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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

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FORM 10-K

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



For the Fiscal Year Ended December 31, 2001



Commission File Number: 000-28063

DELTATHREE, INC.
(Exact name of registrant as specified in charter)

Delaware 13-4006766
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(State or other jurisdiction of (I.R.S. employer
incorporation or organization) identification no.)
75 Broad Street, 31st Floor
New York, New York 10004 10004
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(Address of principal executive offices) (Zip code)

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Registrant's telephone number, including area code: (212) 500-4850

Securities registered pursuant to Section 12(b) of the Act:



None.

Securities registered pursuant to Section 12(g) of the Act:



Name of Each Exchange on Which the
Title of Each Class Securities are Registered
- ------------------- -------------------------
Class A Common Stock, par Nasdaq National Market
value $0.001 per share

Indicate by a check mark whether the Registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such shorter
period that the Registrant was required to file such reports), and (2) has
been subject to such filing requirements for the past 90 days. Yes |X| No
|_|

Indicate by check mark if disclosure of delinquent filers pursuant
to Item 405 of Regulation S-K is not contained herein, and will not be
contained, to the best of the Registrant's knowledge, in definitive proxy
or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K. Yes |X| No |_|

The aggregate market value of the Registrant's Class A common
stock held by non-affiliates of the Registrant on March 27, 2002 was
approximately $8.68 million. On such date, the last sale price of the
Registrant's Class A common stock was $1.07 per share. Solely for purposes
of this calculation, shares beneficially owned by directors and officers of
the Registrant and persons owning 5% or more of the Registrant's Class A
common stock have been excluded, in that such persons may be deemed to be
affiliates of the Registrant. Such exclusion should not be deemed a
determination or admission by the Registrant that such individuals or
entities are, in fact, affiliates of the Registrant.

The number of shares outstanding of the Registrant's capital stock
as of March 27, 2002 is as follows:

Number of Shares Outstanding
Title of Each Class at March 27, 2002
- ------------------- ----------------------------
Class A Common Stock, 29,143,206
$0.001 par value

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DELTATHREE, INC.
2001 ANNUAL REPORT ON FORM 10-K



TABLE OF CONTENTS



Page

PART I
ITEM 1. Business........................................................ 4
ITEM 2. Properties......................................................13
ITEM 3. Legal Proceedings...............................................13
ITEM 4. Submission of Matters to a Vote of Security Holders.............14
PART II
ITEM 5. Market for Registrant's Common Equity and Related
Stockholder Matters............................................ 14
ITEM 6. Selected Financial Data.........................................15
ITEM 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations............................ 16
ITEM 7A. Quantitative and Qualitative Disclosures About
Market Risk.................................................... 30
ITEM 8. Financial Statements and Supplementary Data.................... 30
ITEM 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure............................ 30
PART III
ITEM 10. Directors and Executive Officers of the Registrant............. 30
ITEM 11. Executive Compensation......................................... 30
ITEM 12. Security Ownership of Certain Beneficial Owners and
Management..................................................... 30
ITEM 13. Certain Relationships and Related Transactions................. 31
PART IV
ITEM 14. Exhibits, Financial Statement Schedules and Reports
on Form 8-K.................................................... 31





DELTATHREE, INC.
2001 ANNUAL REPORT ON FORM 10-K


PART I


ITEM 1. BUSINESS
General

We are a provider of integrated Voice over Internet Protocol
(VoIP) telephony services. We were founded in 1996 to capitalize on the
growth of the Internet as a communications tool by commercially offering
Internet Protocol (IP) telephony services. IP telephony is the real time
transmission of voice communications in the form of digitized "packets" of
information over the Internet or a private network, similar to the way in
which e-mail and other data is transmitted. Our business currently includes
the provision of enhanced Web-based and other communications services to
individual consumers, under our iConnectHere brand name, the provision of a
total "Hosted Communications Solution" that enables corporate customers and
service providers to offer private label telecommunications to their
customer bases, and the transmission of voice and data traffic for
communications carriers.

We have built a privately-managed, global network using IP
technology and offer our customers a unique suite of IP telephony products,
including: PC-to-Phone, Phone-to-Phone, and Broadband Phone. We
differentiate ourselves from our competitors by providing a robust set of
value-added services that enables us to effectively address the challenges
that have traditionally made the provision of telecommunications services
difficult. These operations management tools include: account provisioning;
payment processing systems; billing and account management; and customer
care. We are able to provide our services at a cost to users that is
generally lower than that charged by traditional carriers because we
minimize our network costs by using efficient packet-switched technology
and we generally avoid local access charges and by-pass international
settlement charges by routing international long distance calls over our
privately-managed network.

Prior to 1999, our focus was to build a privately-managed, global
network utilizing IP technology. Our business primarily consisted of
carrying and transmitting traffic for communications carriers over our
network. Beginning in 1999, we began to diversify our offerings by layering
enhanced IP telephony services over our network. These enhanced services
were targeted at consumers and were primarily accessible through our
consumer Web site. During 2000, we began offering services on a co-branded
or private-label basis to service providers and other businesses to assist
them in diversifying their product offerings to their customer bases. Our
privately-managed IP network received the Best Built Public Network Award
for excellence in IP services/applications at SUPERCOMM 2000. We were also
recognized as the best IP telephony provider by SmartMoney magazine and PC
World Magazine during 2000. We were recognized for our innovative Broadband
Phone offering during 2001, receiving both the TMC Labs Innovation Award,
and the Communications SOLUTIONS(R) magazine Product of the Year Award.

On June 28, 2001, RSL Communications, Ltd. ("RSL COM"), our then
majority stockholder and sole owner of our Class B Common Stock, par value
$0.001, entered into a share purchase agreement with Atarey Hasharon Chevra
Lepituach Vehashkaot Benadlan (1991) Ltd., an Israeli company ("Atarey"),
to sell to Atarey all of our Class B Common Stock owned by RSL COM. On June
29, 2001, the sale was consummated, and all of RSL COM's shares of Class B
Common Stock, which carried ten votes per share, were automatically
converted into shares of Class A Common Stock, which carry one vote per
share. As a result of the sales transaction, Atarey became the majority
stockholder, owning approximately 72% of our outstanding Class A Common
Stock. No shares of Class B Common Stock remain outstanding. Simultaneously
with the completion of the transaction on June 29, 2001, all of the
contracts and inter-company agreements between us and RSL COM (and all of
its subsidiaries) were terminated. At the same time, we severed our
reliance on RSL COM as our primary pan-European wholesale
telecommunications carrier, and shifted to other service providers.

The Increasing Significance of IP Communications

Historically, the communications services industry has transmitted
voice and data over separate networks using different technologies.
Traditional carriers have typically built telephone networks based on
circuit switching technology, which establishes and maintains a dedicated
path for each telephone call until the call is terminated. Although a
circuit-switched system reliably transmits voice communications, circuit
switching does not efficiently utilize transmission capacity. When a
telephone call is placed, a circuit is established, and the circuit remains
dedicated for transmission of the call and unavailable to transmit any
other call.

Data networks have typically been built utilizing packet switching
technology, such as IP, which divides signals into packets that are
simultaneously routed over different channels to a final destination where
they are reassembled in the original order in which they were transmitted.
Packet switching provides for more efficient use of the capacity in the
network because the network does not establish dedicated circuits and does
not require a fixed amount of bandwidth to be reserved for each
transmission. As a result, substantially greater traffic can be transmitted
over a packet-switched network, such as the Internet, than a
circuit-switched network.

Traditional telecommunications carriers have historically avoided
the use of packet switching for transmitting voice calls due to poor sound
quality attributable to delays and lost packets which prevent real-time
transmission. However, recent improvements in packet switching, compression
and broadband access technologies, improved hardware and the use of
privately-managed networks (such as our network) have significantly
improved the quality of packet-switched voice calls, allowing for real-time
transmission. Service providers that use privately-managed networks are
able to reduce packet loss and latency, or delay, because they are able to
control the amount, timing and route of data transmitted.

As a result, packet switching technology enables service providers
to converge their traditional voice and data networks and more efficiently
utilize their networks by carrying voice, fax and data traffic over the
same network. The improved efficiency of packet-switching technology
creates network cost savings that can be passed on to the consumer in the
form of lower long distance rates. In addition, international telephone
calls carried over the Internet or private IP networks are less expensive
than similar calls carried over circuit-switched networks primarily because
they bypass the international settlement process, which represents a
significant portion of international long distance tariffs.

Gartner Group, a market research firm, estimates that by 2004,
voice over packet communications services will grow to represent 24% of
what they project will be a $1.8 trillion market for global
telecommunications in total. Beyond cost savings, we believe that advanced
IP communications technologies will further the potential for the Internet
to become the preferred medium of communications and commerce.

Limitations of Existing IP Communications Solutions

Although the growth of IP telephony historically has been limited
by poor sound quality attributable to delays and packet loss, recent
technological advancements have significantly improved the quality of
packet-switched telephone calls. As a result, several large long distance
carriers, including AT&T and Sprint, have announced IP telephony service
offerings.

In addition, many smaller service providers have begun to offer
low-cost Internet telephony services from PCs to telephones and from
telephones to telephones. Many of these service providers, however, offer
their services only in certain geographic areas and provide limited
services. In addition, many of these service providers use the Internet for
transmission, rather than a privately-managed IP network. In using the
Internet rather than a privately-managed IP network for transmission, these
service providers have less control over the network management and
monitoring functions that are necessary to ensure quality of service.

Our Products and Services

Products.

We have built a privately-managed, global network using IP
technology and offer our customers a unique suite of IP telephony products.
Our enhanced IP communication products (which represented 54.8% and 44.8%
of our revenues in 2001 and 2000, respectively) include:

PC-to-Phone. Our PC-to-Phone offering enables a user to
conveniently and inexpensively place a call to a standard telephone
anywhere in the world directly from a personal computer while remaining
on-line. In order to use this product, a user need only download our
software from our Web site and have access to the Internet. Once our
software is downloaded, the user is able to place a call from the user's
personal computer and, while browsing the Web, speak to a party who uses a
standard telephone. Alternatively, users of Microsoft's Messenger software
can access our PC-to-Phone product through the "Make a phone call" function
without the need to download any other software.

We are able to provide our PC-to-Phone offering at rates generally
lower than those charged for traditional circuit switched calls. We are
able to charge lower rates because our service utilizes packet-switched
technology and because it routes calls directly from the Internet onto our
privately-managed IP network and to the called destination, thus avoiding
access and settlement rates associated with traditional international and
domestic long distance telecommunications services. PC-to-phone is
currently our most popular product offering.

