility. On September 16, 1998, the bankruptcy court approved, on an interim
basis, the DIP financing which allowed EqualNet to continue to obtain funds from
RFC in the same manner as it did prior to the bankruptcy filing. The financing
cost of the DIP financing is prime rate plus seven percent (7%). A final
hearing to approve the DIP financing for the term of the bankruptcy proceeding
is scheduled for October 15, 1998.

EqualNet was required to seek additional financing to obtain the approval
of creditors of its plan of reorganization. The Company did not have the
capital to provide the exit facility. The Company does intend to raise the
needed capital from outside investors and provide EqualNet with the exit
facility. By providing the exit facility, the Company intends to own EqualNet
after the bankruptcy proceedings.

4. LIQUIDITY AND WORKING CAPITAL DEFICIT

For the years ended June 30, 1996, 1997 and 1998 the Company reported pre-
tax losses of $11.0 million, $12.6 million and $17.8 million, respectively.
Revenues declined from $46.6 million in fiscal

65
<PAGE>

year 1997 to $24.9 million in fiscal year 1998. This decline is attributable to
several internal and external factors. Continuing provisioning challenges led to
delayed billing and higher customer attrition. Provisioning - the time it takes
EqualNet's primary underlying long-distance carrier to activate new customers -
had risen sharply in 1997, from approximately 20 days to approximately 45 days.
In addition, EqualNet converted to a new customer management, billing and rating
system -AMS, purchased from Platinum Communications in March 1998. All of these
factors adversely affected revenues and funding. As of September 25, 1998,
EqualNet is making plans to convert to CostGuard ENTERPRISE, a system being
purchased from Info Directions, Inc., "IDI" and expects an improvement in rating
speed and billing accuracy. In fiscal year 1998, EqualNet recorded write offs of
$270,000 and $417,000 for NetBase and AMS, respectively. The new system,
CostGuard, will cost $272,000 initially, then $68,000 per year in subsequent
years (for ongoing support and software upgrades).

Under the SA Telecom purchase and management agreements (see Note 18), cash
advances of $1.5 million were paid to SA Telecom during fiscal year 1998 to
support their operations during the acquisition transition period. However, an
additional $1.51 million was advanced to SA Telecom because of EqualNet's
billing system problems. Specifically, EqualNet converted SA Telecom's customer
base to AMS. The AMS conversion problems (delays and errors) adversely affected
SA Telecom's ability to get funding. The inability of EqualNet to successfully
transfer the acquired SA Telecom customer base to AMS resulted in a greater than
expected migration of the base to other long-distance providers.

Liquidity was strained upon EqualNet's transition during fiscal year 1998
from a switchless reseller to a switch-based carrier. The Company's lack of
capital resources also affected marketing efforts, which decreased considerably
from prior years. Until late in the fiscal year, EqualNet's overhead continued
to be more appropriate for a substantially larger company.

On December 2, 1997, the Company entered into several related agreements,
(as amended, the "Agreements") involving the Willis Group, LLC, a privately held
investment partnership, and other third parties. Collectively, these Agreements
provided for a recapitalization of the Company and for the Company to acquire
certain telecommunications network assets and switches.

The strategy was to create a platform (network of nine switches) to support
acquisitions of customer bases. However, the Company quickly realized it lacked
the capital resources to support the ongoing costs of the network while waiting
for call volume to increase through acquisitions of customer bases. During the
fourth quarter of fiscal year 1998, losses from the network was approximately
$2.0 million. See Note 7 for additional information regarding the utilization
of the network of nine Switches.

During fiscal year 1997, the Company's borrowing capacity under its credit
facility continued to decline as a result of operating losses, and a decline in
the revenue base. On June 18, 1997 the Company entered into a new receivables
sale agreement with Receivables Funding Corporation ("RFC"). The agreement
funded on July 7, 1997 and has been the Company's primary operating liquidity
source throughout fiscal year 1998. The agreement provides for accounts
receivable purchase commitments of up to $8.0 million, and up to $10.0 million
after the amendment dated July 19, 1998, for the purchase of EqualNet's
receivables from customers that meet specified eligibility requirements.
Funding is based on a percentage of EqualNet's outstanding receivables and
allows for RFC to cease funding new receivables without prior written consent at
RFC's option. The funding percentage varies by billing cycle (AT&T, Sprint,
LEC, etc.) and according to the collections history. The funding percentage
declined late in the fiscal year because of the billing delays and errors. The
program fee applied to the outstanding balance of net purchased receivables was
prime plus 4.5% (13.0% at June 30, 1998), but changed to 7.0% plus prime on
September 17, 1998 (after Chapter 11 filing). As of June 30, 1998, the amount
owed to RFC under this agreement was $2.5 million with a credit reserve of
$144,000. This RFC agreement was extended via an amendment dated July 19, 1998.

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<PAGE>

The Company continues to incur operating deficits and is exploring ways to
increase revenue and reduce operating costs. To operate profitably, the Company
must reduce its variable long-distance carrier costs, right-size and make
efficient its back office and administrative operations and increase revenues by
implementing new sales and marketing plans. There can be no assurance the
Company will have the capital resources necessary to implement these measures
and return to profitability. It is highly likely the Company will need
additional capital to continue in business during its restructuring phase.

5. THE WILLIS GROUP LLC AND OTHER INVESTOR TRANSACTIONS

THE WILLIS GROUP LLC TRANSACTIONS

On October 1, 1997, the Company issued to the Willis Group, LLC ("Willis
Group") a $1.0 million Convertible Secured Note, bearing interest at the rate of
12% per year and maturing April 1, 1998 (the "Note"), and a warrant for the
purchase of up to 0.2 million shares of Common Stock at an exercise price of
$1.00 per share, subject to adjustment (the "October Warrant"). The October
Warrant was exercisable for five years. The outstanding balance of the Note was
convertible into a number of shares of Common Stock determined by dividing the
outstanding balance by the lesser of $1.00 or 85% of the market price of the
Common Stock. As of the date of issuance of the convertible debt the Company
recorded an interest charge of $0.15 million to record the impact of the debt
being convertible at a discount to market. On March 5, 1998, the Note and
accrued interest were exchanged for 1.05 million shares of Common Stock.

On December 2, 1997, the Company entered into several related agreements,
(as amended, the "Agreements") involving the Willis Group and other third
parties. Collectively, these Agreements provided for a recapitalization of the
Company and for the Company to acquire certain telecommunications network assets
and switches (collectively the "Transactions".)

On March 6, 1998 as a result of various transactions the Willis Group
gained control of the Board of Directors of the Company, having nominated for
shareholder approval four of the seven members of the Board of Directors.

Under the terms of the Agreements, the Company acquired nine
telecommunications switches (the "Switches") from the Willis Group for $7.6
million, consisting of $5.85 million in cash, 1.4 million shares of Common
Stock, and warrants to purchase up to 0.4 million shares of Common Stock at an
exercise price of $1.00. The Company secured financing of $6.05 million for the
cash portion of the consideration through an unaffiliated third party lender,
whose loan is secured by the Switches, bears interest at a rate per year of
6.42% above an index rate based on U. S. Treasury Notes (12.1% as of June 30,
1998) and is payable in 36 consecutive monthly payments. An affiliate of the
Company was granted a warrant for the purchase of up to 0.5 million shares of
Common Stock at an exercise price of $1.00 per share for guaranteeing a portion
of this financing.

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<PAGE>

into Common Stock initially at the rate of 1,000 shares of Common Stock per
share of Series A Preferred (or the stated value divided by $1.00), or an
aggregate of 2.0 million shares of Common Stock, subject to adjustment pursuant
to certain anti-dilution provisions. The Series A Preferred has liquidation
preference over the Company's Common Stock equal to the summation of $1,000 per
share plus accrued and unpaid dividends and interest. Dividends are payable at
the determination of the Board of Directors. Dividends when not paid are
cumulative and bear interest at a rate of 12.0%. Cumulative dividends in arrears
at June 30, 1998 are approximately $52,000 or $25.78 per Series A Preferred
share. Under the instrument defining the rights of the holders of the Series A
Preferred, the Company is prohibited from declaring or paying dividends on the
Common Stock unless all accrued dividends on the Series A Preferred have been
paid.

Under the terms of the Agreements, the Company also issued and sold to the
Willis Group 4.0 million shares of Common Stock at a price of $1.00 per share
for total aggregate consideration of $4.0 million in cash.

