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

                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549
                              ---------------------

                                    FORM 10-Q

(MARK ONE)

[X]      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
         SECURITIES EXCHANGE ACT OF 1934

                FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2001

                                       OR

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

                     FOR THE TRANSITION PERIOD FROM TO _____

COMMISSION FILE NUMBER 0 - 26728

                           TALK AMERICA HOLDINGS, INC.
             (Exact name of registrant as specified in its charter)

        DELAWARE                                        23-2827736
(State of incorporation)                    (I.R.S. Employer Identification No.)


         12020 SUNRISE VALLEY DRIVE, SUITE 250, RESTON, VIRGINIA 20191
               (Address of principal executive offices) (Zip Code)


                                 (703) 391-7500
              (Registrant's telephone number, including area code)


     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 the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.

     81,452,721 shares of Common Stock, par value of $0.01 per share, were
issued and outstanding as of November 8, 2001.

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

<PAGE>

                  TALK AMERICA HOLDINGS, INC. AND SUBSIDIARIES

                                      INDEX
<TABLE>
<CAPTION>
                                                                                                  Page
                                                                                                  ----



PART I - FINANCIAL INFORMATION:

<S>                                                                                             <C>

Item 1.   Consolidated Financial Statements:

          Consolidated Balance Sheets - September 30, 2001 (unaudited) and
          December 31,  2000.....................................................................    3

          Consolidated Statements of Operations - Three and Nine Months Ended
          September 30, 2001 and 2000 (unaudited)................................................    4

          Consolidated Statements of Cash Flows - Nine Months Ended September 30,
          2001 and 2000 (unaudited)..............................................................    5

          Notes to Consolidated Financial Statements (unaudited).................................    6

Item 2.   Management's Discussion and Analysis of Financial Condition
          and Results of Operations..............................................................   14

Item 3.   Quantitative and Qualitative Disclosure About Market Risk..............................   24

PART II - OTHER INFORMATION:

Item 2.  Changes in Securities...................................................................   25
Item 6.  Exhibits and Reports on Form 8K.........................................................   25

         (a)  Exhibits
         (b)  Reports on Form 8-K
</TABLE>

                                       2
<PAGE>

                         PART I - FINANCIAL INFORMATION

ITEM 1.    CONSOLIDATED FINANCIAL STATEMENTS

                  TALK AMERICA HOLDINGS, INC. AND SUBSIDIARIES
                           CONSOLIDATED BALANCE SHEETS
               (IN THOUSANDS, EXCEPT FOR SHARE AND PER SHARE DATA)

<TABLE>
<CAPTION>
                                                                                               SEPTEMBER 30,       DECEMBER 31,
                                                                                                   2001                2000
                                                                                               -------------         ----------
                                                                                               (UNAUDITED)
                                        ASSETS
<S>                                                                                                 <C>                 <C>
Current assets:
   Cash and cash equivalents                                                                       $ 24,026              $ 40,604
   Accounts receivable, trade, net of allowance for uncollectible accounts of $76,257
     and $29,459, respectively                                                                       42,400                53,637
   Advances to partitions and notes receivable                                                        1,450                 1,780
   Prepaid expenses and other current assets                                                          1,573                 1,182
                                                                                                   --------              --------
       Total current assets                                                                          69,449                97,203

Property and equipment, net                                                                          79,029                83,656
Goodwill and intangibles, net                                                                        31,137               218,639
Other assets                                                                                          7,540                 8,251
                                                                                                   --------              --------
       Total assets                                                                                $187,155              $407,749
                                                                                                   ========              ========
                    LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)

Current liabilities:
  Accounts payable, trade and other                                                                $ 63,145              $ 70,794
  Sales, use and excise taxes                                                                         8,624                 7,935
  Accrued payroll                                                                                     4,410                 2,204
  Deferred revenue                                                                                   13,670                12,997
  Notes payable and current portion of long-term debt                                                 9,587                 2,822
  Convertible debt                                                                                   66,852                    --
  Other current liabilities                                                                           7,591                 3,519
                                                                                                   --------              --------
       Total current liabilities                                                                    173,879               100,271
                                                                                                   --------              --------
Convertible note payable (principal of $34,000 and accrued future interest of $31,317)               65,317                    --
Convertible debt                                                                                     18,093                84,945
Long-term debt                                                                                       13,852                18,750
Deferred revenue                                                                                        650                 6,200
Deferred income taxes                                                                                   253                   253
                                                                                                   --------              --------
       Total liabilities                                                                            272,044               210,419
                                                                                                   --------              --------
Commitments and contingencies

Contingent redemption value of warrants                                                                  --                36,324
Contingent redemption value of common stock                                                              --                78,306

Stockholders' equity (deficit):
   Preferred stock - $.01 par value, 5,000,000 shares authorized; no shares
     outstanding                                                                                         --                    --
   Common stock - $.01 par value, 300,000,000 shares authorized; 81,452,721 and
     78,445,134 shares issued and outstanding                                                           815                   784
   Additional paid-in capital                                                                       350,626               286,963
   Treasury stock, 274,497 shares at December 31, 2000, at cost                                          --                (3,851)
   Deficit                                                                                         (436,330)             (201,196)
                                                                                                   --------              --------
       Total stockholders' equity (deficit)                                                         (84,889)               82,700
                                                                                                   --------              --------
       Total liabilities and stockholders' equity (deficit)                                        $187,155              $407,749
                                                                                                   ========              ========
</TABLE>

          See accompanying notes to consolidated financial statements.

                                       3
<PAGE>

                  TALK AMERICA HOLDINGS, INC. AND SUBSIDIARIES
                      CONSOLIDATED STATEMENTS OF OPERATIONS
                    (IN THOUSANDS, EXCEPT FOR PER SHARE DATA)
                                   (UNAUDITED)

<TABLE>
<CAPTION>
                                                                      FOR THE THREE MONTHS ENDED     FOR THE NINE MONTHS ENDED
                                                                             SEPTEMBER 30,                  SEPTEMBER 30,
                                                                       ------------------------      -----------------------
                                                                         2001           2000           2001          2000
                                                                       ------------   ---------      -----------  ----------
<S>                                                                     <C>            <C>            <C>           <C>
Sales                                                                  $ 126,335      $ 121,233      $ 397,872      $413,013
Cost of sales                                                             58,679         60,838        186,897       225,530
                                                                       ---------      ---------      ---------      --------
Gross profit                                                              67,656         60,395        210,975       187,483

General and administrative expenses                                       20,537         18,131         64,248        43,997
Provision for doubtful accounts                                           28,888         11,663         79,437        27,173
Promotional, marketing and advertising expenses                           12,123         57,738         75,893       126,901
Depreciation and amortization                                             10,338          6,488         29,250        10,330
Impairment and restructuring charges (see Note 7)                        171,174             --        171,174            --
                                                                       ---------      ---------      ---------      --------
Operating loss                                                          (175,404)       (33,625)      (209,027)      (20,918)

Interest (income)                                                           (257)        (1,334)        (1,088)       (4,193)
Interest expense                                                           1,518          1,417          4,644         3,588
Other (income) expense, net                                                2,501          1,312          2,581         1,968
                                                                       ---------      ---------      ---------      --------
Loss before provision for income taxes                                  (179,166)       (35,020)      (215,164)      (22,281)

Provision for income taxes                                                    --           (250)            --            --
                                                                       ---------      ---------      ---------      --------
Loss  before  cumulative  effect of an  accounting  change  and
extraordinary gain                                                      (179,166)       (34,770)      (215,164)      (22,281)
                                                                       ---------      ---------      ---------      --------
Cumulative effect of an accounting change (see Note 1)                        --             --        (36,837)           --

Extraordinary gain (see Note 2)                                           16,867             --         16,867            --
                                                                       ---------      ---------      ---------      --------
Net loss                                                               $(162,299)     $ (34,770)     $(235,134)     $(22,281)
                                                                       =========      =========      =========      ========

Basic loss per share:
  Loss before  cumulative  effect of an  accounting  change and
  extraordinary gain per share                                         $   (2.27)     $   (0 48)     $   (2.74)     $  (0.33)
  Cumulative effect of an accounting change per share                         --             --          (0.47)           --
  Extraordinary gain per share                                              0.21             --           0.21            --
                                                                       ---------      ---------      ---------      --------
   Net loss per share - Basic                                          $   (2.06)     $   (0.48)     $   (3.00)     $  (0.33)
                                                                       =========      =========      =========      ========
Weighted average common shares outstanding - Basic                        78,742         72,839         78,497        68,005
                                                                       =========      =========      =========      ========
Diluted loss per share:
  Loss before  cumulative  effect of an  accounting  change and
  extraordinary gain per share                                         $   (2.27)     $   (0.48)     $   (2.74)     $  (0.33)
  Cumulative effect of an accounting change per share                         --             --          (0.47)           --
  Extraordinary gain per share                                              0.21             --           0.21            --
                                                                       ---------      ---------      ---------      --------
  Net loss per share - Diluted                                         $   (2.06)     $   (0.48)     $   (3.00)     $  (0.33)
                                                                       =========      =========      =========      ========
  Weighted average common and common equivalent shares
    outstanding - Diluted                                                 78,742         72,839         78,497        68,005
                                                                       =========      =========      =========      ========
</TABLE>

          See accompanying notes to consolidated financial statements.