Phone-to-Phone. Our Phone-to-Phone offering enables a user to
inexpensively place a call or send a fax from a standard telephone or a fax
machine to anywhere in the world. Phone-to-Phone calls originate and
terminate on the PSTN, but travel primarily over our privately-managed IP
network. Through our privately-managed IP network, we are able to carry
phone-to-phone voice communications traffic. Similar to our PC-to-Phone
product, our Phone-to-Phone product is generally less expensive than
services of traditional carriers. Users can access our Phone-to-Phone
product by dialing a local or toll-free access number and providing a PIN
number. We currently offer toll-free access numbers in Austria, Canada,
Finland, France, Germany, Hong Kong, Italy, Sweden, Switzerland, the United
Kingdom and the United States. Users are charged for toll and long distance
calls on a per-minute basis. We and our private-label partners receive
payment for these calls by debiting pre-paid user accounts opened on-line
and through the sale of pre-paid calling cards.

Broadband Phone. In early 2001, we successfully deployed the
world's first commercially available Broadband Phone offering. Our
Broadband Phone product is a complete phone replacement solution available
to business and consumer customers over the "last mile" through broadband
connections via cable modem, DSL or fixed wireless. Broadband Phone
challenges the traditional PSTN and circuit switched networks with a full
VoIP solution. With our high call quality, "always on" reliability and
increased functionality provided by the high bandwidth access line, we are
now able to offer potential partners and their customers some of the most
sophisticated VoIP solutions available in the market through a highly
scalable, low-cost and easily implemented product. Broadband Phone is
designed to take advantage of how people communicate, building on the
current customer experience by allowing them to use their existing phone.
In addition to offering traditional telecommunications capabilities,
Broadband Phone enables a user to conveniently retrieve e-mail, voice mail
and faxes, as well as send e-mail, from a single source, Web functionality,
integration with calendar and memo tools and integration between voice and
data. For our potential partners, the turnkey solution is delivered with
our full back-end infrastructure, including customer service for end users,
customer service for service providers, pricing information, billing and
provisioning and fraud services. Additionally, Broadband Phone is a
technology-neutral solution, easily integrated (the device plugs directly
into a PC or IP network) so as to allow broadband providers to begin
delivering our voice solution rapidly.

Carrier transmission services. In addition to our enhanced IP
communication products, in order to maximize the use of our available
network capacity, we offer carrier transmission services over our
privately- managed IP network to telecommunications carriers.

Services.

We differentiate ourselves from our competitors by providing a
robust set of value-added services that enables us to effectively address
the challenges that have traditionally made the provision of
telecommunications services difficult. These operations management tools
include the following:

o account provisioning: we provide our customers with a
dedicated Web page through which they can order additional
services or accounts, generate and activate PINs and perform
other customary implementation functions;

o payment processing systems: we provide our customers with a
fraud detection and prevention system to permit secure
credit card transactions over the Web;

o billing and account management: we provide our customers
with real-time, Web-based access to billing records to check
billing and usage information or to increase prepaid
accounts; and

o customer care: we have moved and consolidated traditional
first line customer care functions onto the Web for ease and
flexibility and support this with second line customer care
via toll-free access.

iConnectHere

We began marketing our on-line consumer offering under the
iConnectHere brand name in September 2000 in connection with the formal
roll-out of our Hosted Communications Solution. We decided to eliminate our
free on-line service and to move away from a business model focused on
consumers with a high acquisition cost. We have positioned iConnectHere as
a powerful showcase and test facility for our current and future products
and services. iConnectHere demonstrates our products, services and hosting
capabilities to other business customers and service providers. Through
iConnectHere, an account holder can access PC-to-Phone, Phone-to-Phone,
Broadband Phone and the full range of our back-end infrastructure and
support. Additionally, iConnectHere permits us to collect usage information
on our products and services and enables us to provide our partners with
key information and recommendations regarding implementation of our
products and services.

Through iConnectHere, consumer users can:

o sign up for any of our services, including PC-to-Phone,
Phone-to-Phone, and Broadband Phone

o download our software

o recharge their accounts, either by entering their credit
card information or authorizing automatic recharging

o send a PC-to-phone call

o check real-time billing and usage information

o communicate by e-mail with a customer service representative

o view answers to frequently-asked questions

iConnectHere Marketing, Advertising and Promotional Programs

We have developed and will continue to develop diversified
marketing, advertising and promotional programs to stimulate demand for our
iConnectHere services. Our marketing, advertising and promotional programs
include:

On-line agent commission program. We have developed a Web-based agent
program that allows for rapid agent enrollment and agent account
maintenance. Agents may devise their own marketing programs, including
Web-links, direct mail campaigns or co-branding of our services in select
markets. Agents receive as commissions a percentage of revenue generated
from end users who sign up for our services through the agent's Web site.
We believe that providing our agents with easy, on-line access to these
marketing tools helps us to maximize the number of agents selling our
services while significantly reducing the resources needed to recruit
agents.

Off-line agent commission program. Our off-line agent commission
program allows non-Web agents to design their own marketing programs to
solicit sales of our services. Off-line agents market and advertise through
traditional channels such as newspaper and magazine advertisements, direct
mail campaigns and telemarketing campaigns. Off-line agents receive a
percentage of revenue generated from users who sign up for our services
through the agent's programs. We currently have relationships with more
than 30 off-line agents that have generated revenue for us.

Reseller program. We offer individuals and businesses the opportunity
to become resellers of our services through our reseller program. Resellers
are able to purchase bulk iConnectHere account numbers at reseller specific
rates that they are then able to resell to private individuals as either
Phone-to-Phone calling cards or PC-to-Phone accounts.

Microsoft Messenger Affiliation. Through our relationship with
Microsoft, we provide PC-to-Phone service for Microsoft Windows XP and
Microsoft MSN Messenger users, to any phone number in the world. Within the
Microsoft Messenger program, choosing us is similar to choosing a long
distance provider. With a click of the mouse, consumers can select us
(under our iConnectHere brand) when utilizing the voice function bundled
into the Microsoft software applications. When consumers choose us, we
provide the network call delivery and termination as well as all the
billing and customer relationship aspects of the service. By way of this
relationship, we gain exposure to over 42 million current Microsoft
Messenger users.

Our Hosted Communications Solution

Our "Hosted Communications Solution" leverages our VoIP expertise
and delivers to our corporate customers and service providers a highly
customizable, private-label suite of VoIP products and services. Using our
award-winning infrastructure, we enable these enterprises to offer their
customers any combination of our basic products and services, accessible
through a single account. We believe that our Hosted Communications
Solution brings our customers the value-added services they need to
leverage their strong customer bases and generate new revenues. We have
dedicated significant resources to this area of our business and anticipate
significant growth in the number of businesses to which we provide our
Hosted Communications Solution.

With each new module that is added to our suite of VoIP products
and services, customers can realize new revenue streams from their existing
customer base and make their own offering even more powerful in attracting
new customers. The products and services delivered under our Hosted
Communications Solution are operative 24 hours a day, 7 days a week and are
supported at all times by our Network Operations Center ("NOC") and our
customer care center.

Future Products--Broadband focus

The market for broadband access services is projected to grow
significantly over the next several years. Broadband access alone, however,
is not a complete solution. As infrastructure pipes become commodities,
maintaining margin and profitability on them is becoming increasingly
difficult for service providers. We believe that broadband market success
will be determined by the ability to layer high-margin enhanced services
and applications over the infrastructure. Market leaders will need
innovative, value-added solutions to maintain customers, reduce churn and
grow their customer base.

We have been developing a suite of next-generation Broadband Phone
products that we believe will encompass a rich sub-set of the voice-related
services broadband providers will seek to deploy in the near-term. These
products will build on our original Broadband Phone offering, and include a
more diverse set of devices (both hardware devices as well as
"soft-phones") along with additional value-added functionality and features
that will appeal to a wide potential customer-base.

Our Network

In order to deliver unique VoIP services, we operate a
privately-managed IP telephony network. By managing our network, we have
the ability to regulate traffic volumes and to directly control the quality
of service from each originating point of presence ("POP") to the
termination point. In addition, our network allows us to avoid the
significant transmission delays associated with the Internet, which may
impede delivery of high quality, reliable services to our users. Since the
protocols used by the network are highly standard protocols, our IP network
has a tight connection to the Internet, allowing us to use the Internet as
a backup facility. This unique situation, where our IP network is
considered a high-quality extension of the Internet, allows our customers
to enjoy best-of-breed functionality: high quality, low jitter and low
connection delay, on the one hand, and global reach and universal access,
on the other hand.

During 2001, in conjunction with our relationship with Microsoft
and over 12 months of work, we rolled out our state of the art SIP (Session
Initiation Protocol) infrastructure. Our SIP network powers our new
Microsoft relationship. The SIP protocol is one of the most advanced VoIP
protocols and unlike its predecessors, which were modeled after traditional
telephony protocols, SIP has the ability to scale with a distributed
architecture and at a lower cost. SIP's superior attributes also include
faster and more cost effective development and lower hardware requirements,
which allows us to incur lower capital expenditure costs. During 2002, we
intend to migrate our existing products and services to this new network.
At the same time, we continue to build our SIP expertise through
relationships with other SIP leaders such as Cisco and Microsoft.

Backbone

Our network is built around a redundant, high availability
backbone that connects Los Angeles, New York and London. In each of these
locations there are multiple interconnections or peering arrangements with
Internet backbone providers. These points are strategically located to
allow access from our network to and from the Internet with the best
performance. The backbone is based on Cisco routing equipment utilizing Hot
Standby Routing Protocol. In order to achieve maximum redundancy, our
network has several connections to the Internet. While operating as a
private extension of the Internet, the backbone has a high level of
security that isolates it from security threats found on the Internet.

Origination Access

Access to our network is possible through several points. Users
may access services through PSTN connections (toll free and local access).
Carrier transmission access is aggregated through our switch in New York or
through any one of our POPs directly. Call origination is possible from the
PC-to-Phone product, using our downloadable software client or using a Web
browser, Microsoft Messenger or Broadband Phone. These calls enter our
network from the Internet through our interconnect points with the
Internet. We carefully manage each originating port and utilize innovative
capacity planning tools and techniques to provide the best and most cost
effective service to customers.