OTHER INVESTOR TRANSACTIONS

On July 1, 1997, the Company issued to Lexus Commercial Enterprises, Ltd.,
an accredited investor, 0.51 million shares of Common Stock of the Company in
exchange for a $1.0 million secured promissory note, secured by a pledge of the
purchased shares, which bore interest at a rate of 8.0% per annum. Upon default
of the secured promissory note due to missed payments, the Company reacquired,
on October 21, 1997, the remaining 0.37 million shares of the 0.51 million
shares that were purchased.

6. BILLING SYSTEMS

EqualNet converted from NetBase to a new customer management, billing and
rating system, AMS in March 1998. As of October 2, 1998, EqualNet is making
plans to convert to CostGuard ENTERPRISE ("CostGuard"), a more powerful cost
rating, billing and customer care system. This system is expected to improve
rating speed and billing accuracy. Also, EqualNet expects to be able to easily
extract meaningful data and management reports from CostGuard. The system
design is flexible enough to respond to rapid changes in the telecommunications
marketplace. In fiscal year 1998, EqualNet recorded a write-off of
approximately $270,000 for NetBase and estimated the useful life of AMS to be
approximately one year until the CostGuard system can be implemented. The new
system, CostGuard, will cost $272,000 initially, then $68,000 per year in
subsequent years (for ongoing support and software upgrades).

7. FIXED ASSETS

During fiscal year 1998, the Company acquired nine telecommunications
switches (the "Switches") from the Willis Group for $7.6 million of aggregate
consideration. In a related transaction,

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the Company acquired Netco, a corporation controlled by the Willis Group, which
held certain intangible rights related to the operation of the Switches and
assets previously acquired by the Willis Group. The Company acquired Netco for
$5.6 million in aggregate consideration. As a result of these two transactions,
the Company recorded $13.2 million as its cost basis of the Switches and related
network. The Company incurred additional direct cost to purchase, install and
implement the Switches and related network of approximately $1 million which
have been capitalized as cost of the Switches and related network.

Netco, the owner of the Switches, subsequently entered into an agreement
with EqualNet whereby EqualNet assumed the operating responsibilities of the
Switches. EqualNet incurred substantial costs in the fourth quarter of fiscal
1998 in extending the network's access to most of the large metropolitan areas
in the United States in anticipation of a national marketing effort. This
marketing effort did not produce a significant number of sales due to EqualNet's
internal provisioning problems and the lack of sufficient capital. Utilization
of the Switches and national network without sufficient traffic to support the
fixed costs created negative operating margins and created an event that
indicated the $14.2 million asset might be impaired.

EqualNet is currently in the process of turning off the Switches and
network in an effort to reduce significant fixed charges and to reconfigure the
Switches which will be used to provide services to areas of geographic
concentration of customers in Texas and southern California. With respect to
the other Switches, the Company is evaluating alternative uses which may include
leasing or partitioning the Switches.

At the end of fiscal year 1998, the Company has classified the Switches and
network as operating assets and has supported the carrying value of the assets
through a projected undiscounted cash flow analysis of the traffic to be placed
on the network after the reconfiguration discussed above. The traffic to be
placed on the network relates primarily to the customer base acquired from SA
Telecom in July 1998 (see Note 18). However, it is reasonably possible that the
undiscounted cash flows may change in the near future resulting in the need to
write-down those assets to fair value. Additionally, as part of the plan of
reorganization and plan to return the Company to profitability, the Company will
continue to evaluate the best economic use of the Switches and related network.
As a part of this continued evaluation, the Company may elect to sell all or a
portion of the Switches and related network. The Company has recently received
unsolicited offers to purchase all or portions of the Switches and related
network which range from fully recovering the carrying cost of the assets to a
potential loss. Management believes that the carrying value of the assets will
be realized through the operations of the assets or a combination of operating
the assets and potential sale of the assets.

8. DEBT

Effective February 3, 1997, the Company executed an agreement with The
Furst Group, ("Furst"), a New Jersey corporation, pursuant to which Furst loaned
the Company $3.0 million at an annual interest rate of 10%, maturing December
31, 1998. In addition, the Company issued stock purchase warrants to Furst,
exercisable for an aggregate of 1,500,000 shares of Common Stock at a purchase
price of $2.00 per share, subject to adjustment in certain events (including (i)
changes in the capitalization of the Company, (ii) the cessation of Mr. Zane
Russell and Mr. Michael L. Hlinak to serve as Executive Officers of the Company
and (iii) the failure of the Company to satisfy the quantitative continued
listing requirements of the Nasdaq National Market ("Nasdaq") or suspension or
delisting of the Company from trading on that market). The warrants expire on
December 31, 1999. On March 6, 1998, the Company entered into an exchange
agreement ("Exchange Agreement") with Furst, an accredited investor, pursuant to
which Furst exchanged the $3.0 million subordinated note and warrants for 3,000
shares of Series B Senior Convertible Preferred Stock ("Series B Preferred")
along with 0.3

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million shares of the Company's Common Stock to satisfy the accrued interest due
on the notes. Each share of the Series B Preferred has a stated value of $1,000
and is entitled to share with the Common Stock in any dividends declared based
upon the number of shares of Common Stock the Series B is convertible into at
the time such dividend is declared. The Series B Preferred has a $1,000 per
share liquidation preference over the Series A Preferred and the Common Stock.
Each share of Series B Preferred also entitles the holder thereof to one vote,
voting as a single class with the Common Stock, on matters submitted to the
shareholders of the Company.

In March 1998, Netco secured financing of $6.05 million for the cash
portion of the consideration to purchase nine telecommunications switches from
the Willis Group through an unaffiliated third party lender, which loan is
secured by the Switches, bears interest at a rate per year of 6.42% above an
index rate based on U. S. Treasury Notes (12.1% as of June 30, 1998) and is
payable in 36 consecutive monthly payments. In addition, an affiliate of the
Company was granted 0.5 million warrants for guaranteeing a portion of this
financing. Netco defaulted on this loan subsequent to year-end due to failure
to make the monthly payments beginning with the July 1998 payment. The
principal amount outstanding as of June 30, 1998 of approximately $5.75 million
is classified as Debt in Default and considered to be a current liability.

During the quarter ended March 31, 1998, the Company obtained a cash flow
bridge loan of $0.4 million from Netco Acquisition, LLC, an entity owned 50% by
the Willis Group. This note was payable on March 31, 1998 and had an interest
rate of 10% which escalates to 18% after an event of default occurs. This note
is secured by the web page customers. As of June 30, 1998, the Company was in
default on this note as no principal or interest payments have been made.

At June 30, 1997, EqualNet had a $7.5 million revolving line of credit with
a bank which expired July 1, 1997. Interest on the outstanding balance was
prime plus 6% (14.5% at June 30, 1997). The maximum borrowings under the
revolving line of credit were subject to borrowing base limitations as defined
in the agreement. EqualNet replaced the revolving line of credit under which
borrowings at June 30, 1997 were outstanding with a new arrangement with
Receivables Funding Corp. ("RFC") effective June 18, 1997 and which funded July
7, 1997. The agreement with RFC is essentially a receivable purchase
arrangement which bases borrowing capacity on a percentage of EqualNet's
outstanding receivables up to a maximum allowable amount of $8.0 million and
increased to $10.0 million in July 1998 and allows for the lender to cease
funding of new receivables without prior written notice at the lenders option.
The program fee applied to the outstanding balance of net purchased receivables
was prime plus 4.5% per annum (13% at June 30, 1998), but changed to prime plus
7% on September 17, 1998 (after Chapter 11 filing). As of June 30, 1998, the
amount owed to RFC under this agreement is $2.5 million with a credit reserve of
$144,000. This RFC agreement was extended on July 19, 1998 and subsequently
amended on a temporary basis on September 17, 1998. A hearing was scheduled in
Bankruptcy Court on October 15, 1998, to determine if the RFC facility will
remain in place during EqualNet's bankruptcy.

At June 30, 1997, EqualNet had two notes payable with a long-distance
carrier for past long-distance services provided by the carrier which were
converted from trade payables. The notes with original principal of $1,066,603
and $649,987 and which bear interest at 17% and 12% matured on February 5, 1998
and August 15, 1997, respectively, and were payable in equal monthly
installments prior to maturity. As of June 30, 1998, EqualNet had made no
principal payments on these notes payable and was in default with these notes.
In July and August 1998, EqualNet was in discussions with the carrier regarding
the total amount owed to the carrier (including more recent past due amounts),
but on September 10, 1998 filed for Chapter 11 protection under the Bankruptcy
Code.