                                       4
<PAGE>

                  TALK AMERICA HOLDINGS, INC. AND SUBSIDIARIES
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (IN THOUSANDS)
                                   (UNAUDITED)
<TABLE>
<CAPTION>
                                                                                        FOR THE NINE MONTHS
                                                                                         ENDED SEPTEMBER 30,
                                                                                    ----------------------------
                                                                                        2001              2000
                                                                                    ---------          ---------
<S>                                                                                    <C>                <C>
Cash flows from operating activities:
   Net loss                                                                         $(235,134)          $(22,281)
   Reconciliation of net loss to net cash provided by (used in) operating
     activities:
     Provision for doubtful accounts                                                   79,437             27,173
     Depreciation and amortization                                                     29,250             10,330
     Impairment and restructuring charges                                             171,174                 --
     Cumulative effect of an accounting change for contingent redemptions              36,837                 --
     Extraordinary gain on restructuring of contingent redemptions                    (16,867)                --
     Unrealized loss on increase in fair value of contingent redemptions                2,372                 --
     Loss on retirement of assets                                                         116                 --
     Other non-cash charges                                                                77                189
     Changes in assets and liabilities, net of acquisition of business:
         Accounts receivable, trade                                                   (68,200)           (21,626)
         Advances to partitions and notes receivable                                      330              1,957
         Prepaid expenses and other current assets                                       (391)             6,884
         Other assets                                                                     529              2,398
         Accounts payable and accrued expenses                                         (7,649)            14,505
         Deferred revenue                                                              (4,877)            (3,609)
         Sales, use and excise taxes                                                      689             (1,189)
         Other liabilities                                                              4,195             (3,000)
                                                                                    ---------          ---------
           Net cash provided by (used in) operating activities                         (8,112)            11,731
                                                                                    ---------          ---------

Cash flows from investing activities:
   Capital expenditures                                                                (3,440)           (30,049)
   Acquisition of intangibles                                                            (154)              (515)
   Acquisition of Access One, net of cash acquired                                         --             (3,285)
                                                                                    ---------          ---------
           Net cash used in investing activities                                       (3,594)           (33,849)
                                                                                    ---------          ---------

Cash flows from financing activities:
   Payments of borrowings                                                              (1,347)                (5)
   Payments in connection with restructuring of contingent redemptions                 (3,525)                --
   Proceeds from exercise of options and warrants                                          --              2,528
   Proceeds from exercise of common stock rights                                           --             11,094
                                                                                    ---------          ---------
           Net cash provided by (used in) financing activities                         (4,872)            13,617
                                                                                    ---------          ---------

Net decrease in cash and cash equivalents                                             (16,578)            (8,501)
Cash and cash equivalents, beginning of period                                         40,604             78,937
                                                                                    ---------          ---------
Cash and cash equivalents, end of period                                            $  24,026          $  70,436
                                                                                    =========          =========
</TABLE>

          See accompanying notes to consolidated financial statements.


                                       5
<PAGE>

                  TALK AMERICA HOLDINGS, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (UNAUDITED)

1. ACCOUNTING POLICIES:

(A) BASIC PRESENTATION

         The consolidated financial statements include the accounts of Talk
America Holdings, Inc. and its wholly owned subsidiaries (collectively, the
"Company"), and have been prepared as if the entities had operated as a single
consolidated group since their respective dates of incorporation, except as
noted below. All intercompany balances and transactions have been eliminated.
The consolidated financial statements include the results of operations of
Access One Communications Corp. ("Access One") from August 9, 2000, when it was
acquired by the Company in a merger transaction that was accounted for under the
purchase method of accounting for business combinations (see Note 4).

         The consolidated financial statements and related notes thereto as of
September 30, 2001 and for the three and nine months ended September 30, 2001
and 2000 are presented as unaudited but in the opinion of management include all
adjustments necessary to present fairly the information set forth therein. The
consolidated balance sheet information for December 31, 2000 was derived from
the audited financial statements included in the Company's Form 10-K. These
interim financial statements should be read in conjunction with the Company's
Annual Report on Form 10-K for the year ended December 31, 2000 (the "Form
10-K"). The interim results are not necessarily indicative of the results for
any future periods. Certain prior year amounts have been reclassified for
comparative purposes.

(B) RISKS AND UNCERTAINTIES

         Future results of operations involve a number of risks and
uncertainties. Factors that could affect future operating results and cause
actual results to vary materially from historical results include, but are not
limited to:

         -   The Company's business strategy with respect to bundled local and
             long distance services may not succeed
         -   Failure to manage, or difficulties in managing, the Company's
             growth, operations or restructurings including attracting and
             retaining qualified personnel and opening up new territories for
             its services
         -   Dependence on the availability or functionality of incumbent local
             telephone companies' networks, as they relate to the unbundled
             network element platform or the resale of such services
         -   Increased price competition in local and long distance services
         -   Failure or interruption in the Company's network and information
             systems
         -   Changes in government policy, regulation and enforcement
         -   Adverse developments in the Company's relationship with its
             marketing partners
         -   Failure of the marketing of the bundle of the Company's local and
             long distance services under its direct marketing channels and
             under its agreements with its various marketing partners or failure
             to successfully add new marketing partners
         -   Failure of the Company to successfully implement a collection
             management system and credit controls for customers
         -   Inability to obtain additional capital required to fully implement
             the Company's business plan and meet existing obligations
         -   Inability to adapt to technological change
         -   Competition in the telecommunications industry
         -   Inability to manage customer attrition and bad debt expense
         -   Adverse change in Company's relationship with third party carriers

         Negative developments in these areas could have a material effect on
the Company's business, financial condition and results of operations.

         The Credit Facility Agreement between the Company and MCG Finance
Corporation ("MCG") subjects the Company and its subsidiaries to certain
restrictions and covenants related to, among other things, liquidity,
per-subscriber-type revenue, subscriber acquisition costs, leverage ratio and
interest coverage ratio requirements. As of September 30, 2001 the Company would
have been in default of its revenue by subscriber type covenant but received a
waiver from MCG. The waiver covered compliance through the third quarter of
2001. Based on the

                                       6
<PAGE>

                  TALK AMERICA HOLDINGS, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (UNAUDITED)

Company's financial results to date and internal projections, it is possible
that the Company may be required to obtain a waiver from MCG for the fourth
quarter of 2001 and for 2002 or it may again be in default of certain financial
covenants under the Credit Facility Agreement, thus $13.8 million of the loan
balance has remained in long-term debt at September 30, 2001. The Company and
MCG are currently discussing the restructuring of certain portions of the
Credit Facility Agreement, including the financial covenants. Although the
Company has been able to receive waivers from MCG in the previous two quarters
and MCG has indicated a willingness to agree to such a waiver, there can be no
assurances that the Company will receive a waiver from MCG for the fourth
quarter or for periods in 2002 or that MCG will not demand payment under the
Credit Facility Agreement if the Company is in default of certain financial
covenants.

         The Company believes that its current cash position and the cash flow
expected to be generated from operations will be sufficient to fund its capital
expenditures, working capital and other cash operating and regular debt service
requirements for at least the next twelve months. However, based on its existing
cash and cash equivalents and its expectations as to future cash flow from
operations, the Company will be required to obtain additional financing to fund
a substantial portion of the 2002 Convertible Notes that come due September
2002. While the Company believes that, if it continues to address the
operational issues that it encounters (particularly lowering its bad debt
expense and reduced churn) and improves upon the operational efficiencies of the
Company's bundled business model, it could obtain such financing. However, there
can be no assurance that the Company will be able to successfully address the
operational issues it encounters or be able to improve upon the operational
efficiencies of its bundled business model, or that, given current market
conditions, the Company will be able to raise such additional capital on terms
acceptable to the Company. In addition, the Company's use of its cash on hand to
satisfy the 2002 Convertible Note obligations would impair its ability to
continue to implement its business plan, as could the timing of any cash
payments required to be made by the Company in respect of the various actions
against the Company, as discussed in Note 3 and Note 8.

(C) NEW ACCOUNTING PRONOUNCEMENTS

         Effective January 1, 2001, the Company adopted Statement of Financial
Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments
and Hedging Activities," as amended by SFAS No. 137, "Accounting for Derivatives
Instruments and Hedging Activities-Deferral of the Effective Date of FASB
Statement No. 133," and SFAS No. 138, "Accounting for Certain Derivatives
Instruments and Certain Hedging Activities." The standards require an entity to
recognize all derivatives as either assets or liabilities measured at fair
value. The accounting for the changes in fair value of a derivative depends on
the use of the derivative. The cumulative effect of adopting these new
accounting standards did not have a material effect on the Company's results of
operations or its financial position for the periods presented in the financial
statements included herein.

         The Financial Accounting Standards Board ("FASB") Emerging Issues Task
Force ("EITF") has issued Abstract No. 00-19, "Accounting for Derivative
Financial Instruments Indexed to, and Potentially Settled in, a Company's Own
Stock," which addresses how such contracts should be classified and measured by
the Company. Under this issue, contracts that require net-cash settlement would
be initially classified as assets or liabilities, then measured at fair value,
with changes in fair value reported in earnings and disclosed in the financial
statements as long as the contracts remain classified as assets or liabilities.
If contracts classified as assets or liabilities are ultimately settled in
shares, any previous gains or losses on those contracts would continue to be
included in earnings. This abstract is effective for all contracts that remained
outstanding at June 30, 2001, and presented on that date as a cumulative effect
of a change in accounting principle. The cumulative effect of the adoption of
this change in accounting principle resulted in a noncash charge to operations
of $36.8 million in the quarter ended June 30, 2001 (see Note 2).

         In July of 2001, the FASB issued Statements No. 141, "Business
Combinations" and No. 142, "Goodwill and Other Intangible Assets," ("SFAS 142")
which eliminate the pooling of interests method of accounting, establish new
criteria for identification of separate intangibles acquired, and establish the
impairment approach rather than amortization for goodwill. The Company has $18.6
million of net goodwill and $12.5 million of net identifiable intangible assets
as of September 30, 2001 (after an impairment charge of $168.7 million taken in
the third quarter of 2001) and has recorded $19.0 million of amortization
expense in the nine months ended September 30, 2001. Effective January 1, 2002
the Company will no longer be required to record amortization expense on
goodwill, but will instead be required to evaluate these assets for potential
impairment on a quarterly basis and to record a charge for any such impairment.
Management believes the adoption of the impairment evaluation

                                       7
<PAGE>


                  TALK AMERICA HOLDINGS, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (UNAUDITED)

requirements of SFAS 142 will not have a material effect on the Company's
future results of operations or its financial position (see Note 7).

            In August 2001, the FASB issued Statement of Financial Accounting
Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets" ("SFAS 144"), which is effective for fiscal periods beginning after
December 15, 2001 and interim periods within those fiscal years. SFAS 144
establishes an accounting model for impairment or disposal of long-lived assets
to be disposed of by sale. The Company is currently evaluating the potential
impact, if any, the adoption of SFAS 144 may have on its financial position and
results of operation.

2. AOL AGREEMENTS:

     AOL RESTRUCTURING - SEPTEMBER 2001

         On September 19, 2001, the Company restructured its financial
obligations with America Online, Inc. ("AOL") that arose under the Investment
Agreement entered into on January 5, 1999 and also ended its marketing
relationship with AOL effective September 30, 2001 (collectively the "AOL
Restructuring"). In connection with the AOL Restructuring, the Company and AOL
entered into a Restructuring and Note Agreement ("Restructuring Agreement")
pursuant to which the Company issued to AOL a $54 million, 8% secured
convertible note  due September 2011 ("2011 Convertible Note") and 3,078,628
additional shares of the Company's common stock.