Termination

Our network can terminate calls through any of our POPs.
Termination decisions are based on a complex Least Cost Routing system
which applies routing rules based on origination point, time of day,
termination cost and other factors. These rules are constantly updated to
ensure maximum economic and quality efficiency. Our network has termination
facilities that enable us to interconnect with multiple carriers. This
allows us to refile traffic to our own switch, giving us the ability to
route calls to virtually anywhere in the world. Each termination port is
carefully managed with innovative capacity planning tools and techniques to
provide the best and most cost effective service to customers.

Network Services

Our network supports several application building services on the
network level, including:

Programmable Interactive Voice Response (PIVR). Our network is capable
of playing a configurable voice prompt to enable it to provide applications
such as pre-paid calling cards. PIVR services are highly programmable and
can be customized to fulfill a variety of customer needs. The configuration
of the PIVR is controlled from a central location, enabling efficient
management and faster maintenance in the event of malfunctions.

Real Time AAA. We are able to authenticate, authorize and account (AAA)
for inbound services through the network's real time radius protocol.
Whether services are pre-paid or post-paid, the network will disconnect the
call when the user's account balance runs out. These protocols interface
with the billing system to rate the calls correctly and allow access to
permitted services only. Authentication may be customized to utilize
numbers, textual strings, credit card numbers and more.

Reporting Tools. All network services are accounted for in real time,
generating Call Detail Records. These records are aggregated in real time
to both the billing systems, for rating, and to the data warehouse, which
provides access to the information by the marketing, financial, capacity
planning and operational groups through a client or Web interface using
advanced OLAP cubes.

The Network Operations Center (NOC). Our NOC monitors and manages our
network from a central location, seven days a week, 24 hours a day. The NOC
monitors all aspects of our network, including the routers, databases,
switches, leased lines, Internet connections, gatekeepers and gateways, to
ensure that they are functioning at optimal levels. In the event of a
failure of any of these network components, NOC personnel are provided with
a real time, systems generated notification via an instant messaging system
consisting of pagers, cellular phones, screen pop-ups and e-mail, which
identifies the malfunction so that proper measures can be taken to restore
service in a timely fashion. Our NOC utilizes a combination of proprietary
and leading industry technologies, including Hewlett-Packard Open View
software and Ericsson IPT management console, as well as unique
applications developed by us. The NOC serves all of the different parts of
our operations environment, including network nodes, Web servers and
specific applications.

Customer Care. Our services are supported by our on-line interactive
customer service and billing center, which enables an end user to set up an
account, receive an account number and a PIN, pay by credit card for
services, find answers to frequently asked questions and contact customer
service representatives. Once a user has established an account, the user
can prepay for additional usage by credit card as well as access real-time
detailed information such as call logs and transaction records. Through the
on-line billing system, a user can personalize the billing information to
select the data most relevant to them. This on-line interactive customer
service and billing center is supported by a human customer care contact
center that provides voice and e-mail support to the customers.

Proprietary Rights

We rely or expect to be able to rely on patent, trademark and
trade secret laws, confidentiality agreements and other contractual
arrangements with our employees, strategic partners and others to protect
our proprietary rights.

We have registered trademarks for "deltathree" and
"iConnectHere.com" in the United States. However, these trademarks may not
provide adequate protection against competitive technology and may not be
held valid and enforceable if challenged. We do not own any registered
copyrights.

To further safeguard our intellectual property, we have a policy
that requires our employees to execute confidentiality and technology
ownership agreements when they begin their relationships with us.

Regulatory Environment

Regulation of IP Telephony

The use of the Internet and private IP networks to provide
telephone service is a recent market development. While the provision of
voice communication services over the Internet and private IP networks is
currently permitted under United States law, some foreign countries have
laws or regulations that may prohibit voice communications over the
Internet or using private IP networks. Increased regulation of the Internet
may slow its growth, particularly if many countries impose restrictive
regulations. Increased regulation of the Internet and/or IP telephony
providers or the prohibition of Internet and IP telephony in one or more
countries, more aggressive enforcement of existing regulations in such
countries or our failure or the failure of our network partners to comply
with applicable regulations could materially adversely affect our business,
financial condition, operating results and future prospects.

United States. Based on information users provide to us when they signed
up to use our services, we estimate that approximately 60% of our IP
communications services are provided to carriers or users in the United
States. We believe that, under United States law, based on specific
regulatory classifications and recent regulatory decisions, the IP
communications services that we provide constitute information services (as
opposed to regulated telecommunications services). As such, our services
are not currently regulated by the Federal Communications Commission (FCC)
or state agencies charged with regulating telecommunications carriers.
Nevertheless, aspects of our operations may be subject to state or federal
regulation, including regulation governing universal service funding,
payment of access charges, disclosure of confidential communications and
tax issues. However, we cannot assure you that our services will not be
regulated in the future. Several efforts have been made in the United
States to enact federal legislation that would either regulate or exempt
from regulation communications services provided over the Internet.

In addition, the FCC is currently considering reforms to universal
service funding and may consider whether to impose various types of charges
or other common carrier regulations upon some providers of Internet and IP
telephony. The FCC stated in April 1998 that it did not have an adequate
record on which to make a definitive ruling, but that the record suggested
that certain forms of phone-to-phone IP telephony appear to have the same
functionality as non-IP telecommunications services and lack the
characteristics that would render them information services.

If the FCC were to determine that certain services are subject to
FCC regulations as telecommunications services, the FCC might require
providers of Internet and IP telephony services to be subject to
traditional common carrier regulation, make universal service contributions
and/or pay access charges. It is also possible that the FCC may adopt a
regulatory framework other than traditional common carrier regulation,
which would apply to Internet and IP telephony providers.

State regulatory authorities may also retain jurisdiction to
regulate the provision of, and impose charges on, intrastate Internet and
IP telephony services. Several state regulatory authorities have initiated
proceedings to examine the regulation of such.

International. The regulatory treatment of Internet and IP telephony
outside of the United States varies widely from country to country. A
number of countries that currently prohibit competition in the provision of
voice telephony may also prohibit Internet and IP telephony. Other
countries permit, but regulate Internet and IP telephony. Some countries
will evaluate proposed Internet and IP telephony service on a case-by-case
basis and determine whether it should be regulated as a voice service or as
another telecommunications service. Finally, in many countries Internet and
IP telephony has not yet been addressed by legislation or regulatory
action.

With respect to the European Union, we believe that our services
fall outside the classification of regulated voice telephony services. The
current European Union regulatory regime distinguishes between voice
telephony services and other telecommunications services. In January 1998
and again in December 2000, the European Commission concluded that IP
telephony did not at that time meet the definition of "voice telephony"
subject to member state's regulation. However, the Commission noted that
some forms of IP telephony could be considered voice telephony, for
example, where an IP telephony service is marketed as an alternative form
of voice telephony service, users can dial out to any telephone number, and
the provider guarantees the quality of the IP voice service by bandwidth
reservation and claims that the quality of the IP voice service is the same
as traditional voice telephony service.

A determination by the European Commission that IP telephony
constitutes "voice telephony" may trigger significant regulatory
consequences with respect to, among other things, licensing requirements
and contributions to universal service funding. The Commission has
announced that it is drafting a report on regulating the quality of voice
telephony services and related consumer protection issues, as well as
another report discussing the new Internet telecommunications services and
their impact on the European Union's regulatory and policy framework. In
addition, the Commission has adopted directives for a new framework for
electronic communications regulation that, in part, attempt to harmonize
the regulations that apply to services regardless of the technology used by
the provider. We cannot predict what the content of such reports will be,
or what impact, if any, such reports and directives may have on our
business.

Based on the Commission's current position, we believe that
providers of IP telephony should be subjected to no more than a general
authorization or declaration requirement by the European Union Member
States. The Member States of the European Union are: Austria, Belgium,
Denmark, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, The
Netherlands, Portugal, Spain, Sweden and the United Kingdom. However, since
the Commission's findings on IP telephony are not binding on the Member
States, we cannot assure you that the services provided over our network
will not be deemed "voice telephony" subject to heightened regulation by
one or more EU Member States.

As we make our services available in foreign countries, and as we
facilitate sales by our network partners to end users located in foreign
countries, such countries may claim that we are required to qualify to do
business in the particular foreign country. Such countries may also claim
that we are subject to regulation, including requirements to obtain
authorization for the provision of voice telephony or other
telecommunications services, or for the operation of telecommunications
networks. It is also possible that such countries may claim that we are
prohibited in all cases from providing our services or conducting our
business as conducted in those countries.

Our network partners may also currently be, or in the future may
become, subject to requirements to qualify to do business in a particular
foreign country, comply with regulations, including requirements to obtain
authorizations for the provision of voice telephony or other
telecommunications services or for the operation of telecommunications
networks, or to cease providing services or conducting their business as
conducted in that country. We cannot be certain that our network partners
either are currently in compliance with any such requirements, will be able
to comply with any such requirements, and/or will continue in compliance
with any such requirements.

Other Regulation Affecting the Internet

United States. Congress has recently adopted legislation that affects
certain aspects of the Internet, including on-line content, user privacy,
national security and taxation. For example, the extension of the Internet
Tax Freedom Act prohibits certain taxes on Internet uses through November
1, 2003. We cannot predict whether substantial new taxes will be imposed on
our services after that date. In addition, Congress, the FCC and other
federal entities are considering other legislative and regulatory proposals
that would further affect the Internet, including with regard to broadband
network to support high-speed Internet access services. Congress is, for
example, currently considering legislation on a wide range of issues
including Internet spamming, database privacy, gambling, pornography and
child protection, Internet fraud and privacy. Various states have adopted
and are considering Internet-related legislation.

International. The European Union has also enacted several directives
relating to the Internet. The European Union has, for example, adopted a
directive on data protection that imposes restrictions on the processing of
personal data. Under the directive, personal data may not be collected,
processed, used for other purposes or transferred outside the European
Union unless certain specified conditions are met. In addition, persons
whose personal data is processed within the European Union are guaranteed a
number of rights. The directive may affect companies that collect or
transmit information over the Internet from individuals in the European
Union Member States. In particular, companies with establishments in the
European Union may not be permitted to transfer personal data to countries
that do not maintain adequate levels of data protection.