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Interest paid by the Company during the years ended June 30, 1996, 1997 and
1998, totaled $573,721, $946,665 and $842,826, respectively. In fiscal 1998,
the Company exchanged two notes payable and associated interest due for Series B
Preferred and Common Stock of the Company. The interest due on these notes that
was exchanged was $344,500.

9. FEDERAL INCOME TAXES

The following disclosures relate to balances and activity for the fiscal
years ending June 30, 1997 and 1998.

Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components
of the Company's deferred tax liabilities and assets are as follows:

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June 30, 1997 June 30, 1998
------------- -------------
Deferred tax liabilities:
Cash to accrual differences $ (196,250) $ -
Other, net (62,256) (75,075)
----------- ------------
Total deferred tax liabilities (258,506) (75,075)
Deferred tax assets:
Amortization of deferred acquisition costs 4,769,258 4,567,944
Write-off of goodwill - 335,818
Bad debt allowance 562,970 401,290
Accrued liabilities 390,534 265,169
Net operating loss carryforward 2,922,038 9,735,300
Other 258,641 364,693
----------- ------------
Total deferred tax assets 8,903,441 15,670,214
Valuation allowance (8,644,935) (15,595,139)
----------- ------------
Net deferred tax assets $ 0 $ 0
=========== ============

The Company recorded a valuation allowance amounting to the entire net
deferred tax asset balance at June 30, 1997 and June 30, 1998 due to the
Company's operating losses which give rise to uncertainty as to whether the
deferred tax asset is realizable.

The Company has a net operating loss carryforward totaling $25,090,979
million which are available to offset future taxable income which expire in 2012
through 2013. The Company experienced a change in control in March 1998 which
restricted the Company's ability to utilize approximately $15.0 million of the
net operating loss carry forwards.

The differences between income taxes computed at the federal statutory
income tax rate and the provision for income taxes for the years ended June 30,
1997 and 1998 are as follows:

1997 1998
------ ------
Income tax benefit computed at
the federal statutory rate $(4,295,979) $(6,100,752)
State income tax benefit (518,532) (861,283)
Valuation allowances 7,097,236 6,950,202
Other 62,586 11,833
----------- -----------
Provision (benefit) for federal income taxes $ 2,345,311 $ -
=========== ===========

The provision (benefit) for income taxes for the years ended June 30, 1996
and 1997 consisted of the following. For fiscal year 1998, the Company
recorded no benefit for income taxes due to the valuation allowance.

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1996 1997
------ ------
Current
Federal $ (476,612) $ 29,275
State 850 87,959
----------- ----------
(475,762) 117,234

Deferred:
Federal (1,914,217) 1,952,439
State (269,874) 275,638
----------- ----------
(2,184,091) 2,228,077
----------- ----------
Provision (benefit) for federal income taxes $(2,659,853) $2,345,311
=========== ==========

Taxes paid during the fiscal years ended June 30, 1996 and 1997 totaled
$1,355,296 and $87,959, respectively. No income tax payments were made during
fiscal year ended 1998.

10. COMMITMENTS AND CONTINGENCIES

COMMITMENTS WITH PROVIDERS

At June 30, 1998 EqualNet had an agreement with AT&T which expires in April
2000. At expiration or any time prior, EqualNet can negotiate with AT&T for the
renewal of all material aspects of the present agreement with AT&T. In the event
that this is not possible, EqualNet may be able to negotiate equally beneficial
terms with other major telecommunications companies. Should neither of these
alternatives be possible, there could be materially adverse implications for
EqualNet's financial position and operations.

The agreement covers the pricing of the services and establishes minimum
semi-annual revenue commitments ("MSARCs") which must be met to receive the
contractual price and to avoid shortfall penalties. The commitment with AT&T is
segregated into components differentiated by the type of traffic. At June 30,
1998, EqualNet had not yet reached the completion of the term of the third
MSARC; however, EqualNet was approximately $3.7 million below the cumulative pro
rata monthly commitment. Should EqualNet continue at similar revenue levels, it
would be in an estimated shortfall position of approximately $11.6 million at
the end of the third MSARC period in October 1998. Historically, EqualNet has
been able to negotiate a settlement with the carrier which has resulted in no
penalty being incurred by EqualNet and no amount has been accrued in the
financial statements. No assurances can be made that EqualNet will be able to
reach similar favorable settlements with the carrier should it continue to fail
to meet its commitment.

Total future minimum usage commitments to AT&T as of June 30, 1998 are as
follows:

Year ending June 30,
- --------------------
1999 $29,000,000
2000 16,000,000
-----------
$45,000,000
===========

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If the contract with AT&T is terminated prior to the expiration of the full
term, either by EqualNet or by AT&T for non-payment, EqualNet will be liable for
the total amount of the unsatisfied MSARC for the period in which the
discontinuance occurs and for 50% of the MSARCs for each semi-annual period
remaining in the contract tariff term, which amounts to an estimate of $29.1
million.

As a result of its bankruptcy filing, EqualNet has the opportunity to
reject its contract with AT&T. This is not feasible without first entering into
a contract with another carrier who is capable of servicing EqualNet's customer
base. EqualNet plans to enter into a wholesale carrier agreement with an
unrelated switchless reseller which currently services its long-distance
customers on the AT&T network. Under this plan, EqualNet's AT&T customers would
be moved from its AT&T contract to a contract with its new provider but would
continue to utilize the AT&T network. EqualNet would no longer be a direct
customer of AT&T and AT&T would not continue to be subject to any additional
credit risk with EqualNet but would continue to generate revenues from the
EqualNet customers through its contract with EqualNet's new service provider.
EqualNet would be required to pay its carrier cost in advance under the new
agreement. EqualNet has had numerous discussions with AT&T and the prospective
wholesale service provider but no agreements have been formulized to date.

If EqualNet is able to enter into this new wholesale carrier agreement, it
may reject its contract with AT&T. Any liabilities for MSARC relating to periods
after the rejection date would likely be treated in the bankruptcy as
pre-petition unsecured indebtedness. Due to the amount of EqualNet's secured
indebtedness (approximately $16.0 million), it is unlikely AT&T would realize
significant benefits even if it does assert its claim for additional MSARC
payments.

In the event EqualNet is not able to enter into an agreement with another
carrier, it must provide AT&T with adequate assurance of future performance in
order to continue to utilize the AT&T network. AT&T has asserted that it needs
a $2.0 million deposit from EqualNet for adequate assurance. It is unlikely
EqualNet and AT&T will enter into an out of court agreement on adequate
assurance. If AT&T prevails in court and EqualNet is required to make a $2.0
million deposit, it will likely lose its AT&T customer base because it does not
have the resources to make said deposit.

REGULATORY APPROVAL

EqualNet's intrastate long-distance telecommunications operations are
subject to various state laws and regulations, including consumer protection
statutes enforced by the Attorney General of each state. During 1995, 1996 and
1997 the Attorneys General of eleven states alleged violations of various
consumer protection statutes against EqualNet. Each of these matters alleged
that the state received an excessive number of customer complaints that long-
distance service was switched to the Company without the customer's knowledge or
informed consent, with sanctions being sought under the deceptive trade
practices or consumer protection statutes of these states. The Company reached
a settlement agreement on December 22, 1997. The result of the settlement was
that the Company agreed to pay a total of $225,000 to the Attorneys General of
the eleven states involved by February 28, 1998. The payments were
reimbursement for investigative costs and attorney's fees incurred by the
Attorneys General in connection with the investigation of the alleged consumer
protection violations and to conduct consumer education activities. In
addition, the Company agreed to adjust balances appropriately on any pending and
unresolved complaints, which complaints are to be identified by each Attorney
General. It is anticipated that the amount of these adjustments will not be
material. The settlement payments were made to the appropriate states in March
1998.