         The 2011 Convertible Note was issued in exchange for a release of the
Company's reimbursement obligations under the Investment Agreement. The 2011
Convertible Note is convertible into shares of the Company's common stock at
the rate of $5.00 per share, may be redeemed by the Company at any time without
premium and is subject to mandatory redemption at the option of the holder on
the fifth and seventh anniversaries of its issue date. The Company may also
elect to pay up to 50% (100% in the case of the first interest payment) of the
interest on the 2011 Convertible Note in kind rather than in cash. The 2011
Convertible Note is guaranteed by the Company's principal operating
subsidiaries and is secured by a pledge of the Company's and the subsidiaries'
assets.

         Pursuant to the Restructuring Agreement, in exchange for and in
cancellation of the Company's warrants to purchase 3,721,984 shares of the
common stock and the Company's related obligations under the Investment
Agreement to repurchase such warrants from AOL, the Company issued 3,078,628
additional shares of its common stock to AOL, after which AOL holds a total of
7,200,000 shares of common stock. The Company agreed to provide certain
registration rights to AOL in connection with the shares of common stock issued
to it by the Company.

         The Restructuring Agreement provided that the Investment Agreement, the
Security Agreement securing the Company's obligations under the Investment
Agreement and the existing Registration Rights Agreement with AOL were
terminated in their entirety and the parties were released from any further
obligation under these agreements. In addition, AOL, as the holder of the 2011
Convertible Note, entered into an intercreditor agreement with the lender under
the Company's existing secured credit facility.

         In addition to the restructuring of the financial obligations discussed
above, the Company and AOL agreed, in a further amendment to their marketing
agreement, dated as of September 19, 2001, to discontinue, effective as of
September 30, 2001, their marketing relationship under the marketing agreement.
In connection with this discontinuance, the Company paid AOL $6.0 million under
the marketing agreement, payable in two installments - $2.5 million on September
20, 2001 and the remaining $3.5 million on October 4, 2001. AOL, in lieu of any
other payment for the early discontinuance of the marketing relationship, paid
the Company $20 million by surrender and cancellation of $20 million principal
amount of the 2011 Convertible Note delivered to AOL as discussed above, thereby
reducing the outstanding principal amount of the 2011 Convertible Note to $34
million. The amendment also provided for the payment by the Company of certain
expenses related to marketing services until the discontinuance and for the
continued servicing and transition of telecommunications customer relationships
after the discontinuance of marketing.

         In accordance with SFAS No. 15, "Accounting by Debtors and Creditors
for Troubled Debt Restructurings," the AOL Restructuring transaction was
accounted for as a troubled debt restructuring. The Company combined all
liabilities due AOL at the time of the Restructuring Agreement including the
contingent

                                       8
<PAGE>

                  TALK AMERICA HOLDINGS, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (UNAUDITED)

redemption feature of the warrants with a value of $34.2 million and the
contingent redemption feature of the common stock with a value of $54.0 million.
The total liability of $88.2 million was reduced by the fair value of the
3,078,628 incremental shares provided to AOL of $1.4 million and cash paid in
connection with the AOL Restructuring of $3.5 million. Since the remaining value
of $83.3 million was greater than the future cash flows to AOL of $66.4 million
(representing the $34.0 million of convertible debt and $32.4 million of future
interest expense), the liability was written down to the value of the future
cash flows due to AOL and an extraordinary gain of $16.9 million was recorded.
As a result of this accounting treatment, the Company will have no interest
expense associated with these convertible notes in future periods in the
Company's statement of operations.

     AOL HISTORICAL AGREEMENTS - 1997 THROUGH SEPTEMBER 2001

         Since 1997, the Company had a number of agreements and amendments to
its agreements with AOL for the marketing and sale of telecommunications
services to AOL subscribers. A substantial amendment to the AOL agreement in
January 1999 provided for: (a) quarterly payments by the Company to AOL during
the long distance exclusivity period of the agreement, with fixed quarterly
payments ranging from $10.0 to $15.0 million ($19.0 million after July 1, 2000
if AOL had elected to provide certain additional marketing and promotions to the
Company) until June 30, 2001 and quarterly payments thereafter at a fixed 5% of
the Company's marginable long distance revenues from AOL subscribers in the
quarter under the agreement; (b) quarterly payments by the Company to AOL, after
termination of the long distance exclusivity period and so long as AOL continued
to provide certain levels of marketing and promotions to the Company under the
agreement, at an annual declining fixed percentage of the Company's marginable
long distance revenues from AOL subscribers under the agreement, starting at 5%
and declining by one percentage point each year to 1%; (c) the elimination of
the Company's obligation to make bounty and current profit-sharing payments to
AOL; (d) alteration of the terms of the online and offline marketing
arrangements between the Company and AOL; (e) extension of the term of the AOL
agreement, including the exclusivity period, until June 30, 2003, although AOL
had the right, in each year beginning in 2000, to elect, on or before May 1 of
such year, to end the Company's long distance exclusivity period as of June 30
of such year; (f) elimination of AOL's rights to receive further warrants to
purchase common stock based upon customers gained from the AOL subscriber base;
(g) AOL's contribution of up to $4.0 million (up to $6.0 million if the Company
pays $19.0 million as noted above) per quarter until June 30, 2001, for offline
marketing; and (h) establishment of the framework for the Company to offer
additional services and products to AOL subscribers. By an amendment dated as of
June 30, 2000, AOL agreed to give the Company a $1.0 million credit in each of
the second and third quarters of 2000 against amounts otherwise payable by the
Company under the AOL agreement. By a further amendment dated as of August 1,
2000, in consideration of AOL's agreement to provide certain additional
marketing in the last five months of 2000, the Company agreed to make additional
payments to AOL of $3.0 million in August 2000 and $1.0 million in each of the
months in the fourth quarter of 2000, which amounts were to be credited against
the Company's payment obligations in any quarter for which the Company was
required to pay at the quarterly rate of $19.0 million.

         AOL elected to exercise its right to terminate the long distance
exclusivity as of June 30, 2001 and thereafter the Company had the right, prior
to the AOL Restructuring, to offer long distance services on a non-exclusive
basis until June 30, 2003.

         On January 5, 1999, pursuant to an Investment Agreement between AOL and
the Company, AOL purchased a total of 4,121,372 shares of common stock of the
Company for $55.0 million in cash and the surrender of rights to purchase
5,076,016 shares of common stock of the Company pursuant to various warrants
held by AOL. AOL agreed to end further vesting under the outstanding performance
warrant and retained vested warrants exercisable for 2,721,984 shares of common
stock. Under the terms of the Investment Agreement entered into with AOL, the
Company agreed to reimburse AOL for losses AOL may incur on the sale of any of
the 4,121,372 shares of the Company's common stock held by AOL through September
30, 2001. The maximum amount payable to AOL as reimbursement on the sale of
AOL's shares was approximately $54.0 million plus AOL's reasonable expenses
incurred in connection with such sale. In addition, AOL also had the right,
commencing on July 1, 2001, to require the Company to repurchase warrants held
by AOL to purchase 2,721,984 shares of Company's common stock for $36.3 million,
which could have been paid in common stock or cash (provided that some portion
of the repurchase price may be payable in a quarterly amortization, two-year
promissory note of the Company if the repurchase price exceeds the then current
valuation of the warrants being purchased). In addition, upon the occurrence of
certain events, including material defaults by the Company under its AOL
agreements and a "change of control" of the

                                       9
<PAGE>

                  TALK AMERICA HOLDINGS, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (UNAUDITED)

Company, the Company may have been required to repurchase for cash all of the
shares held by AOL for $78.3 million ($19 per share), and the warrants for $36.3
million.

         The Company had originally recorded the contingent redemption value of
the common stock and warrants at $78.3 and $36.3 million, respectively, with a
corresponding reduction in additional paid-in capital. In connection with the
implementation of EITF 00-19, the contingent redemption feature of the common
stock and warrants were recorded as a liability at their fair values of $53.5
and $32.3 million, respectively, as of June 30, 2001. The increase in the fair
value of these contingent redemption instruments from issuance on January 5,
1999 to June 30, 2001 was $36.8 million, which has been presented as a
cumulative effect of a change in accounting principle in the statement of
operations. For the quarter ended September 30, 2001, the Company recorded an
unrealized loss of $2.4 million on the increase in the fair value of the
contingent redemption instruments, which has been reflected in other (income)
expense on the statement of operations. As discussed above, these contingent
redemption instruments were satisfied through the Restructuring Agreement
entered into with AOL on September 19, 2001, thus the requirements under EITF
00-19 will not apply to future changes in the value of these instruments.

3. LEGAL PROCEEDINGS:

         On June 16, 1998, a purported shareholder class action was filed in the
United States District Court for the Eastern District of Pennsylvania (the
"Court") against the Company and certain of its officers alleging violation of
the securities laws in connection with certain disclosures made by the Company
in its public filings and seeking unspecified damages. Thereafter, additional
lawsuits making substantially the same allegations were filed by other
plaintiffs in the same court. A motion to dismiss was granted as to certain
officers of the Company and denied as to the Company. On July 19, 2000, a class
was certified. On July 20, 2001, the Company entered into a Stipulation and
Agreement of Settlement, which received final approval from the Court on
November 9, 2001. The settlement amount shall be paid by the Company's insurance
carrier.

         The Company also is a party to a number of legal actions and
proceedings, arising from the Company's provision and marketing of
telecommunications services, as well as certain arbitration and legal actions
and regulatory investigations and enforcement proceedings arising in the
ordinary course of business.

         The Company believes that the ultimate outcome of the foregoing actions
will not result in liability that would have a material adverse effect on the
Company's financial condition or results of operations. However, it is possible
that, because of fluctuations in the Company's cash position, the timing of
developments with respect to such matters that require cash payments by the
Company, while such payments are not expected to be material to the Company's
financial condition, could impair the Company's ability in future interim or
annual periods to continue to implement its business plan, which could affect
its results of operations in future interim or annual periods (see Note 8).