In addition, the European Union has adopted a separate,
complementary privacy directive that pertains to the telecommunications
sector. This directive establishes certain requirements with respect to,
among other things, the confidentiality, processing and retention of
subscriber traffic and billing data, security of services and networks,
subscriber rights to non-itemized bills, and the presentation and
restriction of calling and connected line identification. In addition, a
number of European countries outside the European Union have adopted, or
are in the process of adopting, rules similar to those set forth in the
European Union directives. Although we do not engage in the collection of
data for purposes other than routing calls and billing for our services,
the data protection directives are quite broad and the European Union
privacy standards are stringent. Accordingly, the potential effect of these
data protection rules on the development of our business is uncertain.

Competition

We compete primarily in the market for enhanced IP communications
services. This market is highly competitive and has numerous service
providers.

The market for enhanced Internet and IP communications services is
new and rapidly evolving. We believe that the primary competitive factors
determining our success, in the Internet and IP communications market are:

o quality of service

o the ability to meet and anticipate customer needs through
multiple service offerings

o responsive customer care services

o price

Future competition could come from a variety of companies both in
the Internet and telecommunications industries. These industries include
major companies who have greater resources and larger subscriber bases than
we have, and have been in operation for many years. We also compete in the
growing market of discount telecommunications services including calling
cards, prepaid cards, call-back services, dial-around or 10-10 calling and
collect calling services. In addition, some Internet service providers have
begun to aggressively enhance their real time interactive communications,
focusing initially on instant messaging, although we expect them to begin
to provide PC-to-Phone services.

IP Telephony Providers. Many companies provide, or are planning to provide,
certain portions of the complete communications solution we offer, including
Net2Phone, iBasis, Inc. and ITXC Corp.

Traditional Telecommunications Carriers. Several traditional
telecommunications companies, including industry leaders such as AT&T,
Sprint, Deutsche Telekom, WorldCom and Qwest Communications International,
have announced their intention to offer enhanced Internet and IP
communications services in both the United States and internationally. All
of these competitors are significantly larger than we are and have:

o substantially greater financial, technical and marketing
resources

o larger networks

o a broader portfolio of services

o stronger name recognition and customer loyalty

o well-established relationships with many of our target
customers

o an existing user base to which they can cross-sell their
services

These and other competitors may be able to bundle services and
products that are not offered by us together with enhanced Internet and IP
communications services, which could place us at a significant competitive
disadvantage. Many of our competitors enjoy economies of scale that can
result in lower cost structure for transmission and related costs, which
could cause significant pricing pressures within the industry.

Employees

As of December 31, 2001, we employed 99 full-time and 53 part-time
employees, of which 123 were located in Israel, and 29 were located in New
York. We consider our relationship with our employees to be good. None of
our employees is covered by collective bargaining agreements.

Generally, all male adult citizens and permanent residents of
Israel under the age of 51 are, unless exempt, obligated to perform up to
31 days of military reserve duty annually. Additionally, all such residents
are subject to being called to active duty at any time under emergency
circumstances. Some of our officers and employees are currently obligated
to perform annual reserve duty. While we have operated effectively under
these requirements since we began operations, no assessment can be made as
to the full impact of such requirements on our workforce or business if
conditions should change, and no prediction can be made as to the effect on
us of any expansion of such obligations.

ITEM 2. PROPERTIES

We maintain our executive offices at 75 Broad Street, New York,
New York under a lease with an annual rent of approximately $650,000,
increasing annually to $870,000 during the final year of the lease. The
lease term extends until July 2010, with an option to extend the lease
for an additional five years.

We lease a 1,440 square meter office, which houses our research
and development facilities, at the Jerusalem Technology Park, Jerusalem,
Israel. The term of this lease extends until February 2003, with an option
to extend the lease for an additional five-year period. We pay annual rent
of approximately $292,000. We sublease a portion of our facility to third
parties.

ITEM 3. LEGAL PROCEEDINGS

On October 8, 1999, Aerotel, Ltd. and Aerotel U.S.A. commenced a
suit against us, RSL COM and an RSL COM subsidiary in the United States
District Court for the Southern District of New York. Aerotel alleges that
we are infringing on a patent issued to Aerotel in November 1987 by making,
using, selling and offering for sale prepaid telephone card products in the
United States. Aerotel seeks an injunction to stop us from using the
technology covered by this patent, monetary damages in an unspecified
amount and reimbursement of attorneys' fees. We have answered the
complaint, and the parties are currently engaged in pre-trial discovery. As
we continue to evaluate these claims, we believe that we have meritorious
defenses to the claims and we intend to defend the lawsuit vigorously.
However, the outcome of the litigation is inherently unpredictable and an
unfavorable result may have a material adverse effect on our business,
financial condition and results of operations. Regardless of the ultimate
outcome, the litigation could result in substantial expenses to us and
significant diversion of efforts by our managerial and other personnel.

We, as well as certain of our former officers and directors, have
been named as a defendant in a number of purported securities class actions
in Federal District Court for the Southern District of New York, arising
out of our initial public offering in November 1999 (the "IPO"). Various
underwriters of the IPO also are named as defendants in the actions. The
complaints allege, among other things, that the registration statement and
prospectus filed with the Securities and Exchange Commission for purposes
of the IPO were false and misleading because they failed to disclose that
the underwriters allegedly (i) solicited and received commissions from
certain investors in exchange for allocating to them shares of our stock in
connection with the IPO and (ii) entered into agreements with their
customers to allocate such stock to those customers in exchange for the
customers agreeing to purchase additional shares in the aftermarket at
predetermined prices. On August 8, 2001, the court ordered that these
actions, along with hundreds of IPO allocation cases against other issuers,
be transferred to Judge Scheindlin for coordinated pre-trial proceedings.
By Order dated October 12, 2001, Judge Scheindlin adjourned all defendants'
time to respond to or answer any of the complaints until further order of
the Court. These cases remain at a preliminary stage and no discovery
proceedings have taken place. We believe that the claims asserted against
us in these cases are without merit and intend to defend vigorously against
them.

We are not a party to any other material litigation and are not
aware of any other pending or threatened litigation that could have a
material adverse effect on us or our business taken as a whole.

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

None.

PART II


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

Market Information

Our common stock has traded on the Nasdaq National Market under
the symbol "DDDC" since November 22, 1999. The following table sets forth
the per share range of high and low closing sales prices of our common
stock for the periods indicated:

High Low
---- ---
Year ended December 31, 2000
First quarter...................................... $62.38 $18.00
Second quarter..................................... 21.38 5.75
Third quarter...................................... 15.00 3.56
Fourth quarter..................................... 5.44 1.19
Year ended December 31, 2001
First quarter...................................... 3.50 1.03
Second quarter..................................... 1.61 0.60
Third quarter...................................... 0.98 0.26
Fourth quarter..................................... 0.93 0.52
Year ended December 31, 2002
First quarter...................................... 1.35 0.74


On March 27, 2002, the last reported sale price for our common
stock on the Nasdaq National Market was $1.07 per share. The market price
for our stock is highly volatile and fluctuates in response to a wide
variety of factors.

Holders

As of March 27, 2002, we had approximately 125 holders of record
of our common stock. This does not reflect persons or entities who hold
their stock in nominee or "street" name through various brokerage firms.

Dividend Policy

We have never declared or paid any cash dividends on our capital
stock. We do not anticipate paying any cash dividends on our capital stock
in the foreseeable future. We currently intend to retain future earnings,
if any, to finance our operations and to expand our business. Any future
determination to pay cash dividends will be at the discretion of our board
of directors and will be dependent upon our financial condition, operating
results, capital requirements and other factors that our board of directors
considers appropriate.

Recent Sales of Unregistered Securities

Pursuant to a stock and warrant purchase agreement, on October 18,
1999, we issued to Yahoo! Inc. 125,275 shares of common stock and a warrant
to purchase 125,275 shares of common stock with an exercise price of $7.98
per share for $1,000,000, in a transaction exempt from the registration
requirements of the Securities Act pursuant to Section 4(2) thereof.

Pursuant to a stock and warrant purchase agreement, on October 20,
1999, we issued to CNET Investments, Inc. ("CNET") 1,085,943 shares of
common stock and warrants to purchase 466,028 shares of common stock at an
exercise price of $19.31 per share for $10,999,994.76 in a transaction
exempt from the registration requirements of the Securities Act pursuant to
Section 4(2) thereof.

In connection with our initial public offering consummated on
November 29, 1999, shares of common stock outstanding prior to the offering
were converted into shares of Class B common stock. This conversion was
effected without registration under the Securities Act in reliance on
Section 3(a)(9) of the Securities Act on a one-for-one basis.

Pursuant to an Agreement and Plan of Merger dated as of February
3, 2000, YourDay Acquisition Corp., our wholly-owned subsidiary, was merged
with and into YourDay.com, Inc. Pursuant to the merger, we issued 229,443
shares of common stock to stockholders of YourDay.com, Inc., in a
transaction exempt from the registration requirements of the Securities Act
pursuant to Section 4(2) thereof.

Use of Proceeds

On November 22, 1999, we offered 6,000,000 shares of our common
stock in an initial public offering. These shares were registered with the
Securities and Exchange Commission on a registration statement on Form S-1
(file no. 333-86503), which became effective on November 22, 1999. We
received net proceeds of approximately $96,255,000 from the sale of
6,900,000 shares at the initial public offering price of $15.00 per share
after deducting underwriting commissions and discounts and expenses of
approximately $6,300,000. The managing underwriters for our initial public
offering were Lehman Brothers Inc., Merrill Lynch & Co., U.S. Bancorp Piper
Jaffray, Lazard Freres & Co. LLC and Fidelity Capital Markets.

For the year ended December 31, 2001, we used approximately $29
million of the net proceeds for sales, marketing and promotional
activities, $19 million for capital expenditures and $12 million for
general corporate purposes. Pending use of the remaining net proceeds, we
have invested the remaining net proceeds in interest-bearing,
investment-grade instruments, certificates of deposit, or direct or
guaranteed obligations of the United States.

ITEM 6. SELECTED FINANCIAL DATA

We derived the selected consolidated financial data presented
below from our consolidated financial statements and related notes included
in this annual report. You should read the selected consolidated financial
data together with our consolidated financial statements and related notes
and the section of this annual report entitled "Management's Discussion and
Analysis of Financial Condition and Results of Operations." Brightman
Almagor & Co., a member firm of Deloitte Touche, independent certified
public accountants, audited our historical financial statements since
inception and as of and for the years ended December 31, 1997, 1998, 1999,
2000 and 2001. Their report appears elsewhere in this annual report.