LITIGATION

In April, 1997, American Teletronics Long Distance, Inc. ("ATLD") and
MetroLink Communications, Inc. ("MetroLink") filed suit against EqualNet
Corporation and EqualNet Wholesale Services, Inc. in the United States District
Court for the Northern District of Illinois, Eastern Division (Cause No. 97-C-
2842) alleging damages based upon breach of contract, fraud and negligent
misrepresentation. Both defendants subsequently were served with process and
filed answers and counterclaims for damages. Plaintiffs allege damages for
EqualNet's failure to complete a purchase of ATLD's customer base, EqualNet's
failure to pay for long distance services provided by MetroLink to EqualNet's
customers through its contract with Unified Network Services LLC ("UNS") and for
damages arising out of EqualNet's alleged breach of contractual obligations to
UNS, a Delaware limited liability company of which EqualNet Corporation,
EqualNet Wholesale Services, Inc. and MetroLink were shareholders. It is
anticipated that these matters will be disposed of in the respective bankruptcy

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proceedings of EqualNet and Wholesale. EqualNet's management denies any
wrongdoing or liability in this matter.

EqualNet committed to make certain payments to AT&T for usage incurred in
prior periods. EqualNet defaulted in the timely payment of those payments
during the fourth fiscal quarter of 1998, and began to enter into a series of
short term, alternative payment agreements with AT&T for the payment of amounts
due to AT&T for current usage with any surplus to be applied to the arrearage
amounts. The failure to make any payments due to AT&T could result in the
termination of service to EqualNet's customers whose long distance service is
provided over AT&T's networks. The pending bankruptcy proceeding discussed below
could have a substantial affect on this obligation. EqualNet Corporation is
negotiating with another AT&T reseller as a potential supplier of these services
instead of dealing with AT&T directly. If so, management would anticipate
negotiating payment terms superior to those available directly from AT&T.

The Company denies any wrongdoing or liability in the matter, and intends
to vigorously defend itself in this action. Since no discovery has taken place
in this matter, it is impossible to state with any degree of certainty the
amount of damages, if any, that the Company may incur, or if it will be
successful in asserting any cross claims or counterclaims it may have in
connection with the employment of Turner.

On August 13, 1998, Steverson & Company, Inc. filed suit against the
Company in case number 704,244 in the County Civil Court at Law Number 2 of
Harris County Texas seeking damages in the amount of $22,892.78 plus attorneys
fees and court costs. The Company maintains that these charges were for
temporary services personnel utilized by EqualNet, and not the Company. The
invoices are addressed to Equal Net Communications, the former name of EqualNet
Corporation before its name change on November 28, 1994. The dates on the
invoices run from June 16, 1998 through August 11, 1998. EqualNet Holding Corp.
did not formally change its name to Equalnet Communications Corp. until June 30,
1998. Due to the fact that these charges may be a claim in the bankruptcy
proceedings of EqualNet discussed below, it is impossible at this time to state
with any degree of certainty the ultimate exposure of either the Company or
EqualNet in this matter. The Company has accrued the amount of damages,
excluding attorney fees and court costs.

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plus interest, attorneys fees and court costs. The fact that these charges are a
claim in the bankruptcy proceedings of EqualNet discussed below make it
impossible at this time to state with any degree of certainty the ultimate
exposure of EqualNet in this matter. However, the Company has provided for the
claim of $24,399 in the financial statements.

On September 21, 1998, Cyberserve, Inc., WSHS Enterprises, Inc. and William
Stuart (collectively "Bluegate") filed suit in the 215th District Court of
Harris County, Texas in case number 98-45115 against the Company, Willis Group,
LLC, Mark A. Willis, and Netco Acquisition LLC alleging damages for breach of
contract, breach of an employment agreement, fraud and fraud in the inducement,
statutory fraud in a stock transaction, tortious interference with a contract,
conspiracy, and quantum meruit. The matters complained of originated with a
letter of intent dated on or about October 28, 1997, wherein the Company
proposed the purchase of certain assets of Cyberserve, Inc. and WSHS
Enterprises, Inc. subject to the performance of due diligence by the parties.
Bluegate and certain of its shareholders had threatened to sue the Company in
the event the proposed transaction was not consummated substantially in
conformity with the terms set forth in the Letter of Intent. The damages
Bluegate alleges it incurred were as a result of, among other things, the
claimed modification of its business to its detriment in anticipation of the
integration of its operations with those of EqualNet. It is impossible to
determine with any degree of certainty what, if any, liability Equalnet, or any
of its subsidiaries, may incur in this matter. The total amount of damages are
unspecified, but include a demand for a cash payment of $685,000, a sufficient
number of shares of Common Stock of the Company for the payment of $585,000, an
additional 525,000 shares of Common Stock, and other damages. The Company
denies any wrongdoing or liability in this matter and intends to vigorously
defend itself against all claims of the plaintiffs.

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revenue through USBI/ZPDI, (iii) reimbursement of $8,149 for switch site leases,
(iv) payment of Specified Network Contracts Liabilities (amount not specified),
(v) delivery of 5,358 shares of Series C Preferred escrowed at closing, and (vi)
for return of certain leased equipment not owned by SA Telecommunications but
previously in its possession and allegedly removed by Equalnet or USC Telecom.
The Company and USC Telecom dispute each of the claims asserted by SA
Telecommunications in its demand.

During the past several months, EqualNet and the Company have experienced
severe liquidity problems and have received numerous notices of default in
payment of trade creditors and other financial obligations. For example and
without providing an exhaustive list, EqualNet has received notice of default of
its agent agreements with Walker Direct, Inc., Future Telecom Networks, Inc.,
Global Pacific Telecom, Inc. and others, making demand for the payment of
commissions due and for mediation pursuant to the terms of their agent
agreements. Netco Acquisition LLC presented a notice dated August 25, 1998
under the terms of the Tri-Party Agreement and Assignment dated January 20, 1998
between Netco Acquisition LLC, EqualNet Corporation and Cyberserve, Inc. that it
was enforcing its rights to foreclose on the web page customer base of EqualNet.
In addition, EqualNet defaulted in making timely payments under the
$1,183,059.03 promissory note payable to Sprint Communications Company L.P., in
the timely payments to AT&T Corp., Premier Communications and MCI WorldCom for
carrier services. In addition, EqualNet received notice it was in default of
its lease agreement with Caroline Partners Ltd., the landlord for the office
space occupied by the Company and its subsidiaries, and that the landlord had
exercised its right to offset rents due against the letter of credit EqualNet
has provided as a security deposit for the landlord's benefit. Finova Capital
Corporation notified Netco of its failure to timely pay installments on its
promissory note in the original principal amount of $6.05 million. The payment
of such note is secured by the switches. Norwest Equipment Finance, Inc. has
notified EqualNet of its default in the payment for leased furniture currently
being utilized by EqualNet in the operation of its business. The remaining
amount owed under such lease is in excess of $100,000. The bankruptcy
proceedings of EqualNet discussed below make it impossible at this time to state
with any degree of certainty the ultimate exposure of EqualNet in these matters.

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CAPITAL LEASES

During 1995, EqualNet entered into long-term lease agreements for the
purchase of equipment and furniture. The leases were capitalized and the
related obligations were recorded in the accompanying financial statements based
on the present value of future minimum lease payments. The gross balance of
assets included in property and equipment at June 30, 1997 was $306,000. These
assets were fully depreciated at June 30, 1998 and the obligation under these
capital leases was met during fiscal year 1998.

OPERATING LEASES

EqualNet leases certain equipment and office space under operating leases
that expire over the next nine years. Rental expense under operating leases was
$1,715,636, $2,137,857 and $1,952,507 in 1996, 1997 and 1998, respectively.
Future minimum lease payments under noncancelable operating leases are as
follows:

Year ended June 30,
- -------------------
1999 $1,586,185
2000 1,093,793
2001 654,801
2002 672,695
2003 672,695
Thereafter $1,009,043
----------
$5,689,212
==========

EqualNet has entered into several agreements for the sale and leaseback of
certain computer equipment and office furniture. EqualNet has purchase and
lease renewal options at projected future fair market values under the
agreements. The leases are classified as operating leases in accordance with
the FASB Statement No. 13 - "Accounting for Leases". The leases have thirty-six
month terms and the future minimum lease payments are included in the table
above. Lease payments on these transactions average $477,000 annually.

11. WRITE DOWN OF ASSETS

The Company wrote down assets during the year ended June 30, 1996, 1997 and
1998, totaling $6.9 million, $4.8 million and $1.1 million, respectively.
Included in the write downs were $4.6 million and $4.4 million non-cash charges
in fiscal 1996 and 1997, respectively, to reduce the carrying value of acquired
customer bases (customer acquisition costs) to the present value of the expected
future cash flows associated with the underlying customer accounts and a $2.2
million non-cash charge in fiscal 1996 to eliminate capitalized software
development costs associated with the NetBase system. The write down of
deferred acquisition costs was necessitated by continued greater than expected
turnover of acquired customer bases which resulted from difficulties in billing
and servicing the Company's customer accounts. Included in the write-downs in
1998 were $0.9 million to write-off goodwill associated with the prior
acquisition of Creative Communications International, Inc. as a result of
winding this operation down and $0.2 million to write-off the undepreciated
balance of the NetBase system upon the implementation of a new billing and
customer service system.