4. ACQUISITION:

         On August 9, 2000, a wholly owned subsidiary of the Company merged with
and into Access One Communications Corp. ("Access One"). Access One was a
private, local telecommunications service provider to nine states in the
southeastern United States. As a result of this merger, Access One became a
wholly owned subsidiary of the Company and Access One stockholders received an
aggregate of approximately 12.2 million shares of the Company's common stock,
and outstanding options and warrants to purchase shares of Access One common
stock converted to options and warrants to purchase an aggregate of 2.1 million
shares of the Company's common stock. The total purchase price was approximately
$201.6 million and the merger was accounted for under the purchase method of
accounting for business combinations. Accordingly, the consolidated financial
statements include the results of operations of Access One from the merger date.
The merger resulted in the recording of intangible assets of approximately $15.9
million and goodwill of $210.0 million, to be amortized on a straight-line basis
over their expected benefit period of five years for intangible assets and ten
years for goodwill (see Note 7).

                                       10
<PAGE>


         The following unaudited pro forma information presents a summary of the
consolidated results of operations of the Company as if the Access One merger
had taken place at the beginning of the periods presented (in thousands, except
per share data):

                  TALK AMERICA HOLDINGS, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (UNAUDITED)

                                      Three Months Ended     Nine Months Ended
                                      September 30, 2000    September 30, 2000
                                      ------------------    ------------------
Sales                                      $131,364               $444,219

Net loss                                   $(39,833)              $(46,809)

    Basic net loss per common share        $  (0.55)              $  (0.69)

    Diluted net loss per common share      $  (0.55)              $  (0.69)

         The pro forma consolidated results of operations include adjustments to
give effect to amortization of intangibles, consulting fees and shares of common
stock issued. These unaudited pro forma results have been prepared for
comparative purposes only and do not purport to be indicative of the results of
operations that actually would have occurred had the merger been made at the
beginning of the periods presented or the future results of the combined
operations.


                                       11
<PAGE>

                  TALK AMERICA HOLDINGS, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (UNAUDITED)

5. PER SHARE DATA:

         Basic earnings per common share is calculated using the average number
of shares of common stock outstanding, while diluted earnings per common share
reflects the potential dilution that could occur if stock options and warrants
were exercised and convertible bonds were converted into common stock. Earnings
per share are computed as follows (amounts in thousands, except per share data):

<TABLE>
<CAPTION>
                                                       Three Months Ended                    Nine Months Ended
                                                          September 30,                        September 30,
                                                   ----------------------------         -----------------------------
                                                      2001               2000               2001               2000
                                                      ----               ----               ----               ----
<S>                                                <C>                 <C>               <C>                <C>
Loss before cumulative effect of an
accounting change and extraordinary gain           $ (179,166)         $ (34,770)        $ (215,164)        $ (22,281)

Cumulative effect of an accounting change                  --                 --            (36,837)               --
Extraordinary gain                                     16,867                 --             16,867                --
                                                   ----------          ---------         ----------         ---------
Net loss                                           $ (162,299)         $ (34,770)        $ (235,134)        $ (22,281)
                                                   ==========          =========         ==========         =========
Weighted average shares of common stock
outstanding used to compute basic loss per
common share                                           78,742             72,839             78,497            68,005

Additional common shares to be issued assuming
exercise of stock options and
warrants, net of shares assumed reacquired
and the conversion of convertible bonds *                  --                 --                 --                --
                                                   ----------          ---------         ----------         ---------
Weighted average shares used to compute
diluted loss per share                                 78,742             72,839             79,497            68,005
                                                   ==========          =========         ==========         =========
Basic loss per share:
  Loss before cumulative effect of an
  accounting change and extraordinary gain
  per share                                        $    (2.27)         $  (0.48)         $    (2.74)         $  (0.33)
  Cumulative effect of an accounting change
  per share                                                --                 --              (0.47)               --
  Extraordinary gain per share                           0.21                 --               0.21                --
                                                   ----------          ---------         ----------         ---------
  Net loss per share-Basic                         $    (2.06)         $  (0.48)         $    (3.00)        $   (0.33)
                                                   ==========          =========         ==========         =========
Diluted loss per share:
  Loss before cumulative effect of an
  accounting change and extraordinary gain
  per share                                        $    (2.27)         $  (0.48)         $    (2.74)        $   (0.33)
  Cumulative effect of an accounting change
  per share                                                --                 --              (0.47)               --
  Extraordinary gain per share                           0.21                 --               0.21                --
                                                   ----------          ---------         ----------         ---------
  Net loss per share-Diluted                       $    (2.06)         $  (0.48)         $    (3.00)        $   (0.33)
                                                   ==========          =========         ==========         =========
</TABLE>

* The diluted share basis for the three and nine months ended September 30, 2001
excludes options and warrants to purchase 17,420,771 shares and convertible
bonds that are convertible into 3,436,891 shares of common stock. These shares
are excluded due to their antidilutive effect as a result of the Company's net
loss from continuing operations.

6. CREDIT FACILITY:

The Company has a Credit Facility Agreement with MCG Finance Corporation
("MCG"), providing for a term loan of up to $20.0 million and a line of credit
facility permitting such subsidiaries to borrow up to an additional $30.0

                                       12
<PAGE>

                  TALK AMERICA HOLDINGS, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (UNAUDITED)

million. The Credit Facility Agreement subjects the Company and its subsidiaries
to certain restrictions and covenants related to, among other things, liquidity,
per-subscriber-type revenue, subscriber acquisition costs, leverage ratio and
interest coverage ratio requirements. As of September 30, 2001 the Company would
have been in default of its revenue by subscriber type covenant but received a
waiver from MCG. The waiver covered compliance through the third quarter of
2001. See Note 1 and Management's Discussion and Analysis of Financial
Conditions and Results of Operations- Liquidity and Capital Resources. In
connection with a waiver received for the second quarter of 2001 and certain
other amendments by MCG under the Credit Facility Agreement, the Company issued
warrants to purchase 150,000 shares of its common stock at $0.68 per share to
MCG.

7.  IMPAIRMENT AND RESTRUCTURING CHARGES:

         In the quarter ended September 30, 2001, the Company recorded an
impairment charge of $168.7 million primarily related to the write-down of
goodwill associated with the acquisition of Access One, which was created by
purchase accounting treatment of the merger transaction that closed in August
2000 (see Note 4). SFAS 121 "Accounting for the Impairment of Long-Lived Assets
and for Long-Lived Assets to be Disposed of" requires the evaluation of
impairment of long-lived assets and identifiable intangibles whenever events or
changes in circumstances indicate that the carrying amount of an asset may not
be recoverable. Management determined that goodwill should be evaluated for
impairment in accordance with the provisions of SFAS 121 due to the increased
bad debt rate and increased customer churn as well as the AOL Restructuring that
occurred in the quarter ended September 30, 2001. The Company is addressing
these operational issues through improving credit quality by credit scoring the
existing and future customer base, slowing down growth of new expected customers
through decreased marketing, and decreasing product pricing. These and other
actions taken by the Company result in lower current and future projected growth
of bundled revenues and cash flows than those originally projected at the time
of the Access One merger. The write-down of goodwill was based on an analysis of
projected discounted cash flows using a discount rate of 18%, which results
determined that the fair value of the goodwill was substantially less than the
carrying value.

         In September 2001, the Company approved a plan to close the call center
operation in Sunrise, Florida. The Company recorded a charge of $2.5 million in
the quarter ended September 30, 2001 to reflect the elimination of approximately
225 positions amounting to $1.0 million and lease exit costs amounting to $1.5
million in connection with the call center closure. The employees identified in
the plan were notified in September 2001 and terminated in October 2001 and
lease exit costs are expected to be incurred within the next twelve months.

8.  SUBSEQUENT EVENTS

         On November 12, 2001, the Company received an award of arbitrators
awarding Traffix, Inc. approximately $6.9 million in an arbitration concerning
the termination of a marketing agreement between the Company and Traffix, Inc.
The Company does not agree with this award and is currently reviewing the award
and its legal alternatives with its attorneys.  The Company believes that this
award will not have a material adverse effect on the Company's financial
condition or results of operations.  However, it is possible that, because of
fluctuations in the Company's cash position, the timing of developments with
respect to other matters that require cash payments by the Company, together
with this payment, could impair the Company's ability in future interim or
annual periods to continue to implement its business plan, which could affect
its results of operations in future interim or annual periods.

                                       13
<PAGE>

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

OVERVIEW

         Talk America Holdings, Inc. through its subsidiaries (the "Company" or
"Talk") provides local and long distance telecommunication services to
residential and small business customers throughout the United States.

         The Company's telecommunication services offerings include local and
long distance telecommunication services, primarily local services bundled with
long distance services, inbound toll-free service and dedicated private line
services for data transmission. The Company seeks to expand its customer base
through its direct marketing channels and marketing arrangements with business
partners and to build a more diverse products and services portfolio, including
non-telecommunication products and services. In connection with the Company's
strategy to diversify its product portfolio and to bundle local service with
its core long distance service offerings, the Company acquired Access One
Communications Corp. ("Access One") in August 2000. Access One was a private,
local telecommunication services provider to nine states in the southeastern
United States. See Notes 4 and 7 to the Consolidated Financial Statements in
this Report.

         On September 19, 2001, the Company restructured its financial
obligations with America Online, Inc. ("AOL") that arose under the Investment
Agreement entered into on January 5, 1999 and ended its marketing relationship
with AOL effective September 30, 2001 (see Note 2 to Consolidated Financial
Statements included in this Report and Management's Discussion and Analysis of
Financial Condition and Results of Operations: "Liquidity and Capital
Resources").

         The Company continues to focus its resources on addressing operational
issues that it has encountered in its business and improving efficiencies of the
Company's bundled business model, managing its business to generate free cash
flow and building a scaleable nationwide platform to provision, bill and service
bundled customers. Currently, the top priorities of the Company are to lower bad
debt expense and to reduce churn by improving the credit quality of the existing
customer base and slowing down growth until operational efficiencies are
achieved. In addition, the Company has improved product pricing for both local
and long distance services and will focus on delivering better service and value
to customers. The Company expects revenues to decline in the fourth quarter due
to churn and the decrease in expected new customers.