1997 1998 1999 2000 2001
---- ---- ---- ----
Year Ended December 31,
(In thousands, except share data)

Statement of Operations Data:
Revenues:

Affiliates.......................................... $468 $3,896 $7,431 $13,977 $1,669
Non-affiliates...................................... 778 1,742 3,621 16,399 13,991

Total revenues........................................ 1,246 5,638 11,052 30,376 15,660
Costs and operating expenses:
Cost of revenues, net............................... (892) (4,459) (9,723) (24,932) (13,486)
Research and development expenses, net.............. (294) (650) (1,233) (6,625) (5,648)
Selling and marketing expenses...................... (632) (2,431) (7,403) (20,548) (7,800)
General and administrative expenses (exclusive of (1,388) (1,842) (2,754) (6,694) (6,982)
non-cash compensation expense)......................
Non-cash compensation expense....................... - (743) (19,116) (6,331) (825)
Depreciation and amortization....................... (370) (2,671) (3,721) (7,919) (8,996)
Write-down of fixed assets......................... - - - - (1,003)
Expenses due to cancellation of supplier agreement.... - - - - (3,628)
Impairment of goodwill.............................. - - - (8,905) (4,151)

Total costs and operating expenses.................... (3,576) (12,796) (43,950) (81,954) (52,519)

Loss from operations.................................. (2,330) (7,158) (32,898) (51,578) (36,859)
Interest income (expense), net........................ (37) (186) (873) 3,632 1,677
Minority interest..................................... - 223 - - -
Income taxes.......................................... - - - (311) (552)
Net loss.............................................. $(2,367) $(7,121) $(33,771) $(48,257) $(35,734)
Net loss per share - basic and diluted............... $(0.19) $(0.37) $(1.65) $(1.67) $(1.23)


Weighted average shares outstanding - basic and
diluted............................................ 12,390 19,254 20,418 28,833 29,035



1997 1998 1999 2000 2001
---- ---- ---- ---- ----
Year Ended December 31,
(In thousands)
Balance Sheet Data:
Cash and cash equivalents............................. $3,196 $1,357 $89,957 $20,857 $13,583
Working capital (deficiency).......................... 2,763 (3,232) 82,942 43,538 23,374
Total assets.......................................... 8,403 25,676 126,832 86,169 45,869
Long-term debt due to affiliates...................... - 5,107 - - -
Total stockholder's equity (deficiency)............... 6,272 12,370 102,580 72,479 38,921



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

The following discussion of our financial condition and results of
operations should be read together with our consolidated financial
statements and the related notes thereto included in another part of this
annual report.

Overview

We are a provider of integrated Voice over Internet Protocol
(VoIP) telephony services. We were founded in 1996 to capitalize on the
growth of the Internet as a communications tool by commercially offering
Internet Protocol (IP) telephony services. IP telephony is the real time
transmission of voice communications in the form of digitized "packets" of
information over the Internet or a private network, similar to the way in
which e-mail and other data is transmitted. Our business currently includes
the provision of enhanced Web-based and other communications services to
individual consumers, under our iConnectHere brand name, the provision of a
total "Hosted Communications Solution" that enables corporate customers and
service providers to offer private label telecommunications to their
customer bases, and the transmission of voice and data traffic for
communications carriers.

Prior to 1999, our focus was to build a privately-managed, global
network utilizing IP technology. Our business primarily consisted of
carrying and transmitting traffic for communications carriers over our
network. Beginning in 1999, we began to diversify our offerings by layering
enhanced IP telephony services over our network. These enhanced services
were targeted at consumers and were primarily accessible through our
consumer Web site. During 2000, we began offering services on a co-branded
or private-label basis to service providers and other businesses to assist
them in diversifying their product offerings to their customer bases. In
early 2001, we deployed our Broadband Phone offering - a complete phone
replacement solution available to business and consumer customers over the
"last mile" through broadband connections via cable modem, DSL or fixed
wireless.

Factors Affecting Future Results

Competitive Factors: The telecommunications industry is highly competitive.
There is competition within the traditional telecommunications marketplaces
(landline and wireless) and also with other emergent "next generation"
telecommunications providers, including IP telecommunications providers in
supplying the overall telecommunications needs of businesses and individual
consumers. We compete with other telecommunications firms in the sale and
purchase of various products and services in many national and
international markets and employ all methods of competition which are
lawful and appropriate for such purposes. A key component of our
competitive position, particularly given the commodity-based nature of many
of our products, is our ability to manage operating expenses successfully,
which requires continuous management focus on reducing unit costs and
improving efficiency.

Political Factors: Our operations and earnings have been, and may in the
future be, affected from time to time in varying degree by political
instability and by other political developments and laws and regulations,
such as forced divestiture of assets; restrictions on production, imports
and exports; war or other international conflicts; civil unrest and local
security concerns that threaten the safe operation of company facilities;
price controls; tax increases and retroactive tax claims; expropriation of
property; cancellation of contract rights; and telecommunications
regulations. Both the likelihood of such occurrences and their overall
effect upon us vary greatly from country to country and are not
predictable.

Industry and Economic Factors: Our operations and earnings are affected by
local, regional and global events or conditions that affect supply and
demand for telecommunications products and services. These events or
conditions are generally not predictable and include, among other things,
general economic growth rates and the occurrence of economic recessions;
the development of new supply sources; supply disruptions; technological
advances, including advances in telecommunications technology and advances
in technology relating to telecommunications usage; changes in
demographics, including population growth rates and consumer preferences;
and the competitiveness of alternative telecommunications sources or
product substitutes.

Project Factors: In addition to the factors cited above, the advancement,
cost and results of particular projects depend on the outcome of
negotiations with potential partners, governments, suppliers, customers or
others; changes in operating conditions or costs; and the occurrence of
unforeseen technical difficulties.

Risk Factors: See "-- Risk Factors" below for discussion of the impact of
market risks, financial risks and other uncertainties.

Revenues

Prior to June 28, 2001, our majority shareholder was RSL COM, a
large telecommunications provider, who was also our largest customer. As
such, for financial reporting purposes for fiscal year 2001 and prior
years, revenues were derived from affiliates and non-affiliates. Revenues
from affiliates consist of revenues received from RSL COM for the carrier
transmission and calling card services we provided to RSL COM, prior to
Atarey's acquisition of RSL COM's holdings of our stock. The majority of
the services we provided to RSL COM were resold by RSL COM to other
communications companies, and the remainder were used directly by RSL COM's
customers. Carrier transmission services to RSL COM accounted for 10.7% of
our total revenues in 2001 and 16.1% of our total revenues in 2000.

Revenues from non-affiliates consist of revenues from end-users of
our enhanced IP communications services, including PC-to-Phone and
Phone-to-Phone, which are generated by our both our consumer offering,
iConnectHere, and our Hosted Communications Solution, and revenues from
carriers other than RSL COM for carrier transmission services. All revenues
are recognized as the services are performed. The provision of enhanced IP
communications services (primarily PC-to-Phone) through iConnectHere
accounted for 32.7% and 18.3% of our total revenues in 2001 and 2000,
respectively, while the provision of enhanced IP communications services
through our Hosted Communications Solution sales efforts accounted for
22.1% and 26.5% of our total revenues in 2001 and 2000, respectively.
Carrier transmission services to non-affiliates accounted for 11.2% and
9.2% of our total revenues in 2001 and 2000, respectively.

Costs and Operating Expenses

Costs and operating expenses consist of cost of revenues, research
and development expenses, selling and marketing expenses, general and
administrative expense, depreciation and amortization of goodwill, non-cash
stock compensation, write-down of fixed assets, expenses due to
cancellation of agreement with a supplier and impairment of goodwill
related expenses.

o Cost of revenues consist primarily of access, termination
and transmission costs paid to carriers that we incur when
providing services and fixed costs associated with leased
transmission lines. The term of our contracts for leased
transmission lines is generally one year, or less, and
either party can terminate with prior notice. We incurred
extraordinary costs of approximately $1.4 million in 1999 in
integrating the hardware and software purchased from
Ericsson into our network. To compensate us for our costs,
Ericsson agreed to offset our payable to them for network
telecommunications equipment that we previously purchased
from them with a fair market value of $3 million,
representing Ericsson's reimbursement of costs incurred by
us. As a result, we classified this payable as deferred
revenues and costs, which we recognized as an offset to cost
of revenues and research and development expenses as they
are incurred.

o Research and development expenses consist primarily of costs
associated with establishing our network and the initial
testing of our services and compensation expenses of
software developers involved in new product development and
software maintenance. In the future, these expenses may
fluctuate as a percentage of revenue depending on the
project undertaken during the reporting period. Since our
inception, we have expensed all research and development
costs in each of the periods in which they were incurred.

o Selling and marketing expenses consist primarily of
advertising and promotional expenses incurred to attract
potential consumer users of iConnectHere and expenses
associated with our direct sales force incurred to attract
potential business customers and service providers for our
Hosted Communications Solution. We expect to decrease our
overall selling and marketing expenses as we focus our
attention on growing the percentage of sales related to our
Hosted Communications Solution. We anticipate that as we add
new paid users we will be able to spread these costs over a
larger revenue base and accordingly improve our operating
margins.

o General and administrative expenses consist primarily of
compensation and benefits for management, finance and
administrative personnel, occupancy costs and legal and
accounting fees, as well as the expenses associated with
being a public company, including costs of directors' and
officers' insurance.

o Amortization of goodwill consists of amortization of the
goodwill related to the purchase by RSL COM of all of the
outstanding shares of our capital stock. In July 1997, we
issued shares representing 51% of our outstanding share
capital to RSL COM for $5 million. No goodwill was recorded
as a result of this issuance. However, as a result of
acquiring a controlling interest in us, RSL COM recorded
goodwill in the amount of $450,000, representing our net
liabilities. RSL COM then proceeded to offer to purchase
from our stockholders all of our outstanding shares it did
not already own. By April 1998, RSL COM had paid
approximately $14.7 million in cash and securities for the
remaining 49% of our shares that it did not own and RSL COM
recorded goodwill in the amount of $14.7 million. As a
result of these transactions, RSL COM "pushed down" a total
of approximately $15.2 million of goodwill to our financial
statements, accounted for in our financial statements as an
increase in both goodwill and additional paid-in capital of
approximately $15.2 million in the aggregate. We have
recorded amortization expense of approximately $11.0 million
through December 31, 2001. During the fourth quarter of
2001, the net carrying amount of goodwill was written-off
and there will be no amortization relating to the RSL COM
acquisition in 2002.

o Write down of fixed assets represents a one-time charge due
to the write down of equipment in the second quarter of 2001
that was purchased in previous periods to support contracts
and inter-company agreements between RSL COM and us that
were cancelled at the time of RSL COM's sale of its majority
ownership interest in us to Atarey.

o Expenses due to cancellation of a supplier agreement
consists of a one-time expense due to the early termination
of a long-term marketing and promotion agreement with CNET
during the second quarter of 2001. Under the remaining terms
of the original agreement, we were required to pay CNET $
5.5 million. We negotiated the early termination of this
agreement for a one-time cash payment of $1.75 million. The
remainder of the $3.6 million CNET related charge includes
approximately $1.5 million in previously deferred non-cash
compensation.

o Impairment of goodwill is an expense resulting from our
determination that events or changes in circumstances have
occurred that impact the net carrying amount of goodwill on
our financial statements. During the fourth quarter of 2001,
we determined that as a result of the sale of majority
ownership of us by RSL COM to Atarey, a full write-off of
the net carrying amount of goodwill pushed down into our
books at the time of the RSL acquisition was necessary.
Accordingly, approximately $4.2 million was written-off in
accordance with generally accepted accounting principles.
During the fourth quarter of 2000, we decided to
de-emphasize our consumer offering, iConnectHere and focus
our efforts on generating revenues primarily through sales
of our Hosted Communications Solution. As a result, the
technology we acquired through our acquisition of
YourDay.com, Inc. was not incorporated into iConnectHere as
originally planned. Accordingly, we determined that a full
write-off of approximately $8.9 million was required in
accordance with generally accepted accounting principles.