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12. INTANGIBLE ASSETS

On November 12, 1996, the Company purchased certain assets of Creative
Communications International, Inc., a Texas-based debit card company, for
150,000 shares of EqualNet Holding Corp. common stock, $.01 par value per share
("Common Stock"), a warrant to purchase 100,000 shares of Common Stock, and the
assumption of certain liabilities totaling $379,328. The total purchase
consideration was $1 million. Substantially all of the purchase price was
recorded as goodwill and was being amortized over ten years using the straight
line method of amortization. The acquisition was accounted for as a purchase
and the operations of Creative Communications, Inc. is included in the
operations of the Company from the date of acquisition. During the fourth
quarter of fiscal year 1998, the Company considered the goodwill associated with
Creative Communications to be fully impaired and wrote off the remaining
unamortized balance of goodwill of $0.9 million.

13. EMPLOYMENT AGREEMENT

The Company had employment agreements with Zane Russell and Michael Hlinak,
its former president and former chief operating officer. The agreements
contained certain conditions of employment including a covenant not to compete
upon termination of employment with the Company. Employment under both of these
contracts was terminated during fiscal 1998. The Company replaced the
employment agreements with severance agreements upon termination.

14. SAVINGS PLAN

The Company sponsors a 401(k) Plan (the "Plan") which became effective
January 1, 1993. The Plan is open to all employees over the age of 21. To
become eligible, an employee must have been employed on the effective date or
must complete six consecutive months of employment. The Plan gives the Company
the option to determine the amount they will contribute each year. The Company
matched 50% of the first 6% contributed by the participants until May 22, 1998.
Subsequent to that date, the Company was unable to match employee contributions
due to limited funds. Contributions were made to the Plan in the amount of
$81,597, $63,061 and $43,479 for the years ended June 30, 1996, 1997 and 1998,
respectively.

15. RELATED PARTY TRANSACTIONS

The Willis Group received a finders fee of $54,000 related to certain
financing transactions which closed during fiscal year 1998. The Willis Group
entered into an agreement with the Company in April 1998, related to mergers and
acquisitions consulting services. Pursuant to their agreement, the Company was
obligated to pay the Willis Group $20,000 per month beginning in May 1998, and a
success fee based on a percentage of the purchase price of acquisitions closed
by the Company.

During fiscal year 1998, the Willis Group incurred $0.14 million in out of
pocket expenses on behalf of the Company related to services provided by
consultants, travel expenses and other miscellaneous expenses. Subsequent to
June 30, 1998, the Company executed a note payable to the Willis Group for these
expenses.

James T. Harris and Ronald J. Salazar, directors of the Company, were paid
$86,895 and $20,000, respectively, for consulting services during fiscal year
1998, of which $36,000 and $20,000, respectively, was advanced by the Willis
Group.

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Effective April 1, 1998, the Company entered into a severance agreement
with Michael L. Hlinak, former Chief Financial Officer, Chief Operating Officer
and Director of the Company, which requires the Company to pay Mr. Hlinak
severance payments of $155,833 over an eleven month severance period and to pay
health insurance benefits to Mr. Hlinak during the severance period.
Additionally, the Company issued to Mr. Hlinak a warrant for the purchase of up
to 90,000 shares of Common Stock at an exercise price of $2.00.

Effective April 1, 1998, the Company entered into a severance agreement
with Zane Russell, former Chief Executive Officer and Director of the Company,
which requires the Company to pay Mr. Russell severance payments through January
31, 1999 at an annualized rate of $87,500 and forgive and cancel a $75,000 note
payable by Mr. Russell to the Company. Additionally, the Company issued to Mr.
Russell a warrant for the purchase of up to 90,000 shares of Common Stock at an
exercise price of $2.00.

Note 5, The Willis Group, LLC Transactions, describes other transactions
related to the sale of the Switches and sale of Netco to the Company.

Michael T. Willis, a member of the Willis Group, personally guaranteed $3.0
million of the Company's $6.05 million note payable to Finova Capital
Corporation. Mr. Willis received warrants to acquire 500,000 shares of Common
Stock.

During the year ended June 30, 1996, EqualNet entered into a joint venture
with MetroLink, Inc., an Illinois Corporation ("MetroLink"), the purpose of
which was to market and sell wholesale long-distance services to the Company and
other long-distance resellers. The joint venture, Unified Network Services, LLC
("UNS"), is owned 49% by Wholesale, 25% by MetroLink, 25% by MediaNet, Inc., an
Illinois Corporation and wholly-owned subsidiary of MetroLink, and 1% by
EqualNet. EqualNet utilized the services of UNS during fiscal years 1997 to
provide wholesale long-distance for resale and had accounts payable, net of
advances, to UNS at June 30, 1997 and 1998 of $644,301 and $0, respectively.

During fiscal years 1996 and 1997, EqualNet utilized the marketing services
of a marketing company managed and directed by the brother-in-law of one of the
principal shareholders of the Company. EqualNet paid commissions to the
marketing company of $75,388 and $6,223 in 1996 and 1997, respectively.
Advances due the Company from the marketing company were $43,015 and $0 at June
30, 1996 and 1997, respectively.

16. SHAREHOLDERS' EQUITY

STOCK PURCHASE PLAN

During 1995, the Company adopted the EqualNet Holding Corp. Employee Stock
Purchase Plan (the Stock Purchase Plan) in which substantially all employees are
eligible to participate. The Stock Purchase Plan provides eligible employees of
the Company and its subsidiaries an opportunity to purchase shares of Common
Stock through after-tax payroll deductions. The Company will match

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<PAGE>

contributions in an amount equal to 15% of each participant's contribution. The
Stock Purchase Plan is administered by an independent administrator which
purchases shares of Common Stock on the open market with the amounts contributed
by the participants and the matching contributions made by the Company. The
Stock Purchase Plan was implemented during fiscal year 1996 and the Company
contributed $4,653 , $13,704 and $20,331 on behalf of employees toward the
purchase of Company stock during the years ended June 30, 1996, 1997 and 1998,
respectively.

STOCK OPTION AND RESTRICTED STOCK PLAN

During 1995, the Company adopted the EqualNet Holding Corp. Stock Option
and Restricted Stock Plan (the 1995 Plan). The 1995 Plan is designed to provide
certain full-time key employees, including officers and directors of the
Company, with additional incentives to promote the success of the Company's
business and to enhance the ability to attract and retain the services of
qualified persons. The 1995 Plan is administered by a committee of no less than
two persons (the Committee) appointed by the Board of Directors. Committee
members cannot be employees of the Company and must not have been eligible to
participate under the 1995 Plan for a period of at least one year prior to being
appointed to the Committee. Under the 1995 Plan, the Committee may grant
restricted stock awards or options to purchase up to an aggregate of 800,000
shares of Common Stock. In June 1998, the Plan was amended to increase the
aggregate number of shares for grant to 4.0 million. The exercise price of an
option granted pursuant to the 1995 Plan is determined by the Committee on the
date the option is granted. In the case of a grant to an employee who owns ten
percent or more of the outstanding shares of Common Stock (a 10% Shareholder),
the exercise price of each option under the 1995 Plan may not be less than 110%
of the fair market value of the Common Stock on the date of the grant. No
option may be granted under the 1995 Plan with a term of more than ten years.
In the case of a 10% Shareholder, no option may be granted with a term of more
than five years. Options under the 1995 Plan are considered non-incentive stock
options when the aggregate fair market value of the stock with respect to which
the options are exercisable for the first time by the option holder in any
calendar year, under the 1995 Plan or any other incentive stock option plan of
the Company, exceeds $100,000. Under the 1995 Plan, the Committee may issue
shares of restricted stock to employees for no payment by the employee or for a
payment below the fair market value on the date of grant. The restricted stock
is subject to certain restrictions described in the 1995 Plan, with no
restrictions continuing for more than five years from the date of the award.
The 1995 Plan may be amended by the Board of Directors without any requirement
of shareholder approval, except as required by Rule 16b-3 under the Securities
Exchange Act of 1934 and the incentive option rules of the Internal Revenue Code
of 1986. The Company granted restricted stock awards for 63,638 shares of
Common Stock having an aggregate fair market value, based on the per share price
of the Common Stock at the measurement date, March 14, 1995, of $700,000 to
certain key employees, none of whom is a director or executive officer of the
Company. These employees will not be required to make any payment for these
restricted stock awards, which vest over five years in 20% increments.
Restrictions on transfer and forfeiture provisions upon termination of
employment will apply to the restricted stock covered by the awards for a period
of five years, after which time the restrictions will lapse and the stock will
be owned by the employees free of further restrictions under the 1995 Plan.
During fiscal years 1996 and 1998, 18,182 shares and 5,454 shares of Common
Stock were received into treasury stock resulting from the forfeiture of
restricted stock awards.