         As it pursues this plan to improve efficiencies of the Company's
bundled business model and implements the front-end customer quality
initiatives, and in light of the termination of the AOL marketing agreement, the
Company anticipates that it will incur a significantly lower level of marketing
and promotional expenditures during the balance of 2001 of between $5 and $7
million. The Company intends to increase its marketing and promotional
expenditures in the first quarter of 2002, provided that the Company improves
the efficiencies of the Company's bundled services and has addressed its
initiatives regarding bad debt expense and reduced churn. Consequently, the
Company expects its EBITDA for the fourth quarter of 2001 to be between $12 and
$14 million or between $4 and $6 million for the year ended 2001. EBITDA for
the third quarter of 2001 was $6.1 million. EBITDA for the year ended 2002 is
expected to be between $25 and $35 million. EBITDA is defined as net income
before cumulative effect of accounting changes and extraordinary items adjusted
to eliminate interest income and expense, taxes, other (income) expenses, net,
depreciation and amortization, and impairment and restructuring charges. EBITDA
is not intended to represent cash flow or any other measure of performance in
accordance with generally accepted accounting principles.

                                       14
<PAGE>

RESULTS OF OPERATIONS

The following table sets forth for the periods indicated certain financial data
of the Company as a percentage of sales:

<TABLE>
<CAPTION>
                                              For the Three Months         For the Nine Months Ended
                                              Ended September 30,                September 30,
                                           ---------------------------     ---------------------------
                                              2001            2000            2001            2000
                                           -----------     -----------     -----------     -----------
<S>                                        <C>            <C>                 <C>            <C>
Sales                                         100.0%          100.0%           100.0%          100.0%
Cost of sales                                  46.4            50.2             47.0            54.6
                                             ------           -----            -----            ----

Gross profit                                   53.6            49.8             53.0            45.4
                                             ------           -----            -----            ----
General and administrative expenses            16.2            14.9             16.1            10.7
Provision for doubtful accounts                22.9             9.6             20.0             6.6
Promotional, marketing and advertising
expenses                                        9.6            47.6             19.1            30.7
Depreciation and amortization                   8.2             5.4              7.3             2.5
Impairment and restructuring charges          135.5              --             43.0              --
                                             ------           -----            -----            ----
Operating loss                               (138.8)          (27.7)           (52.5)           (5.1)

Interest (income)                              (0.2)           (1.1)            (0.3)           (1.0)
Interest expense                                1.2             1.2              1.2             0.8
Other expense, net                              2.0             1.1              0.7             0.5
                                             ------           -----            -----            ----
Loss before income taxes                     (141.8)          (28.9)           (54.1)           (5.4)

Provision for income taxes                       --            (0.2)              --              --
                                             ------           -----            -----            ----

Loss  before cumulative effect of an
accounting change and extraordinary gain     (141.8)          (28.7)           (54.1)           (5.4)

Cumulative effect of an accounting change        --              --             (9.2)             --

Extraordinary gain                             13.3              --              4.2              --
                                             ------           -----            -----            ----
Net Loss                                     (128.5)          (28.7)           (59.1)           (5.4)
                                             ======           =====            =====            ====
</TABLE>

QUARTER ENDED SEPTEMBER 30, 2001 COMPARED TO QUARTER ENDED SEPTEMBER 30, 2000

         Sales. Sales increased by 4.2% to $126.3 million for the quarter ended
September 30, 2001 from $121.2 million for the quarter ended September 30, 2000.
Sales for the quarter ended September 30, 2001 decreased by 5.5% compared to
sales of $133.7 million for the quarter ended June 30, 2001. The Company's long
distance sales decreased to $69.4 million for the quarter ended September 30,
2001 from $103.9 million for the quarter ended September 30, 2000. The decrease
in long distance sales for the quarter ended September 30, 2001 compared to
September 30, 2000 primarily reflected the Company's (i) decision to focus its
efforts in the local telecommunication services market by offering local
telecommunication services bundled with long distance services in 2000; (ii) the
Company's election to exit the international wholesale business in the second
quarter of 2000; (iii) the conversion of long distance customers to the
Company's bundled service offering; and (iv) a decrease in the Company's other
sales. A significant percentage of the Company's revenues in the quarter ended
September 30, 2000 were derived from long distance telecommunication services
provided to customers who were obtained under the AOL marketing agreement.
Effective June 30, 2001, AOL exercised its right to terminate the Company's long
distance exclusivity under the marketing agreement and continue on a
non-exclusive basis, which resulted in

                                       15
<PAGE>

the Company receiving less marketing, further adding to the decline in
long-distance revenues. Pursuant to the AOL Restucturing, marketing under the
AOL agreement was discontinued effective September 30, 2001.

         The Company's bundled sales for the quarter ended September 30, 2001
totaled $57.0 million compared to $17.3 million in the third quarter of last
year and $52.9 million for the quarter ended June 30, 2001. Although the Company
expects bundled revenue to be down approximately 20% to 30% in the fourth
quarter from the third quarter of 2001, as the Company pursues its plans to
improve efficiencies of the Company's bundled business model and continues to
improve customer collections, growth is expected to resume in the first quarter
of 2002. Bundled revenues for the year ended 2002 are expected to be between
$150 and $165 million. Long distance revenues are expected to drop 15% to 20%
sequentially in the fourth quarter from the third quarter of 2001 and to be down
approximately 20% to 25% in 2001 compared to 2000 after adjusting long distance
revenue for the year ended 2000 to exclude international wholesale revenue, as
the Company continues to focus on marketing its bundled services plan. Long
distance revenues for the year ended 2002 are expected to be between $135 and
$150 million.

         Cost of Sales. Cost of sales decreased by 3.5% to $58.7 million in the
quarter ended September 30, 2001 from $60.8 million in the quarter ended
September 30, 2000, and, as a percentage of sales, decreased to 46.4% as
compared to 50.2% for the same quarter last year. The decreases were primarily
due to a decrease in network costs as a result of exiting the international
wholesale business, a lower number of long distance customers, a reduction in
access and usage charges and a reduction in primary interexchange carrier
charges ("PICC"). The decrease in network costs was offset by increases in costs
to incumbent local telephone companies related to the Company's efforts in the
local telecommunication market.

         Gross Profit. Gross profit increased by 12.0% in the quarter ended
September 30, 2001 to $67.7 million from $60.4 million in the quarter ended
September 30, 2000, and, as a percentage of sales, increased to 53.6% as
compared to 49.8% for the same quarter last year. The gross margin percentage in
the third quarter of 2001 increased slightly from the second quarter percentage
of 52.5%. The increase in gross profit percentage was primarily due to lower
network and billing costs and increased margin associated with the Company's
bundled sales compared to the margin of international wholesale, offset by
increased cost associated with the growing local business. Due to the growth of
local bundled service revenue as a percentage of total revenue, the still early
stage of development of the Company's local service initiative, as well as the
intensification of price competition for the Company's products and initiatives
by the Company regarding lower priced products, the Company expects to
experience a downward trend in gross profits in the future. The Company expects
that gross profit percentage will remain in the range of 50% to 53% throughout
the remainder of the year and expects it to be between 45% and 50% for the year
ended 2002.

         General and Administrative Expenses. General and administrative
expenses increased by 13.3% to $20.5 million in the quarter ended September 30,
2001 from $18.1 million in the quarter ended September 30, 2000, and, as a
percentage of sales, increased to 16.2% as compared to 14.9% for the same
quarter last year. The increase in general and administrative expenses was due
primarily to increased personnel costs associated with supporting the
Company's growth in the local services business and the additional sales,
provisioning and customer service support for its local customers. General and
administrative expenses for the quarter ended September 30, 2001 decreased by
11.7% compared to $23.3 million for the quarter ended June 30, 2001. The
decrease from second to third quarters of 2001 is attributed to significant
workforce reductions and other cost cutting efforts by the Company as it pursues
improvements in operating efficiencies of Company's bundled business model.

         Provision for Doubtful Accounts. Provision for doubtful accounts
increased by 147.7% to $28.9 million in quarter ended September 30, 2001 from
$11.7 million in 2000, and, as a percentage of sales, increased to 22.9% as
compared to 9.6% for the same quarter last year. As a percentage of revenue, the
Company's bad debt rate has remained at a high level during the third quarter,
although it shows some improvement from the second quarter percentage of 26.8%.
A portion of the bad debt reflects customers acquired through discontinued
marketing programs and customers provisioned to the Company's bundled service
that the Company now believes are unlikely to pay. The Company has taken several
steps to address the existing and future customer collection issues, including
the following: (a) adoption of more stringent credit controls through the
implementation of credit scoring of the existing customer base and pre-screening
of new customers based on specific levels and criteria; (b) implementation of a
new collections management system in the third quarter that is integrated with
the billing and payment applications; (c) improved in-house and third party
collection efforts; and (d) enhanced paper invoicing process. The Company
expects the provision for doubtful accounts to be reduced to approximately $13
to $15 million for the

                                       16
<PAGE>

quarter ended December 31, 2001 due in part to the implementation of a new
collections management system and adoption of more stringent credit controls, as
discussed above.

              Promotional, Marketing and Advertising Expenses. During the
quarter ended September 30, 2001, the Company incurred $12.1 million of
promotional, marketing and advertising expenses as compared to $57.7 million in
the quarter ended September 30, 2000, a 79.0% decrease, and, as a percentage of
sales, a decrease to 9.6% as compared to 47.6% for the same quarter last year.
The decrease is primarily attributed to reduced marketing fees paid to AOL when
the AOL marketing agreement changed from an exclusive to a non-exclusive basis
on July 1, 2001, the decrease in the AOL rewards points program, which ended in
the second half of 2000, and the decrease in the level of other AOL marketing
programs. Further, the decrease is attributable to decreased promotional and
advertising campaigns as the Company continues to implement its previously
announced plan to slow down growth as it pursues its plan to improve
efficiencies of the Company's bundled business model outlined above. The Company
expects to incur promotional, marketing and advertising expenses of between
$5 and $7 million for the fourth quarter of 2001 as it continues to pursue
subscribers to its bundle of local and long distance telecommunication service.
The Company intends to increase its promotional, marketing and advertising
expenditures in the first quarter of 2002, provided that the Company has
improved the efficiencies of the Company's bundled services and has addressed
its initiatives regarding bad debt expense and reduced churn among good paying
customers.