We have not recorded any income tax benefit for net losses and
credits incurred for any period from inception to December 31, 2001. The
utilization of these losses and credits depends on our ability to generate
taxable income in the future. Because of the uncertainty of our generating
taxable income, we have recorded a full valuation allowance with respect to
these deferred assets.

Deferred Compensation Charge

We recognized approximately $24.3 million of deferred compensation
charges in 1999 related to non-cash compensation expense due to the
issuance of 2,198,025 shares of our common stock to our employees granted
with exercise prices below the fair market value in periods prior to
December 31, 1999. We recorded additional deferred compensation charges of
approximately $4.4 million in 1999 in connection with our sale of common
stock and warrants to both Yahoo!, Inc. and CNET. The deferred compensation
charge represents the difference between each of the purchase prices of the
common stock and the exercise price of the warrants as compared to the fair
value of the common stock at the date of sale. We began amortizing this
deferred compensation charge during the fourth quarter of 1999. The
deferred compensation charge has been fully amortized for Yahoo! and the
remaining CNET balance was accelerated and fully amortized along with the
cancellation of the marketing and promotion agreement.

We recognized $6.3 million in non-cash compensation expense in
2000 and $825,000 in 2001, and we will recognize an additional $270,000
during the period January 1, 2002 through May 31, 2002.

Results of Operations

The following table sets forth the statement of operations data
presented as a percentage of revenues for the periods indicated:




1999 2000 2001
---- ---- ----
Year Ended December 31,

Revenues:

Affiliates............................................................ 67.2% 46.0% 10.7%
Non-affiliates........................................................ 32.8 54.0 89.3
-------- ------- ------

Total revenues.......................................................... 100.0 100.0 100.0
Costs and operating expenses:
Cost of revenues, net................................................. 88.0 82.1 86.0
Research and development expenses, net................................ 11.2 21.8 36.0
Selling and marketing expenses........................................ 67.0 67.6 49.8
General and administrative expenses (exclusive of non-cash 24.9 22.0 44.6
compensation expense).................................................
Non-cash compensation expense......................................... 173.0 20.8 5.3
Depreciation and amortization......................................... 33.7 26.1 57.4
Write down of fixed assets............................................ - - 6.4
Expenses due to cancellation of supplier agreement.................... - - 23.2
Impairment of goodwill................................................ - 29.3 26.5
-------- ------- ------

Total costs and operating expenses.................................... 397.6 269.8 335.3
-------- ------- ------

Loss from operations.................................................... (297.6) (169.8) (235.3)
Interest income (expense), net.......................................... (7.9) 12.0 10.7
Income taxes............................................................ - 1.0 (3.5)
-------- ------- ------

(305.5)% (158.9)% (227.4)%
======== ======== =======



Comparison of 2001 and 2000

Revenues

Affiliates. Revenues from affiliates decreased by $12.3 million or
87.9% to $1.7 million in 2001 from $14.0 million in 2000, due to the sale
of all of our Class B Common Stock on June 29, 2001 by RSL COM to Atarey
and our disconnection from the RSL COM network. After June 29, 2001, there
were no further revenues from affiliates, and we do not anticipate
receiving revenues from affiliates in the future.

Non-affiliates. Revenues from non-affiliates decreased by $2.4
million or 14.6% to $14.0 million in 2001 from $16.4 million in 2000.
Revenues from enhanced IP communications services (including our Hosted
Communications Solution) decreased by $1.4 million or 10.3% to $12.2
million in 2001 from $13.6 million in 2000, due to a lesser number of new
Hosted Communications Solution partners, yielding lower up-front
integration fees, partially offset by a greater number of PC-to-Phone and
Phone-to-Phone calls being placed by an increasing user base. Revenues from
carrier transmission services for telecommunications carriers other than
RSL COM decreased by $1.0 million or 35.7% to $1.8 million in 2001 from
$2.8 million in 2000, due primarily to decreased demand from a smaller
customer base.

Revenues from carrier transmission services to RSL COM and other
telecommunications carriers accounted for 19.5% and 25.3% of revenues in
2001 and 2000, respectively. As revenues from our enhanced IP communication
services continue to grow as a percentage of total revenue, we expect that
our revenues from carrier transmission services will continue to account
for a declining percentage of our revenues. Other than RSL COM, no other
customer accounted for greater than 10% of our revenues during these
periods.

Costs and Operating Expenses

Cost of revenues. Cost of revenues decreased by $11.4 million or
45.8% to $13.5 million in 2001 from $24.9 million in 2000, due primarily to
a decrease in the amount of traffic being terminated.

Research and development expenses. Research and development
expenses decreased by $1.0 million or 15.2% to $5.6 million in 2001 from
$6.6 million in 2000, due to lower personnel costs associated with the
development of new services and enhancements to our existing services.

Selling and marketing expenses. Selling and marketing expenses
decreased by $12.8 million or 62.1% to $7.8 million in 2001 from $20.6
million in 2000, due to a significant decrease in branding and promotional
activities.

General and administrative expenses. General and administrative
expenses increased by $0.3 million or 4.5% to $7.0 million in 2001 from
$6.7 million in 2000, primarily due to increased personnel and occupancy
costs.

Non-cash compensation expenses. Non-cash compensation expenses
decreased by $5.5 million or 87.3% to $0.8 million in 2001 from $6.3
million in 2000, due to the completed amortization of costs incurred during
1998. Remaining amortization of costs related to the 1999 grants of options
and warrants below the then fair market value will continue to be reflected
in future financial statements.

Depreciation and amortization of goodwill. Depreciation and
amortization of goodwill increased by $1.1 million or 13.9% to $9.0 million
in 2001 from $7.9 million in 2000, due to our on-going purchase, and
subsequent depreciation of fixed assets.

Impairment of goodwill. We incurred a one-time expense of $4.2
million for the year ended December 31, 2001 related to the impairment of
goodwill. This one-time charge was due to the write-off of `pushed-down'
goodwill associated with the acquisition of us by RSL COM, the valuation of
which was impacted by the sale of majority ownership by RSL COM to Atarey.
We incurred a one-time expense of $8.9 million for the year ended December
31, 2000 related to the impairment of goodwill. This one-time charge was
due to the write-off of goodwill associated with the technology acquired
through our acquisition of Yourday.com, which was not incorporated into
iConnectHere as originally planned.

Write down of fixed assets from RSL sale. We incurred a one-time
expense of approximately $7.0 million from the write down of equipment that
was purchased in previous periods to support contracts and inter-company
agreements between us and RSL COM that were cancelled at the time of RSL
COM's sale of its majority ownership interest to Atarey. See Note 12 to the
accompanying financial statements for further details.

Expenses due to the cancellation of a supplier agreement. We
incurred a one-time expense of approximately $3.6 million that resulted
from the cancellation of a development and promotion agreement between CNET
and us. Expenses included a payment to terminate the contract and
the acceleration of the amortization of compensation charges deferred in
previous years.

Loss from Operations

Loss from operations decreased by $14.7 million or 28.5% to $36.8
million in 2001 from $51.5 million in 2000, due primarily to the decrease
in costs and operating expenses, including non-cash compensation expenses
and selling and marketing expenses. We expects to continue to incur losses
for the foreseeable future.

Interest (Expense) Income, Net

Interest income decreased by $1.9 million or 52.8% to $1.7 million
in 2001 from $3.6 million in 2000, due primarily to lower interest rates
earned on a reduced balance of remaining proceeds from our initial public
offering.

Income Taxes, Net

We paid net income taxes of $0.6 million in 2001 compared to $0.3
million in 2000.

Net Loss

Net loss decreased $12.5 million or 25.9% to $35.7 million in 2001
from $48.2 million in 2000, due to the foregoing factors.

Comparison of 2000 and 1999

Revenues

Affiliates. Revenues from affiliates increased by $6.6 million or 88.1%
to $14.0 million in 2000 from $7.4 million in 1999, due to an increase in
sales of calling card products through our affiliate, RSL COM USA, and an
increase in sales to RSL COM due to increased demand for our carrier
transmission services, partially offset by decreases in prices.

Non-affiliates. Revenues from non-affiliates increased by $12.8 million
or 352.9% to $16.4 million in 2000 from $3.6 million in 1999. Revenues from
enhanced IP communications services (including our Hosted Communications
Solution) increased by $11.6 million or 473.8% to $13.6 million in 2000
from $2.0 million in 1999, due to integration and other service fees
received from partners in our Hosted Communications Solution as well as a
greater number of PC-to-Phone and Phone-to-Phone calls being placed by an
increasing user base. Revenues from carrier transmission services for
telecommunications carriers other than RSL COM increased by $1.4 million or
100% to $2.8 million in 2000 from $1.4 million in 1999, due primarily to an
increased demand from a larger customer base.