NON-EMPLOYEE DIRECTOR STOCK OPTION PLAN

The shareholders approved on November 28, 1995, the adoption of the Non-
Employee Director Stock Option Plan (the "Director Option Plan"). The Director
Option Plan is designed to attract and retain the services of experienced and
knowledgeable non-employee directors of the Company and to provide an incentive
for such directors to increase their proprietary interest in the Company and in
the Company's long-term success and progress. The Director Option Plan is
administered by the Board of

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<PAGE>

Directors. The Company has adopted the Director Plan, as amended in May 1998,
pursuant to which each non-employee director receives options to purchase a
number of shares of Common Stock equal to $60,000 divided by the average of the
highest and lowest price of the Common Stock the day before the date of his
election as a director ("Fair Market Value") and options to purchase a number of
shares of Common Stock equal to $30,000 divided by the Fair Market Value of the
Common Stock the day before each annual meeting of the Company's shareholders
for each year thereafter. These options have an exercise price equal to the Fair
Market Value of the Common Stock and the initial grants vest over three years in
33-1/3% increments and the annual grants vest in six months from the date of
grant, assuming continued service on the Board of Directors. Employee directors
of the Company do not receive any additional compensation from the Company for
their services as directors. Each stock option granted to a non-employee
director will have a ten-year term. All options granted under the Director
Option Plan are non-qualified stock options and may not be repriced. No awards
may be granted under the Director Option Plan after May 8, 2005, or such earlier
date as determined by the Board of Directors. The Director Option Plan may be
amended by the Board of Directors without any requirement of shareholder
approval, except as required by Rule 16b-3 under the Securities Exchange Act of
1934 and the incentive stock option provisions of the Internal Revenue Code of
1986, and except that no amendment may be made more than once every six months
that would change the amount, price or timing of grants under the Director
Option Plan.

There are currently five non-employee directors eligible to participate in
the Director Option Plan. Options to purchase 5,000 shares of common stock
awarded May 9, 1995 with an exercise price of $14 3/4, 1,000 shares of common
stock awarded November 29, 1995, with an exercise price of $17 7/8 per share,
5,000 options to purchase shares of common stock awarded November 30, 1995, with
an exercise price of $18 1/2 per share and options to purchase 2,000 shares of
common stock awarded November 27, 1996 with an exercise price of $2 3/16 are
still outstanding at June 30, 1998.

The Company has elected to follow Accounting Principles Board Opinion No.
25, "Accounting for Stock Issued to Employees" ("APB 25") and related
Interpretations in accounting for its employee stock options because, as
discussed below, the alternative fair value accounting provided for under FASB
Statement No. 123, "Accounting for Stock-Based Compensation," requires use of
option valuation models that were not developed for use in valuing employee
stock options. Under APB 25, because the exercise price of the Company's
employee stock options is greater than or equals the market price of the
underlying stock on the date of grant, no compensation expense is recognized.

Pro forma information regarding net income and earnings per share is
required by Statement 123, and has been determined as if the Company had
accounted for its employee stock options under the fair value method of that
Statement. The fair value for these options was estimated at the date of grant
using a Black-Scholes option pricing model with the following weighted-average
assumptions for fiscal 1996, 1997 and 1998: risk-free interest rate of 6%; no
dividend yield; volatility factors of the expected market price of the Company's
common stock of 2.3 in 1996 and 1997 and 1.4 in 1998; and a weighted-average
expected life of the option of 10 years.

The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the Company's employee stock options have characteristics
significantly different from those of traded options, and because changes in the
subjective input assumptions can materially affect the fair value estimate, in
management's opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of its employee stock options.

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<PAGE>

For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. The Company's
pro forma information follows:

<TABLE>
<CAPTION>
1996 1997 1998
------ ------ ------
<S> <C> <C> <C>
Pro forma net loss ($8,417,413) ($15,583,461) ($18,077,967)
Pro forma basic and diluted loss per share ($1.40) ($2.56) ($1.65)
</TABLE>

A summary of the Company's stock option activity, and related information
for the years ended June 30 follows:

1996 1997 1998
-------------------------- -------------------------- --------------------------
Weighted-Average Weighted-Average Weighted Average
Options Exercise Price Options Exercise Price Options Exercise Price
------- ---------------- ------- ---------------- ------- ----------------
<S> <C> <C> <C> <C> <C> <C>
Outstanding-beginning of year 10,000 $14.75 11,000 $16.74 526,000 $3.57
Granted 7,000 18.32 538,000 3.31 20,000 1.88
Exercised - - - - -
Forfeited (6,000) 15.27 (23,000) 3.87 (366,000) 3.66
------ ------- --------
Outstanding- end of year 11,000 $16.74 526,000 $ 3.57 180,000 $3.79
====== ======= ========
Exercisable at end of year 2,667 $15.92 3,333 $16.63 94,834 $3.93

Weighted-Average fair value
of options granted during
the year $18.32 $ 2.73 $1.84
</TABLE>

Exercise prices for options outstanding under the Stock Option and
Restricted Stock Option Plan (147,000 shares) as of June 30, 1998 ranged from
$1.88 to $4.25. The weighted-average remaining contractual life of those
options is 8 years.

WARRANTS

The following sets forth warrants granted to purchase shares of the
Company's Common Stock at June 30, 1998. Each warrant may be used to purchase
one share of Common Stock.

Warrants Exercise Price Exercise Period
-------- -------------- ---------------
200,000 $1.00 October 1997 - September 2002
400,000 1.00 March 1998 - March 2003
500,000 1.00 March 1998 - March 2008
116,667 1.50 March 1998 - February 2003
100,000 7.50 November 1996 - November 2001
90,000 2.00 July 1998 - June 2003
90,000 2.00 July 1998 - June 2001
170,000 1.00 April 1998 - April 2003

The Company also granted 2,716,665 warrants to agents to purchase Common
Stock which vest based upon performance of specific services. The warrant
expires in June 1999 if such services are not performed. As of June 30, 1998,
the agents had not performed the necessary services to vest in any of the
warrants and no services have been provided subsequent to year-end.
Additionally, management believes the warrants will not vest. As a result, the
warrants have not been included in the financial statements as

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<PAGE>

of June 30, 1998. If the performance criteria is met prior to June 30, 1999, the
vested warrants would be exercisable within one year of vesting at an exercise
price of $2.00.

17. EARNINGS PER SHARE

The following table sets forth the computation of basic and diluted
earnings per share:

<TABLE>
<CAPTION>
YEARS ENDED JUNE 30,
---------------------------------------------------
1996 1997 1998
--------- --------- ---------
<S> <C> <C> <C>
Numerator:
- ----------
Net loss $(8,417,413) $(14,980,544) $(17,943,388)
Preferred stock dividends 0 0 52,000
----------- ------------ ------------
Numerator for basic and diluted loss per common
share - income avail. to common shareholders $(8,417,413) $(14,980,544) $(17,995,388)
Effect of Dilutive Securities: 0 0 0
----------- ------------ ------------
Numerator for diluted loss per common share -
income available to common shareholders $(8,417,413) $(14,980,544) $(17,995,388)

Denominator:
- ------------
Denominator for basic loss per common share -
weighted average shares 6,017,332 6,096,932 10,943,630
Dilutive potential common shares 0 0 0
----------- ------------ ------------
Denominator for diluted loss per common share
adjusted weighted-average shares and assumed
conversions 6,017,332 6,096,932 10,943,630
----------- ------------ ------------
Basic and diluted loss per common share $(1.40) $(2.46) $(1.64)
=========== ============ ============
</TABLE>

The analysis assumes that there are no conversions of any securities during
the periods shown because there is a loss in each fiscal year, and therefore the
effect of the conversion of any security would be anti-dilutive.