         Depreciation and Amortization. Depreciation and amortization for the
quarter ended September 30, 2001 was $10.3 million, an increase of $3.8 million
compared to $6.5 million in the quarter ended September 30, 2000, and, as a
percentage of sales, an increase to 8.2% as compared to 5.4% for the same
quarter last year. This increase is due primarily to a full quarter of
depreciation and amortization of the goodwill, intangibles and property from the
Access One acquisition that occurred in August 2000, as well as additional
property and equipment that was acquired by the Company since the third quarter
of 2000. The excess of the purchase price over the fair value of the net assets
acquired in the Access One acquisition was approximately $225.9 million and has
been recorded as goodwill and intangible assets, which is being amortized on a
straight-line basis. Intangibles consist primarily of a service mark and
purchased customer accounts and workforce. Depreciation and amortization will
decrease significantly in the fourth quarter of 2001 due to the goodwill
impairment charge discussed below and in Note 7 to the Consolidated Financial
Statements included in this Report.

         Impairment and Restructuring Charges. The Company incurred impairment
and restructuring charges of $171.2 million for the quarter ended September 30,
2001. Included in the amount for the quarter ended September 30, 2001 was an
impairment charge of $168.7 million primarily related to the write down of
goodwill associated with the acquisition of Access One, as discussed above. In
September 2001, the Company approved a plan to close the call center operation
in Sunrise, Florida. The Company recorded a charge of $2.5 million in the
quarter ended September 30, 2001 to reflect the elimination of approximately 225
positions and lease exit costs in connection with the call center closure. There
were no impairment or restructuring charges in the third quarter of 2000 (see
Note 7 to the Consolidated Financial Statements in this Report).

         Interest Income. Interest income was $257,000 for the quarter ended
September 30, 2001 versus $1.3 million for the quarter ended September 30, 2000.
The interest income in 2000 was higher due to the Company's higher average cash
balances during 2000.

         Interest Expense. Interest expense was $1.5 million for the quarter
ended September 30, 2001 versus $1.4 million for the quarter ended September 30,
2000. The increase is due to interest on debt assumed with the acquisition of
Access One and interest on additional borrowings by the Company in the second
half of 2000.

         Other (Income) Expense, Net. Net other expense was $2.5 million for the
quarter ended September 30, 2001 compared to $1.3 million for the quarter ended
September 30, 2000. The amount for the quarter ended September 30, 2001
primarily represents a $2.4 million unrealized loss on the increase in fair
value of the AOL contingent redemptions in accordance with the fair value
accounting treatment under EITF Abstract No. 00-19. This amount will not be
recurring, as the AOL contingent redemptions have been restructured effective
September 2001. The amount for the three months ended September 30, 2000
primarily reflects a $1.0 million increase in the reserve on a note receivable
incurred in the third quarter of 2000.

                                       17
<PAGE>

         Extraordinary Gain. The Company incurred an extraordinary gain in the
quarter ended September 30, 2001 of $16.9 million, which represents the gain on
restructuring of the AOL contingent redemptions in accordance with SFAS No. 15,
"Accounting by Debtors and Creditors for Troubled Debt Restructurings," as
discussed above in Note 2 of the Consolidated Financial Statements in this
Report.

NINE MONTHS ENDED SEPTEMBER 30, 2001 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30,
2000

         Sales. Sales decreased by 3.7% to $397.9 million for the nine months
ended September 30, 2001 from $413.0 million for the nine months ended September
30, 2000. The decrease in sales for the nine months ended September 30, 2001
compared to September 30, 2000 primarily reflected the Company's (i) decision to
focus its efforts in the local telecommunication market by offering local
telecommunication services bundled with long distance services in 2000; (ii) the
Company's election to exit the international wholesale business; and (iii) a
decline in the number of long distance customers obtained under various
marketing agreements (including AOL) and a decrease in the Company's other
sales. The Company's bundled sales for the nine months ended September 30, 2001
totaled $159.6 million compared to $17.9 million for the nine months ended
September 30, 2000. The Company's international wholesale sales for the nine
months ended September 30, 2000 were $29.7 million; however, the Company elected
to exit the international wholesale business in the second quarter of 2000
because of the low gross profit margins associated therewith; consequently, the
Company had no international sales in the nine months ended September 30, 2001.
The Company's long distance sales, excluding international wholesale revenue,
decreased to $238.3 million for the nine months ended September 30, 2001 from
$365.4 million for the nine months ended September 30, 2000 due in part to the
Company's focus on bundled sales, churn, a decline in gross additions of new
long distance customers and the conversion of long distance customers to the
Company's bundled service offering.

         Cost of Sales. Cost of sales decreased by 17.1% to $186.9 million in
the nine months ended September 30, 2001 from $225.5 million in the nine months
ended September 30, 2000, and, as a percentage of sales, decreased to 47.0% as
compared to 54.6% for the same period last year. The decreases were primarily
due to a decrease in network costs as a result of exiting the international
wholesale business, a lower number of long distance customers, a reduction in
access and usage charges and a reduction in PICC charges. The decrease in
network costs was partially offset by increases in costs to incumbent local
telephone companies related to the Company's efforts in the local
telecommunication market. In addition, partition costs and billing costs were
lower.

         Gross Profit. Gross profit increased by 12.5% for the nine months ended
September 30, 2001 to $211.0 million from $187.5 million for the nine months
ended September 30, 2000, and, as a percentage of sales, increased to 53.0% as
compared to 45.4% for the same period last year. The increase in gross profit
percentage was primarily due to lower network, partition and billing costs and
increased margin associated with the Company's bundled sales compared to the
margin of international wholesale, offset by increased cost associated with the
growing local business.

         General and Administrative Expenses. General and administrative
expenses increased by 46.0% to $64.2 million for the nine months ended September
30, 2001 from $44.0 million for the nine months ended September 30, 2000, and,
as a percentage of sales, increased to 16.1% as compared to 10.7% for the same
period last year. The increase in general and administrative expenses was due
primarily to increased costs associated with additional personnel to support the
Company's growth in the local services business and the additional sales,
provisioning and customer service support for its local customers.

         Provision for Doubtful Accounts. Provision for doubtful accounts
increased by 192.3% to $79.4 million for the nine months ended September 30,
2001 from $27.2 million in 2000, and, as a percentage of sales, increased to
20.0% as compared to 6.6% for the same period last year. The increase in
provision for doubtful accounts was due to (i) the provision for certain
receivables that the Company does not expect to collect; and (ii) the provision
for customers with poor credit quality acquired through discontinued marketing
programs.

         Promotional, Marketing and Advertising Expenses. During the nine months
ended September 30, 2001, the Company incurred $75.9 million of promotional,
marketing and advertising expenses as compared to $126.9 million for the nine
months ended September 30, 2000, a 40.2% decrease, and, as a percentage of
sales, a decrease to 19.1% as compared to 30.7% for the same period last year.
This decrease is attributable to decreased promotional and advertising campaigns
for long distance customers, partially offset by expanding efforts for the
Company's local

                                       18
<PAGE>

bundled customer base. Fees to AOL significantly decreased from the nine months
ended September 30, 2000 to the nine months ended September 30, 2001, including
a decrease in the marketing fees paid to AOL when the AOL marketing agreement
changed from an exclusive to a non-exclusive basis on July 1, 2001, the decrease
in the AOL rewards points program, which ended in the second half of 2000, and
the decrease in the level of other AOL marketing programs. In addition, the
Company's efforts to scale down promotional, marketing and advertising expenses
in the second and third quarters of 2001 also contributed to the overall
decrease as the Company continued to implement its previously announced plan to
slow down growth as it pursues its plans to improve efficiencies of the
Company's bundled business model outlined above.

         Depreciation and Amortization. Depreciation and amortization for the
nine months ended September 30, 2001 was $29.3 million, an increase of $19.0
million compared to $10.3 million in the nine months ended September 30, 2000,
and, as a percentage of sales, an increase to 7.3% as compared to 2.5% for the
same period last year. This increase is due primarily to depreciation and
amortization of the goodwill, intangibles and property from the Access One
acquisition that occurred in August 2000, as well as additional property and
equipment that was acquired by the Company since the third quarter of 2000.

         Impairment and Restructuring Charges. The Company incurred impairment
and restructuring charges of $171.2 million for the quarter ended September 30,
2001. Included in the amount was an impairment charge of $168.7 million
primarily related to the write down of goodwill associated with the acquisition
of Access One acquired in August 2000. In September 2001, the Company approved a
plan to close the call center operation in Sunrise, Florida. The Company
recorded a charge of $2.5 million in quarter ended September 30, 2001 to reflect
the elimination of approximately 225 positions and lease exit costs in
connection with the call center closure. There were no impairment or
restructuring charges in the nine months ended September 30, 2000 (see
Note 7 to the Consolidated Financial Statements included in this Report).

         Interest Income. Interest income was $1.1 million for the nine months
ended September 30, 2001 versus $4.2 million for the nine months ended September
30, 2000. The interest income in 2000 was higher due to the Company's higher
average cash balances during 2000.

         Interest Expense. Interest expense was $4.6 million for the nine months
ended September 30, 2001 versus $3.6 million for the nine months ended September
30, 2000. The increase is due to interest on debt assumed with the acquisition
of Access One and interest on additional borrowings by the Company in the second
half of 2000.

         Other (income) Expense, Net. Net other expense was $2.6 million for
the nine months ended September 30, 2001 compared to $2.0 million for the nine
months ended September 30, 2000. The amount for the nine months ended September
30, 2001 primarily represents a $2.4 million unrealized loss on the increase in
fair value of the AOL contingent redemptions in the third quarter of 2001 in
accordance with the fair value accounting treatment under EITF Abstract No.
00-19. This amount will not be recurring, as the AOL contingent redemptions have
been restructured effective September 2001. The amount for the nine months ended
September 30, 2001 is due primarily to a $1.0 million increase in the reserve on
a note receivable incurred in the third quarter of 2000.

         Cumulative Effect of an Accounting Change. The Company adopted Emerging
Issues Task Force ("EITF") Abstract No. 00-19, "Accounting for Derivative
Financial Instruments Indexed to, and Potentially Settled in, a Company's Own
Stock," in the quarter ended June 30, 2001. The cumulative effect of the
adoption of this change in accounting principle resulted in a non-cash charge to
operations of $36.8 million in the quarter ended June 30, 2001, representing the
change in fair value of contingent redemption features of warrants and common
stock held by AOL from issuance on January 5, 1999 through June 30, 2001.