Revenues from carrier transmission services to RSL COM and other
telecommunications carriers accounted for 25.3% and 59.8% of revenues in
2000 and 1999, respectively. As revenues from our enhanced IP communication
services continue to grow as a percentage of total revenue, we expect that
our revenues from carrier transmission services will continue to account
for a declining percentage of our revenues. Other than RSL COM, no other
customer accounted for greater than 10% of our revenues during these
periods.

Costs and Operating Expenses

Cost of revenues. Cost of revenues increased by $15.2 million or 156.4%
to $24.9 million in 2000 from $9.7 million in 1999, due primarily to an
increase in the costs associated with the increase in the amount of traffic
being terminated over our network.

Research and development expenses. Research and development expenses
increased by $5.4 million or 437.3% to $6.6 million in 2000 from $1.2
million in 1999, due to greater costs incurred in hiring personnel to
develop several new services and enhancements to our existing services.

Selling and marketing expenses. Selling and marketing expenses
increased by $13.2 million or 177.6% to $20.6 million in 2000 from $7.4
million in 1999, due to the expansion of our marketing and promotional
activities during the first half of 2000 and an increase in our direct
sales activities during the second half of 2000.

General and administrative expenses. General and administrative
expenses increased by $3.9 million or 143.1%to $6.7 million in 2000 from
$2.8 million in 1999, due primarily to additional personnel and increased
occupancy costs.

Non-cash compensation expenses. Non-cash compensation expenses
decreased by $12.8 million or 67.0% to $6.3 million in 2000 from $19.1
million in 1999, due to the completed amortization of costs incurred during
1997. Remaining amortization of costs related to the 1998 and 1999 grants
of employee stock options and warrants to Yahoo! and CNET below the then
fair market value will continue to be reflected in future financial
statements.

Depreciation and amortization of goodwill. Depreciation and
amortization of goodwill increased by $4.2 million or 112.8% to $7.9
million in 2000 from $3.7 million in 1999, due to the continued increase in
our fixed assets and the acquisition of YourDay.com, Inc. during the first
quarter of 2000.

Impairment of goodwill. We incurred a one-time expense of $8.9 million
in 2000 related to the impairment of goodwill. This one-time charge was due
to the write-off of goodwill associated with the technology acquired
through our acquisition of Yourday.com, which was not incorporated into
iConnectHere as originally planned.

Loss from Operations

Loss from operations increased by $18.7 million or 56.8% to $51.6
million in 2000 from $32.9 million in 1999, due primarily to the increase
in costs and operating expenses, including non-cash compensation expenses,
sales and marketing expenses, and a one-time expense for goodwill
impairment, as well as a decrease in prices we charged for carrier
transmission services.

Interest (Expense) Income, Net

Interest income increased by $4.5 million or 515.5% to $3.6
million in 2000 from $0.9 million in 1999 due to interest earned on the
remaining proceeds from our initial public offering, less the interest
expense we incurred in connection with our borrowings from RSL COM, which
were repaid in November 2000.

Income Taxes, Net

We paid income taxes, net of $0.3 million in 2000 compared to no
income taxes in 1999.

Net Loss

Net loss increased by $14.5 million or 42.9% to $48.3 million in
2000 from $33.8 million in 1999, due to the foregoing factors.

Liquidity and Capital Resources

Since our inception in June 1996, we have incurred significant
operating and net losses due in large part to the start-up and development
of our operations. As of December 31, 2001, we had an accumulated deficit
of approximately $127.4 million. We anticipate that we will continue to
incur operating and net losses as we implement our growth strategy.

As of December 31, 2001, we had cash and cash equivalents of
approximately $13.6 million, marketable securities and other short-term
investments of approximately $14.2 million and working capital of
approximately $23.4 million. We generated negative cash flow from operating
activities of approximately $22.7 million during 2001 compared with
negative cash flow from operating activities of $23.4 million during 2000.
Accounts receivable were approximately $1.1 million and $3.2 million at
December 31, 2001 and December 31, 2000, respectively.

Our capital expenditures decreased from approximately $13.6
million in the year ended December 31, 2000 compared to approximately $1.6
million in the year ended December 30, 2001, as we better utilize our
existing domestic and international network infrastructure.

Short-term, we obtain our funding from our utilization of the
remaining proceeds from our initial public offering offset by positive or
negative cash flow from our operations. These proceeds are maintained as
cash and cash equivalents with an original maturity of three months or
less. Based on current trends in our operations, these funds will be
sufficient to meet our working capital requirements, including operating
losses, and capital expenditure requirements for at least the next fiscal
year, assuming that our business plan is implemented successfully, and
that:

o our recent revenue trends, which reflected an increase in
our higher-margin (primarily PC-to-Phone) products and
services continues to increase;
o our expense trends remain at or near the rates of our fourth
quarter 2001 rates, which were significantly reduced during
the year through reductions in personnel, curtailment of
discretionary expenditures, and reduced network rent and
termination rates from our carriers; and
o our net cash-burn rate, which was significantly reduced
during the year due to the foregoing factors to
approximately $3.0 million in the fourth quarter of 2001,
continues to improve throughout 2002 and beyond.

To the extent that these trends do not remain steady, or if in the
longer-term we are not able to successfully implement our business strategy
we may be required to raise additional funds for our ongoing operations.
Additional financing may not be available when needed or, if available,
such financing may not be on terms favorable to us. If additional funds are
raised through the issuance of equity securities, our existing stockholders
may experience significant dilution. In addition, while the indentures
governing outstanding indebtedness of RSL COM were cancelled and no longer
restrict our ability to incur indebtedness, we cannot assure you that any
third party will be willing or able to provide additional capital on
favorable terms or at all.

Certain Relationships and Related Transactions

We believe that all of the transactions described below were made
on an arms-length basis. All future transactions between us and our
officers, directors, principal stockholders and affiliates will be approved
by a majority of the Board of Directors, including a majority of the
outside directors, and will continue to be on terms no less favorable to us
than could be obtained from unaffiliated third parties.

RSL COM

Prior to June 28, 2001, we had various inter-company contracts and
agreements with RSL COM (and all of its subsidiaries). Simultaneously with
the completion of the transaction on June 29, 2001, when RSL COM sold all
of their holding of us to Atarey, all of these contracts and inter-company
agreements were terminated.

Atarey

There are no inter-company contracts or agreements with Atarey.

CNET

On October 20, 1999, we issued to CNET Investments, Inc., for
approximately $11 million, 1,085,943 shares of the our Class A Common Stock
and warrants to purchase 466,028 shares of our Common Stock at an exercise
price of $19.31 per share exercisable for the term of our promotion
agreement with CNET. CNET was entitled to request that we register their
shares under the Securities Act and to include their shares in our future
registered equity offerings. On July 6, 2001, CNET, entered into a share
purchase agreement with Atarey. Under this agreement, Atarey purchased
1,085,943 shares of our Class A Common Stock owned by CNET in accordance
with the "tag-along" rights granted to CNET pursuant to the Investor Rights
Agreement, dated as of October 20, 1999, by and among us, RSL COM and CNET.

Simultaneously with its equity investment in us, in October 1999,
we entered into a marketing and promotion agreement with CNET. Under this
agreement, merchants on CNET's shopping sites were able to integrate our
PC-to-phone software to enable users to make a PC-to-phone call directly to
such merchant from the CNET shopping site using the our Click IT service.
In addition, CNET had agreed to display banners and other promotions on its
Web sites that will link to our Web site. The initial term of the contract
was two years. This contract was mutually terminated on May 24, 2001.

Risk Factors

In addition to the other information in this report, the following
factors should be carefully considered in evaluating our business and
prospects.

Risks Related to Our Company

We Have a History of Losses and We Anticipate Our Losses Will Continue

We have incurred significant losses since inception, and we expect
to continue to incur significant losses for the foreseeable future. We
reported net losses of approximately $35.7 million in 2001, approximately
$48.3 million in 2000, and approximately $33.8 million in 1999. As of
December 31, 2001, our accumulated deficit was approximately $127.4
million. As a percentage of revenues, our net loss was 228.2% in 2001,
158.9% in 2000 and 305.5% in 1999. Our revenues may not grow or even
continue at their current level. In addition, we expect to maintain our
operating expenses at current levels as we develop and expand our business.
As a result, we will need to increase our revenues significantly to become
profitable. In order to increase our revenues, we need to attract and
maintain customers to increase the fees we collect for our services. If our
revenues do not increase as much as we expect or if our expenses increase
at a greater pace than revenues, we may never be profitable or, if we
become profitable, we may not be able to sustain or increase profitability
on a quarterly or annual basis.

We Will Need Additional Capital to Finance Our Operations in the Future

We intend to continue to enhance and expand our network in order
to maintain our competitive position and meet the increasing demands for
service quality, capacity and competitive pricing. Also, the introduction
of new products and/or service will require significant marketing and
promotional expenses that we often incur before we begin to receive the
related revenue. If our cash flow from operations is not sufficient to meet
our capital expenditure and working capital requirements, we will need to
raise additional capital to continue our operations. We may not be able to
raise additional capital, and if we are able to raise additional capital
through the issuance of additional equity, our current investors could
experience dilution. If we are unable to obtain additional capital, we may
be required to reduce the scope of our business or our anticipated growth,
which would reduce our revenues.

We Have a Limited Operating History Upon Which You Can Evaluate Us

We have only a limited operating history upon which you can
evaluate our business and prospects. We commenced operations in June 1996.
You should consider our prospects in light of the risks, expenses and
difficulties we may encounter as an early stage company in the new and
rapidly evolving market for IP communications services. These risks include
our ability:

o to increase acceptance of our Hosted Communications
Solution, thereby increasing the number of users of our IP
telephony services
o to compete effectively
o to develop new products and keep pace with developing
technology

In addition, because we expect an increasing percentage of our
revenues to be derived from our enhanced IP communications services and our
Hosted Communications Solution, our past operating results may not be
indicative of our future results.

We May Not be Able to Expand Our Revenue and Achieve Profitability

Our business strategy is to expand our revenue sources to include
the provision of enhanced IP communications services to several different
customer groups. We can neither assure you that we will be able to
accomplish this nor that this strategy will be profitable. Currently, our
revenues are primarily generated by sales of enhanced IP communications
services through our direct consumer offering, iConnectHere. Enhanced IP
communications services generated 54.8%, 44.8%, and 18.4% of our total
revenues in 2001, 2000 and 1999, respectively. The provision of enhanced IP
communications services has not been profitable to date and may not be
profitable in the future.