18. SA TELECOM ACQUISITION

On January 21, 1998, the Company signed an agreement with SA
Telecommunications, Inc., ("SA Telecom") a switched based, long distance
telecommunications carrier serving customers primarily in Texas and California
to acquire certain assets and customer bases in exchange for a combination of
shares of stock, cash and assumption of certain liabilities. The transaction
was subject to certain conditions, including approval of the bankruptcy court
supervising the reorganization of SA Telecom under Chapter 11 of the United
States Bankruptcy Code. On March 9, 1998, the Company won approval from the
bankruptcy court. The purchase of SA Telecom was approved by the Company's
shareholders on June 30, 1998 and finalized on July 23, 1998 for approximately
$3.47 million in cash and approximately $5.4 million in preferred stock and the
assumption of approximately $4 million in debt, payable to Greyrock Business
Credit, subject to final closing adjustments. Prior to the closing of the
transaction, the Company advanced $3.0 million to SA Telecom on the cash portion
of the proceeds. This amount is recorded in current assets in the financial
statements. Also, prior to the closing of this transaction and for the purpose
of providing for a smooth transaction of the acquired customer base, the

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<PAGE>

Company and SA Telecom entered into a management agreement pursuant to which the
Company would manage the operations of SA Telecom from April 1, 1998 until the
close of the transaction whereby the Company was responsible for any losses from
SA Telecom's operations on or after April 1, 1998. SA Telecom has provided the
Company with notice that the Company owes SA Telecom approximately $655,000 for
operating losses during the period the management agreement was effective. The
determination of operating losses under the management agreement is subject to
interpretation and the Company has disputed the amount of operating losses as
provided by SA Telecom. The Company estimates that the final amount of operating
losses under the management agreement are significantly lower than what has been
requested and could be as low as zero. Additionally, SA Telecom is disputing the
final purchase price settlement and has requested additional funding. It is most
likely the Company and SA Telecom will settle these disputes at the same time
and it is not possible to estimate the outcome of these proceedings at this
time. Any additional amount paid by the Company, if any, is anticipated to be
recorded as additional purchase consideration. The Company has not included any
losses associated with the SA Telecom operations in its Consolidated Statement
of Operations for the fiscal year 1998.

19. SUBSEQUENT EVENTS

OPERATIONS

During the first quarter of fiscal year 1999, the Company continued to
operate at a loss. Although the Company began to take actions to reduce its
costs of operations and general and administrative costs, the favorable results
of these cost saving actions will not be fully recognized until the second or
third quarter of fiscal year 1999.

The Company's revenues have increased since the end of fiscal year 1998 due
to the acquisition of the assets of SA Telecom on July 22, 1998 (see SA Telecom
Acquisition). In September 1998, the Company's monthly gross revenue
approximated $2.9 million of which approximately $1.5 million was generated from
the former customers of SA Telecom. The Company has had a modest marketing
program, which has not been sufficient to cover the decrease in revenue
resulting from the attrition of its customer bases.

The Company's gross margin during the first quarter of fiscal year 1999 was
negative due to the continued operation of the Switches in areas in which it had
nominal long-distance traffic and problems the Company experienced in billing
its customers with its current billing system.

The Company has made a number of recent changes to reduce its operating
losses, improve its administrative operations and infuse its balance sheet. In
July and August 1998, the Company terminated or accepted resignations from six
members of its management team including its Chief Executive Officer, Chief
Operating Officers and Senior Vice President of Finance. The Company has
recently reduced its number of employees from 124 full time employees in June
1998 to 94 in October 1998. The Company is also in the process of reconfiguring
its network of Switches, therefore eliminating the fixed costs associated with
the network in areas in which the Company has nominal revenues.

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<PAGE>

CONVERTIBLE NOTE TRANSACTIONS

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<PAGE>

Any holder of a 2001 Note may convert the 2001 Note, in whole or in part,
into shares of Common Stock at a conversion price per share equal to the lesser
of:

[ ] the product of (1) the average of the lowest sales price of the
Company's Common Stock on Nasdaq for the five days immediately
preceding the date of conversion and (2) 85% (subject to
reduction pursuant to the terms of the 2001 Notes); and

[ ] $0.9006 (subject to reduction pursuant to the terms of the 2001
Notes).

Holders of shares of Series D Preferred will have the right to convert each
of their shares into a number of shares of Common Stock equal to the quotient
of:

[ ] the sum of (1) $1,000 (subject to adjustment pursuant to the
Series D Preferred documents), (2) accrued but unpaid dividends
to the applicable conversion date on the share of Series D
Preferred being converted and (3) accrued but unpaid interest on
the dividends on the share of Series D Preferred being converted;
and

[ ] an amount equal to the lesser of:

[ ] the product of (1) the average of the lowest sales price of the
Common Stock on Nasdaq for any five trading days during the 25
trading days immediately preceding the conversion date and (2)
85% (subject to downward adjustment, if applicable, pursuant to
the Series D Preferred documents); and

[ ] $1.2281 (subject to reduction pursuant to the Series D Preferred
documents),

subject to adjustment pursuant to the anti-dilution provisions.

NASDAQ LISTING

The Company's Common Stock currently trades on Nasdaq. If the Company
fails to maintain the minimum bid price or the minimum net tangible assets
requirements of Nasdaq, the Common Stock could be subject to delisting
therefrom. At June 30, 1998, the Company did not meet the minimum net worth
requirement. On September 30, 1998, Nasdaq notified the Company it would be
delisted on December 31, 1998 if its average closing bid price does not equal or
exceed the $1.00 minimum bid price requirement for a minimum of ten consecutive
trading days during the 90 day period ending December 29, 1998. On October 8,
1998, Nasdaq also notified the Company that it would be delisted if the market

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<PAGE>

value of its public float was not equal to or greater than $5.0 million for a
minimum of ten consecutive trading days during the period from October 9, 1998
to January 6, 1999.

FORECLOSURE OF WEB PAGES

Netco Acquisition, LLC issued a foreclosure letter on August 25, 1998 to
EqualNet stating its intent to immediately foreclose on the customer base of
EqualNet's web page hosting customers. At the time, EqualNet was in default on
a $400,000 note payable to Netco Acquisition, LLC.

RFC LOAN TO THE COMPANY

On July 23, 1998, the Company entered into a Loan and Security Agreement
with RFC which was subsequently amended on September 8, 1998 (the agreement as
amended, "RFC Loan"). RFC loaned the Company $1.5 million. Periodic monthly
principal and interest payments of $14,812 are due commencing on November 30,
1998. The balance due on the RFC Loan is payable on June 30, 2000. Interest is
payable on the outstanding principal balance in an amount equal to the prime
lending rate plus 5.5%. The RFC Loan is secured by all of the assets of the
Company and the stock of EqualNet and USC Telecom. In connection with the RFC
loan, the Company granted to RFC a warrant for the purchase of up to 294,000
shares of Common Stock at the exercise price equal to the arithmetic average of
the closing price of the Common Stock on Nasdaq for the three trading days
immediately preceding the consummation of the RFC loan. This warrant expires
July 23, 2003.

WILLIS GROUP LOAN

On September 2, 1998, the Company executed a loan agreement in favor of the
Willis Group in the amount of $241,106. The loan documented certain advances
which the Willis Group had made on the Company's behalf. The Willis Group loan
is secured by the assets of the Company and each of its subsidiaries. This loan
bears interest at 11% and matures on January 31, 1999.

RFC FUNDING TO USC TELECOM

In August 1998, USC Telecom entered into a receivables purchase facility
with RFC and used the proceeds of the initial funding of $2.1 million to pay off
a portion of the debt to Greyrock Business Credit, which was assumed in the SA
Telecom transaction. This facility is USC Telecom's primary source of working
capital. The maximum purchase commitment amount from RFC is $4.0 million, and
the program fee is the prime rate plus 4.0%. The term of the facility is two
years from the funding date.