         Extraordinary gain. The Company incurred an extraordinary gain in the
quarter ended September 30, 2001 of $16.9 million, which represents the gain on
restructuring of the AOL contingent redemptions in accordance with SFAS No. 15,
"Accounting by Debtors and Creditors for Troubled Debt Restructurings" as
discussed above in Note 2 of the Consolidated Financial Statements in this
Report.

                                       19
<PAGE>

LIQUIDITY AND CAPITAL RESOURCES

         The Company had $24.0 million of cash and cash equivalents as of
September 30, 2001, and $40.6 million as of December 31, 2000. The decrease in
cash and cash equivalents is primarily the result of the operating loss for the
first nine months of 2001 and other cash outlays, including decreases in
accounts payables, purchases of property, plant and equipment and payments in
connection with the restructuring of the AOL contingent redemptions.

         Net cash used in operating activities was $8.1 million for the nine
months ended September 30, 2001. Net cash provided by operating activities was
$11.7 million for the nine months ended September 30, 2000. For the nine months
ended September 30, 2001, the major contributors to the net cash used in
operating activities were the net loss of $235.1 million, an increase in
accounts receivable of $68.2 million, a decrease in accounts payable and accrued
expenses of $7.6 million and a non-cash extraordinary gain on restructuring of
contingent redemptions of $16.9 million, offset by non-cash charges of $319.3
million. The non-cash items primarily consisted of provision for doubtful
accounts of $79.4 million, depreciation and amortization of $29.3 million,
impairment and restructuring charges of $171.2 million and the cumulative effect
of an accounting change for contingent redemptions of $36.8 million. For the
nine months ended September 30, 2000, the net cash provided by operating
activities was mainly generated by net loss of $22.3 million and increase in
trade receivables of $21.6 million, offset by a decrease in prepaid expenses and
other current assets of $6.9 million, increase of accounts payable and accrued
expenses of $14.5 million and adjustments to net income for non-cash items of
$37.7 million.

         Net cash used in investing activities of $3.6 million during the nine
months ended September 30, 2001 related primarily to the purchase of property
and equipment. Net cash used in investing activities of $33.8 million during the
nine months ended September 30, 2000, related primarily to the purchase of
property and equipment and the acquisition of Access One.

         The cash used in financing activities for the nine months ended
September 30, 2001 of $4.9 million was primarily attributed to payment of
borrowings under the Company's credit facility of $1.3 million and payments in
connection with the restructuring of the AOL contingent redemptions of $3.5
million. The net cash provided by financing activities for the nine months ended
September 30, 2000 of $13.6 million was received from the exercise of stock
options of $2.5 million and common stock rights of $11.1 million.

         The Company generally does not have a significant concentration of
credit risk with respect to net trade accounts receivable, due to the large
number of end users comprising the Company's customer base and their dispersion
across different geographic regions. The increase in provision for doubtful
accounts was due to the provision for certain receivables that the Company does
not now expect to collect and the provision for customers with poor credit
history acquired through discontinued marketing programs (see Management's
Discussion and Analysis - Overview).

          In September 1997, the Company sold $300 million of 4 1/2% Convertible
Subordinated Notes that mature on September 15, 2002 (the "2002 Convertible
Notes"). Interest on the 2002 Convertible Notes is due and payable semiannually
on March 15 and September 15 of each year. The 2002 Convertible Notes are
convertible, at the option of the holder, into shares of the Company's common
stock at a conversion price of $24.54 per share, as adjusted for the dilutive
effect of the exercise of rights pursuant to the Company's rights offering. The
2002 Convertible Notes are redeemable, in whole or in part, at the Company's
option, at any time on or after September 15, 2000 at 101.80% of par prior to
September 14, 2001 and 100.90% of par thereafter. At September 30, 2001, $66.9
million principal amount of the 2002 Convertible Notes remained outstanding.

         In December 1997, the Company sold $200 million of 5% Convertible
Subordinated Notes that mature on December 15, 2004 (the "2004 Convertible
Notes"). Interest on the 2004 Convertible Notes is due and payable semiannually
on June 15 and December 15 of each year. The 2004 Convertible Notes are
convertible, at the option of the holder, at a conversion price of $25.38 per
share, as adjusted for the dilutive effect of the exercise of rights pursuant to
the Company's rights offering. The 2004 Convertible Notes are redeemable, in
whole or in part, at the Company's option, at any time on or after December 15,
2002 at 101.43% of par prior to December 14, 2003 and 100.71% of par thereafter.
At September 30, 2001, $18.1 million principal amount of the 2004 Convertible
Notes remained outstanding.

         On January 5, 1999, pursuant to an Investment Agreement between AOL
and the Company, AOL purchased a total of 4,121,372 shares of common stock of
the Company for $55.0 million in cash

                                       20
<PAGE>

and the surrender of rights to purchase 5,076,016 shares of common stock of the
Company pursuant to various warrants held by AOL. AOL agreed to end further
vesting under the outstanding performance warrant and retained vested warrants
exercisable for 2,721,984 shares of common stock. Under the terms of the
Investment Agreement entered into with AOL, the Company agreed to reimburse AOL
for losses AOL may incur on the sale of any of the 4,121,372 shares of the
Company's common stock held by AOL through September 30, 2001. The maximum
amount payable to AOL as reimbursement on the sale of AOL's shares was
approximately $54.0 million plus AOL's reasonable expenses incurred in
connection with such sale. In addition, AOL also had the right, commencing on
July 1, 2001, to require the Company to repurchase warrants held by AOL to
purchase 2,721,984 shares of Company's common stock for $36.3 million, which
could have been paid in common stock or cash (provided that some portion of the
repurchase price may be payable in a quarterly amortization, two-year promissory
note of the Company if the repurchase price exceeded the then current valuation
of the warrants being purchased). In addition, upon the occurrence of certain
events, including material defaults by the Company under its AOL agreements and
a "change of control" of the Company, the Company may have been required to
repurchase for cash all of the shares held by AOL for $78.3 million ($19 per
share), and the warrants for $36.3 million.

         On September 19, 2001, the Company restructured its financial
obligations with AOL that arose under the 1999 Investment Agreement and also
ended its marketing relationship with AOL effective September 30, 2001
(collectively the "AOL Restructuring"). In connection with the AOL
Restructuring, the Company and AOL entered into a Restructuring and Note
Agreement ("Restructuring Agreement") pursuant to which the Company issued to
AOL a $54 million, 8% secured convertible note due September 2011 ("2011
Convertible Note") and 3,078,628 additional shares of the Company's common
stock. See  Note 2 of the Consolidated Financial Statements included in this
Report.

         The 2011 Convertible Note was issued in exchange for a release of the
Company's reimbursement obligations under the Investment Agreement. The 2011
Convertible Note is convertible into shares of the Company's common stock at
the rate of $5.00 per share, may be redeemed by the Company at any time without
premium and is subject to mandatory redemption at the option of the holder on
the fifth and seventh anniversaries of its issue date. The Company may also
elect to pay up to 50% (100% in the case of the first interest payment) of the
interest on the 2011 Convertible Note in kind rather than in cash.

         Pursuant to the Restructuring Agreement, in exchange for and in
cancellation of the Company's warrants to purchase 3,721,984 shares of the
common stock and the Company's related obligations under the Investment
Agreement to repurchase such warrants from AOL, the Company issued 3,078,628
additional shares of its common stock to AOL, after which AOL holds a total of
7,200,000 shares of common stock. The Company agreed to provide certain
registration rights to AOL in connection with the shares of common stock issued
to it by the Company.

         The Restructuring Agreement provided that the Investment Agreement, the
Security Agreement securing the Company's obligations under the Investment
Agreement and the existing Registration Rights Agreement with AOL were
terminated in their entirety and the parties were released from any further
obligation under these agreements. In addition, AOL, as the holder of the 2011
Convertible Note, entered into an intercreditor agreement with the lender under
the Company's existing secured credit facility.

         In addition to the restructuring of the financial obligations discussed
above, the Company and AOL agreed, in a further amendment to their marketing
agreement dated as of September 19, 2001, to discontinue, effective as of
September 30, 2001, their marketing relationship under the marketing agreement.
In connection with this discontinuance, the Company paid AOL $6.0 million under
the marketing agreement, payable in two installments - $2.5 million on September
20, 2001 and the remaining $3.5 million on October 4, 2001. AOL, in lieu of any
other payment for the early discontinuance of the marketing relationship, paid
the Company $20 million by surrender and cancellation of $20 million principal
amount of the 2011 Convertible Note delivered to AOL as discussed above, thereby
reducing the outstanding principal amount of the 2011 Convertible Note to $34
million. The amendment also provided for the payment by the Company of certain
expenses related to marketing services until the discontinuance and for the
continued servicing and transition of telecommunications customer relationships
after the discontinuance of marketing.

         At the time of the Company's acquisition of Access One, Access One and
its subsidiaries had approximately $15.0 million of loans outstanding under an
existing credit facility with MCG Finance Corporation ("MCG"). The loans under
the credit facility were secured by a pledge of all of the assets of Access One
and its subsidiaries. In addition, the Company guaranteed the obligations of
Access One and its subsidiaries under the

                                       21
<PAGE>

credit facility. The $15.0 million loan was repaid on October 20, 2000 when
certain subsidiaries of the Company entered into a Credit Facility Agreement
with MCG, providing for a term loan of up to $20.0 million and a line of credit
facility permitting such subsidiaries to borrow up to an additional $30.0
million. The effectiveness of the line of credit facility is subject, among
other things, to the successful syndication of that facility. The Credit
Facility Agreement subjects the Company and its subsidiaries to certain
restrictions and covenants related to, among other things, liquidity,
per-subscriber-type revenue, subscriber acquisition costs, leverage ratio and
interest coverage ratio requirements. As of September 30, 2001 the Company would
have been in default of its revenue by subscriber type covenant but received a
waiver from MCG. The waiver covered compliance through the third quarter of
2001. Based on the Company's financial results to date and internal projections,
it is possible the Company may be required to obtain a waiver from MCG for the
fourth quarter of 2001 and for 2002 or it may again be in default of certain
financial covenants under the Credit Facility Agreement, thus $13.8 million of
the loan balance has remained in long-term debt at September 30, 2001. The
Company and MCG are currently discussing the restructuring of certain portions
of the Credit Facility Agreement, including the financial covenants. Although
the Company has been able to receive waivers from MCG in the previous two
quarters and MCG has indicated a willingness to agree to such a waiver, there
can be no assurances that the Company will receive a waiver from MCG for the
fourth quarter or for periods in 2002 or that MCG will not demand payment under
the Credit Facility Agreement if the Company is in default of certain financial
covenants.