20. INTERIM FINANCIAL DATA (UNAUDITED)

Selected quarterly financial results for the years 1997 and 1998 are
summarized below (in thousands except per share data):

<TABLE>
<CAPTION>
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
------- ------- ------- -------
<S> <C> <C> <C> <C>
1997
Revenues $13,315 $12,090 $10,662 $10,521
Gross margin 3,027 2,445 2,818 3,817
Net loss (1,558) (7,151) (1,940) (4,332)
Net loss per share-basic and diluted $ (0.26) $ (1.18) $ (0.32) $ (0.70)

1998
Revenues $ 8,327 $ 6,481 $ 5,766 $ 4,302
Gross margin 2,063 1,753 1,125 (2,056)
Net loss (2,097) (2,178) (4,054) (9,614)
Net loss per share-basic and diluted $ (0.33) $ (0.35) $ (0.43) $ (0.53)
</TABLE>

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<PAGE>

The quarter ending December 31, 1996, includes a $4.4 million write down of
deferred acquisition costs (See Note 11). The quarter ending March 31, 1996,
includes a $3.6 million charge to the provision for uncollectible accounts, a
$1.0 million write down of deferred acquisition costs, a $2.2 million write off
of capitalized software development costs associated with the NetBase Plus
system and $700,000 of other charges which included accruals for estimated
settlements related to disputed carrier charges, long-distance commitment
shortfalls and consumer complaints filed with state agencies.

(1) Earnings per share are computed independently for each of the quarters
presented. Therefore, the sum of the quarterly earnings per share in 1997
does not equal the total computed for the year due to stock transactions
which occurred during the year.

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<PAGE>

Equalnet Communications Corp.
Schedule II - Valuation and Qualifying Accounts
(in thousands)

<TABLE>
<CAPTION>
Balance at Charged to Balance at
Beginning Costs and Charged to Deductions End of
of Period Expenses other Accounts Describe(A) Period
---------- ---------- -------------- ----------- ----------
<S> <C> <C> <C> <C> <C>
Fiscal Year Ended June 30, 1998
Allowance for Doubtful Accounts $1,451 $1,661 $ (112) $1,966 $1,034

Fiscal Year Ended June 30, 1997
Allowance for Doubtful Accounts $3,285 $1,727 $2,011(B) $5,572 $1,451
Allowance for Advances to Agents $1,000 $ - $ - $1,000 $ -

Fiscal Year Ended June 30, 1996
Allowance for Doubtful Accounts $1,219 $3,821 $ 705(B) $2,460 $3,285
Allowance for Advances to Agents $ - $1,000 $ - $ - $1,000
</TABLE>

(A) Uncollectible accounts written off, net of recoveries
(B) Provision for uncollectible accounts receivable taken against agent
commissions payable

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Exchange Act, the
registrant has duly caused this Amendment No. 1 to the Annual Report on Form 10-
K/A to be signed on its behalf by the undersigned, thereunto duly authorized.

Equalnet Communications Corp.
(Registrant)

by: /s/ Mitchell H. Bodian
-----------------------------------------
Mitchell H. Bodian, President, Co-Chief
Executive Officer, Director and principal
financial and accounting officer

Dated: June 17, 1999

In accordance with the Securities and Exchange Act of 1934, this Amendment No. 1
to the Annual Report on Form 10-K/A has been signed by the following persons on
behalf of the registrant and in the capacities and on the dated indicated:

<TABLE>
<CAPTION>
Signature Title Date
--------- ----- ----
<S> <C> <C>
/s/ Mark A. Willis Chairman of the Board and Director June 17, 1999
- ---------------------------------------
Mark A. Willis

/s/ Mitchell H. Bodian President, CoChief Executive Officer, June 17, 1999
- --------------------------------------- Director and principal financial and
Mitchell H. Bodian accounting officer

Co-Chief Executive Officer June 17, 1999
- ---------------------------------------
Barrett Wissman

/s/ John Isaac "Ike" Epley Director June 17, 1999
- ---------------------------------------
John Isaac "Ike" Epley

/s/ Ronald J. Salazar Director June 17, 1999
- ---------------------------------------
Ronald J. Salazar
</TABLE>

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<PAGE>

EXHIBIT INDEX
-------------

EXHIBIT NO. DESCRIPTION

3.1 Articles of Incorporation of the Registrant (incorporated by reference to
Exhibit 3.1 to Amendment No. 1 to the Registrant's Registration Statement
on Form S-1 (Registration No. 33-88742); filed on February 13, 1995).

3.2 Bylaws of the Registrant (incorporated by reference to Exhibit 3.2 to the
Registrant's Registration Statement on Form S-1 (Registration No. 33-
88742); filed on January 24, 1995).

4.1 $1,000,000 Note dated October 1, 1997, issued by the Company to the Willis
Group (incorporated by reference to exhibit 4.1 of the Company's Quarterly
Report on Form 10-Q for the quarter ended 12/31/97).

4.2 Loan and Security Agreement, dated March 6, 1998, between the Company and
Finova Capital Corporation (incorporated by reference to exhibit 4.2 of
the Company's Quarterly Report on Form 10-Q for the quarter ended
3/31/98).

10.1 Lease Agreement dated June 28, 1994, between EqualNet and Caroline
Partners, Ltd., as amended by First Amendment dated August 15, 1994, and
Second Amendment dated September 8, 1994 (incorporated by reference to
Exhibit 10.6 to Registrant's Registration Statement on Form S-1
(Registration No. 33-88742) filed on January 24, 1995).

10.2 Financing agreement between Receivables Funding Corporation and EqualNet
Holding Corporation, dated June 18, 1997 (incorporated by reference to
Exhibit 10.17 to Amendment 2 to the Registrant's Annual Report on Form 10-
K for the year ended June 30, 1997, filed on October 28, 1997)

10.3 Carrier Agreement between AT & T and EqualNet Corporation, dated May 13,
1997 (certain confidential portions of this exhibit have been omitted
pursuant to a request for confidential treatment pursuant to Rule 246-2
under the Securities Exchange Act of 1934, incorporated by reference to
Exhibit 10.18 to Amendment 2 to the Registrant's Annual Report on Form 10-
K for the year ended June 30, 1997, filed on October 28, 1997)

10.4 Subscription Agreement, dated as of July 1, 1997, among the Company and
Lexus Commercial Enterprises, Ltd. (incorporated by reference to exhibit
10. 1 of the Company's Quarterly Report on Form 10-Q for the quarter ended
9/30/97).

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10.7 Switch Agreement, dated December 2, 1997, between the Company and the
Willis Group, as amended by the First Amendment dated December 19, 1997,
and Second Amendment dated February 12, 1998 (incorporated by reference to
exhibit 10.2 of the Company's Quarterly Report on Form 10-Q for the
quarter ended 12/31/97).

10.8 Agreement of Merger and Plan of Reorganization, dated December 2, 1997,
between the Company and EQ Acquisition Sub. Inc., Netco Acquisition, LLC
and Netco Acquisition Corp., as amended by the First Amendment dated
December 19, 1997, and Second Amendment dated February 12, 1998
(incorporated by reference to exhibit 10.3 of the Company's Quarterly
Report on Form 10-Q for the quarter ended 12/31/97).

10.9 Stock Purchase Agreement, dated December 2, 1997, by and among the Company
and the Willis Group., as amended by the First Amendment dated December
19, 1997, (incorporated by reference to exhibit 10.4 of the Company's
Quarterly Report on Form 10-Q for the quarter ended 12/31/97).

10.10 Exchange Agreement, dated March 6, 1998 between the Company and The Furst
Group, Inc. (incorporated by reference to exhibit 10.5 of the Company's
Quarterly Report on Form 10-Q for the quarter ended 3/31/98).

10.11 Stock and Warrant Purchase Agreement dated March 26 1998, between the
Company and First Sterling Ventures Corp. and Frank Hevrdejs (incorporated
by reference to exhibit 10.6 of the Company's Quarterly Report on Form
10-Q for the quarter ended 3/31/98).

10.12 Stock Purchase Warrant dated March 26 1998, between the Company and First
Sterling Ventures Corp. (incorporated by reference to exhibit 10.7 of the
Company's Quarterly Report on Form 10-Q for the quarter ended 3/31/98).

10.14 Stock and Warrant Purchase Agreement dated April 24, 1998, between the
Company and James R. Crane (incorporated by reference to exhibit 10.9 of
the Company's Quarterly Report on Form 10-Q for the quarter ended
3/31/98).

10.17 Purchase Agreement dated January 15, 1998 between the Company and SA
Telecommunications, Inc. and Certain of its Subsidiaries as amended by
Amendment dated March 10, 1998 (incorporated by reference to exhibit 10.12
of the Company's Quarterly Report on Form 10-Q for the quarter ended
3/31/98).

93
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