          In connection with the waiver from MCG in the second quarter of 2001
and certain other amendments under the Credit Facility Agreement, the Company
issued warrants to purchase 150,000 shares of its common stock at $0.68 per
share to such lenders. The credit facilities under the Credit Facility Agreement
were extended at the Company's election up to June 30, 2005 for the term loan
facility and up to June 30, 2003 for the line of credit facility. The principal
of the term loan is required to be repaid in quarterly installments of $1.25
million on the last calendar day of each fiscal quarter, commencing on September
30, 2001. The loans under the Credit Facility Agreement are collateralized by a
pledge of all of the assets of the subsidiaries of the Company that are parties
to that agreement. In connection with the AOL Restructuring, MCG entered into an
Intercreditor Agreement with AOL. In addition, the Company has guaranteed the
obligations of those subsidiaries under the Credit Facility Agreement and
related documents. The Company's guarantee subjects the Company to certain
restrictions and covenants, including a prohibition against the payment of
dividends in respect of the Company's equity securities, except under certain
limited circumstances. Upon its execution of the Credit Facility Agreement, the
Company issued warrants to purchase 300,000 shares of its common stock at $4.36
per share, 150,000 of which vested on December 31, 2000 and the balance of which
would have vested if the Company failed to exceed certain EBITDA thresholds for
the fiscal quarter ended March 31, 2001. The Company exceeded the EBITDA
threshold for the quarter ended March 31, 2001 and consequently the balance of
the warrants did not vest. At September 30, 2001, $18.8 million remained
outstanding under the term loan facility and no amounts are outstanding under
the line of credit facility.

         As discussed in Note 8 to the Consolidated Financial Statements in
this Report, on November 12, 2001, the Company received an award of arbitrators
awarding Traffix, Inc. approximately $6.9 million in an arbitration concerning
the termination of a marketing agreement between the Company and Traffix, Inc.

            The Company believes that its current cash position and the cash
flow expected to be generated from operations will be sufficient to fund its
capital expenditures, working capital and other cash operating and regular debt
service requirements for at least the next twelve months. However, based on its
existing cash and cash equivalents and its expectations as to future cash flow
from operations, the Company will be required to obtain additional financing to
fund a substantial portion of the 2002 Convertible Notes that come due September
2002. While the Company believes that, if it continues to address the
operational issues that it encounters (particularly lowering its bad debt
expense and reduced churn) and improves upon the operational efficiencies of
the Company's bundled business model, it could obtain such financing. However,
there can be no assurance that the Company will be able to successfully address
the operational issues it encounters or be able to improve upon the operational
efficiencies of its bundled business model, or that, given current market
conditions, the Company will be able to raise such additional capital on terms
acceptable to the Company. In addition, the Company's use of its cash on hand
to satisfy the 2002 Convertible Note obligations would impair its ability to
continue to implement its business plan, as could the timing of any cash
payments required to be made by the Company in respect of the various actions
against the Company, as discussed in Note 3 and Note 8 of Notes to Consolidated
Financial Statements in this Report.

RECENT ACCOUNTING PRONOUNCEMENTS

         Effective January 1, 2001, the Company adopted Statement of Financial
Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments
and Hedging Activities," as amended by SFAS No. 137,

                                       22
<PAGE>

"Accounting for Derivatives Instruments and Hedging Activities-Deferral of the
Effective Date of FASB Statement No. 133," and SFAS No. 138, "Accounting for
Certain Derivatives Instruments and Certain Hedging Activities." The standards
require an entity recognize all derivatives as either assets or liabilities
measured at fair value. The accounting for the changes in fair value of a
derivative depends on the use of the derivative. The cumulative effect of
adopting these new accounting standards did not have a material effect on the
Company's results of operations or its financial position for the periods
presented in the financial statements included herein

         The Financial Accounting Standards Board ("FASB") EITF has issued
Abstract No. 00-19, "Accounting for Derivative Financial Instruments Indexed to,
and Potentially Settled in, a Company's Own Stock," which addresses how such
contracts should be classified and measured by the Company. Under this issue,
contracts that require net-cash settlement would be initially classified as
assets or liabilities, then measured at fair value, with changes in fair value
reported in earnings and disclosed in the financial statements as long as the
contracts remain classified as assets or liabilities. If contracts classified as
assets or liabilities are ultimately settled in shares, any previous gains or
losses on those contracts would continue to be included in earnings. This
abstract is effective for all contracts that remained outstanding at June 30,
2001, and presented on that date as a cumulative effect of a change in
accounting principle. The cumulative effect of the adoption of this change in
accounting principal resulted in a noncash charge to operations of $36.8 million
in the quarter ended June 30, 2001 related to the contingent redemption
instruments under the AOL 1999 Investment Agreement. With the September 2001
satisfaction of these instruments pursuant to the AOL Restructuring Agreement,
the requirements of EITF 00-19 will not apply to future changes in the values of
these instruments.

         In July of 2001, the FASB issued Statements No. 141, "Business
Combinations" ("SFAS 141") and No. 142, "Goodwill and Other Intangible Assets,"
("SFAS 142") which eliminate the pooling of interests method of accounting,
establish new criteria for identification of separate intangibles acquired, and
establish the impairment approach rather than amortization for goodwill. The
Company has $18.6 million of net goodwill and $12.5 million of net identifiable
intangible assets as of September 30, 2001 (after an impairment charge of $168.7
million taken in the third quarter of 2001) and has recorded $19.0 million of
amortization expense in the nine months ended September 30, 2001. Effective
January 1, 2002 the Company will no longer be required to record amortization
expense on goodwill, but will instead be required to evaluate these assets for
potential impairment on a quarterly basis and to record a charge for any such
impairment. Management believes the adoption of the impairment evaluation
requirements of SFAS 142, will not have a material effect on the Company's
future results of operations or its financial position.

         In August 2001, the FASB issued Statement of Financial Accounting
Standards No. 144, "Accounting for the impairment or Disposal of Long-Lived
Assets" ("SFAS 144"), which is effective for fiscal periods beginning after
December 15, 2001 and interim periods within those fiscal years. SFAS 144
establishes an accounting model for impairment or disposal of long-lived assets
to be disposed of by sale. The Company is currently evaluating the potential
impact, if any, the adoption of SFAS 144 may have on its financial position and
results of operation.

                                  * * * * * * *

SAFE HARBOR FOR FORWARD-LOOKING STATEMENTS

         Certain of the statements contained herein may be considered
forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Such
statements are identified by the use of forward-looking words or phrases,
including, but not limited to, "estimates," "expects," "expected,"
"anticipates," and "anticipated." These forward-looking statements are based on
the Company's current expectations. Although the Company believes that the
expectations reflected in such forward-looking statements are reasonable, there
can be no assurance that such expectations will prove to have been correct.
Forward-looking statements involve risks and uncertainties and the Company's
actual results could differ materially from the Company's expectations. In
addition to those factors discussed in the foregoing Management's Discussion and
Analysis and in the Company's Annual Report on Form 10-K, see Note 1(b) of the
Notes to Consolidated Financial Statements in this Report for important factors
that could cause such actual results to differ materially. The Company
undertakes no obligation to update its forward-looking statements.

                                       23
<PAGE>

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK:

         In the normal course of business, the financial position of the Company
is subject to a variety of risks, such as the collectability of its accounts
receivable and the receivability of the carrying values of its long-term assets.
The Company's long-term obligations consist primarily of its own convertible
notes and credit facility. The Company does not presently enter into any
transactions involving derivative financial instruments for risk management or
other purposes due to the stability in interest rates in recent times and
because management does not consider the potential impact of changes in interest
rates to be material.

         The Company's available cash balances are invested on a short-term
basis (generally overnight) and, accordingly, are not subject to significant
risks associated with changes in interest rates. Substantially all of the
Company's cash flows are derived from its operations within the United States
and the Company is not subject to market risk associated with changes in foreign
exchange rates.

                                       24
<PAGE>

                           PART II - OTHER INFORMATION

ITEM 2.  CHANGES IN SECURITIES.

            In connection with the Company's Restructuring and Note Agreement,
dated as of September 19, 2001 (the "Restructuring Agreement"), with America
Online, Inc. ("AOL"), the Company, in exchange for a release of the Company's
obligations under the Investment Agreement with AOL entered into in January,
1999, , issued to AOL a $54 million, 8% secured convertible note due 2011 and
3,078,628 additional shares of its common stock to AOL. The Company agreed to
provide certain registration rights to AOL in connection with the shares of
common stock issued or to be issued to it by the Company.

            In connection with a waiver received for the second quarter of 2001
and certain other amendments by MCG Finance Corporation ("MCG") under the Credit
Facility Agreement with MCG, on August 10, 2001, the Company issued warrants to
purchase 150,000 shares of its common stock at $0.68 per share to MCG.

            The issuances of such securities were made by the Company in
reliance on Section 4(2) of the Securities Act of 1933.

ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K

         (a)  Exhibits:

              10.1 Employment Agreement between the Company and Jeffrey Earhart
dated October 2, 2001. *


     * Management contract or compensatory plan or arrangement.


         (b) Reports on Form 8-K:

     During the quarter ended September 30, 2001, the Company filed one Current
Report on Form 8-K, dated September 19, 2001, reported under Item 5, Other
Events, reporting the restructuring of financial obligations to America Online,
Inc. and the discontinuance of the marketing agreement with AOL.

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<PAGE>

                                   SIGNATURES

     Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.



                                TALK AMERICA HOLDINGS, INC.



Date:  November 13, 2001        By: /s/ Gabriel Battista
                                   ------------------------------------
                                   Gabriel Battista
                                   Chairman of the Board of Directors,
                                   Chief Executive Officer and Director

Date:  November 13, 2001        By: /s/ Edward B. Meyercord, III
                                   ------------------------------------
                                    Edward B. Meyercord, III
                                    President, Chief Financial Officer, Director
                                    and Treasurer

Date:  November 13, 2001        By: /s/ Thomas M. Walsh
                                   ------------------------------------
                                      Thomas M. Walsh
                                      Senior Vice President - Finance

                                       26