In the future, we intend to generate increased revenues from
multiple sources, many of which are unproven, including the commercial sale
of our Hosted Communications Solution and enhanced IP communications
services. We expect that our revenues for the foreseeable future will be
dependent on, among other factors:

o sales of enhanced IP communications services and our Hosted
Communications Solution
o acceptance and use of IP telephony
o expansion of service offerings
o traffic levels on our network
o the effect of competition, regulatory environment,
international long distance rates and access and
transmission costs on our prices
o continued improvement of our global network quality

We may not be able to sustain our current revenues or successfully
generate additional revenues from the sale of enhanced IP communications
services, Hosted Communications Solutions or carrier transmission services.

We Cannot Assure You That a Market for Our Services Will Develop

We are uncertain whether a market will develop for our enhanced IP
communications services or our Hosted Communications Solutions. Our market
is new and rapidly evolving. Our ability to sell our services may be
inhibited by, among other factors, the reluctance of some end users to
switch from traditional communications carriers to IP communications
carriers and by concerns with the quality of IP telephony and the adequacy
of security in the exchange of information over the Internet. End users in
markets serviced by recently deregulated telecommunications providers are
not familiar with obtaining services from competitors of these providers
and may be reluctant to use new providers, such as us. Our ability to
increase revenues depends on the migration of traditional telephone network
traffic to our IP network. We will need to devote substantial resources to
educate customers and end users about the benefits of IP communications
solutions in general and our services in particular. If enterprises and
their customers do not accept our enhanced IP communications services and
our Hosted Communications Solutions as a means of sending and receiving
communications, we will not be able to increase our number of paid users or
successfully generate revenues in the future.

Our Future Success Depends on the Growth in the Use of the Internet as a Means
of Communications

If the market for IP communications, in general, and our services
in particular, does not grow at the rate we anticipate or at all, we will
not be able to increase our number of users or generate revenues we
anticipate. To be successful, IP communications requires validation as an
effective, quality means of communication and as a viable alternative to
traditional telephone service. Demand and market acceptance for recently
introduced services are subject to a high level of uncertainty. The
Internet may not prove to be a viable alternative to traditional telephone
service for reasons including:

o inconsistent quality or speed of service
o traffic congestion on the Internet
o potentially inadequate development of the necessary
infrastructure
o lack of acceptable security technologies
o lack of timely development and commercialization of
performance improvements
o unavailability of cost-effective, high-speed access to the
Internet

If Internet usage grows, the Internet infrastructure may not be
able to support the demands placed on it by such growth, or its performance
or reliability may decline. In addition, Web sites may from time to time
experience interruptions in their service as a result of outages and other
delays occurring throughout the Internet network infrastructure. If these
outages or delays frequently occur in the future, Internet usage, as well
as usage of our communications portal and our services, could be adversely
affected.

Potential Fluctuations in Our Quarterly Financial Results Make it Difficult
for Investors to Predict Our Future Performance

Our quarterly operating results may fluctuate significantly in the
future as a result of a variety of factors, many of which are outside our
control. The factors generally within our control include:

o the rate at which we are able to attract users to purchase
our enhanced IP communications services and our Hosted
Communications Solutions
o the amount and timing of expenses to enhance marketing and
promotion efforts and to expand our infrastructure
o the timing of announcements or introductions of new or
enhanced services by us

The factors outside our control include:

o the timing of announcements or introductions of new or
enhanced services by our competitors
o technical difficulties or network interruptions in the
Internet or our privately-managed network
o general economic and competitive conditions specific to our
industry

The foregoing factors also may create other risks affecting our
long-term success, as discussed in the other risk factors.

We believe that quarter-to-quarter comparisons of our historical
operating results may not be a good indication of our future performance,
nor would our operating results for any particular quarter be indicative of
our future operating results.

Our Network May Not Be Able to Accommodate Our Capacity Needs

We expect the volume of traffic we carry over our network to
increase significantly as we expand our operations and service offerings.
Our network may not be able to accommodate this additional volume. In order
to ensure that we are able to handle additional traffic, we may have to
enter into long-term agreements for leased capacity. To the extent that we
overestimate our capacity needs, we may be obligated to pay for more
transmission capacity than we actually use, resulting in costs without
corresponding revenues. Conversely, if we underestimate our capacity needs,
we may be required to obtain additional transmission capacity from more
expensive sources. If we are unable to maintain sufficient capacity to meet
the needs of our users, our reputation could be damaged and we could lose
users.

We Face a Risk of Failure of Computer and Communications Systems Used in
Our Business

Our business depends on the efficient and uninterrupted operation
of our computer and communications systems as well as those that connect to
our network. We maintain communications systems in four facilities in New
York, Los Angeles, London and Jerusalem. Our systems and those that connect
to our network are subject to disruption from natural disasters or other
sources of power loss, communications failure, hardware or software
malfunction, network failures and other events both within and beyond our
control. Any system interruptions that cause our services to be
unavailable, including significant or lengthy telephone network failures or
difficulties for users in communicating through our network or portal,
could damage our reputation and result in a loss of users.

Our Computer Systems and Operations May Be Vulnerable to Security Breaches

Our computer infrastructure is potentially vulnerable to physical
or electronic computer viruses, break-ins and similar disruptive problems
and security breaches that could cause interruptions, delays or loss of
services to our users. We believe that the secure transmission of
confidential information over the Internet, such as credit card numbers, is
essential in maintaining user confidence in our services. We rely on
licensed encryption and authentication technology to effect secure
transmission of confidential information, including credit card numbers. It
is possible that advances in computer capabilities, new technologies or
other developments could result in a compromise or breach of the technology
we use to protect user transaction data. A party that is able to circumvent
our security systems could misappropriate proprietary information or cause
interruptions in our operations. Security breaches also could damage our
reputation and expose us to a risk of loss or litigation and possible
liability. Although we have experienced no security breaches to date of
which we are aware, we cannot guarantee you that our security measures will
prevent security breaches.

Third Parties Might Infringe Upon Our Proprietary Technology

We cannot assure you that the steps we have taken to protect our
intellectual property rights will prevent misappropriation of our
proprietary technology. To protect our rights to our intellectual property,
we rely on a combination of trademark and patent law, trade secret
protection, confidentiality agreements and other contractual arrangements
with our employees, affiliates, strategic partners and others. We may be
unable to detect the unauthorized use of, or take appropriate steps to
enforce, our intellectual property rights. Effective copyright and trade
secret protection may not be available in every country in which we offer
or intend to offer our services. Failure to adequately protect our
intellectual property could harm our brand, devalue our proprietary content
and affect our ability to compete effectively. Further, defending our
intellectual property rights could result in the expenditure of significant
financial and managerial resources.

Our Services May Infringe on the Intellectual Property Rights of Others

Third parties may assert claims that we have violated a patent or
infringed a copyright, trademark or other proprietary right belonging to
them. We incorporate licensed third-party technology in some of our
services. In these license agreements, the licensors have agreed to
indemnify us with respect to any claim by a third party that the licensed
software infringes any patent or other proprietary right so long as we have
not made changes to the licensed software. We cannot assure you that these
provisions will be adequate to protect us from infringement claims. Any
infringement claims, even if not meritorious, could result in the
expenditure of significant financial and managerial resources.

On October 8, 1999, we were named as a defendant in a lawsuit
alleging that we are infringing on a patent by making, using, selling and
offering for sale prepaid telephone card products in the United States. The
plaintiffs are seeking an injunction to stop us from using the technology
covered by this patent, monetary damages in an unspecified amount and
reimbursement of attorneys' fees. We have answered the complaint, and the
parties are currently engaged in pre-trial discovery. As we continue to
evaluate these claims, we believe that we have meritorious defenses to the
claim and we intend to defend the lawsuit vigorously. However, the outcome
of the litigation is inherently unpredictable and an unfavorable result may
have a material adverse effect on our business, financial condition and
results of operations. Regardless of the ultimate outcome, the litigation
could result in substantial expenses to us and significant diversion of
efforts by our managerial and other personnel.

Operating Internationally Exposes Us to Additional and Unpredictable Risks

We intend to continue to enter additional markets in Eastern
Europe, Latin America, Africa and Asia and to expand our existing
operations outside the United States. International operations are subject
to inherent risks, including:

o potentially weaker protection of intellectual property
rights
o political instability
o unexpected changes in regulations and tariffs
o fluctuations in exchange rates
o varying tax consequences
o uncertain market acceptance and difficulties in marketing
efforts due to language and cultural differences

We Have Experienced Losses as a Result of Fraud

We have experienced losses due to fraud. In 2001, we experienced
losses from fraud of less than 2% of our revenues. Callers have obtained
our services without rendering payment by unlawfully using our access
numbers and personal identification numbers. Although we have implemented
anti-fraud measures in order to control losses relating to these practices,
these measures may not be sufficient to effectively limit all of our
exposure in the future from fraud and we continue to experience losses from
fraud. While we have established reserves for bad debts in accordance with
historical levels of uncollectible receivables resulting primarily from
these fraudulent practices, our losses may exceed our reserves and could
rise significantly above anticipated levels.

Intense Competition Could Reduce Our Market Share and Harm Our Financial
Performance

Competition in the market for enhanced IP communications services
is becoming increasingly intense and is expected to increase significantly
in the future. The market for enhanced Internet and IP communications is
new and rapidly evolving. We expect that competition from companies both in
the Internet and telecommunications industries will increase in the future.
Our competitors include both start-up IP telephony service providers and
established traditional communications providers. Many of our existing
competitors and potential competitors have broader portfolios of services,
greater financial, management and operational resources, greater brand-name
recognition, larger subscriber bases and more experience than we have. In
addition, many of our IP telephony competitors use the Internet instead of
a private network to transmit traffic. Operating and capital costs of these
providers may be less than ours, potentially giving them a competitive
advantage over us in terms of pricing.

We also compete in the growing market of discount
telecommunications services including calling cards, prepaid cards,
call-back services, dial-around or 10-10 calling and collect calling
services. In addition, some Internet service providers have begun to
aggressively enhance their real time interactive communications, focusing
initially on instant messaging, although we expect them to begin to provide
PC-to-phone services.

If we are unable to provide competitive service offerings, we may
lose existing users and be unable to attract additional users. In addition,
many of our competitors, especially traditional carriers, enjoy economies
of scale that result in a lower cost structure for transmission and related
costs, which cause significant pricing pressures within the industry.
Although the minutes of use we sell are increasing, revenues are not
increasing at the same rate due primarily to a decrease in revenue per
minute for our carrier transmission services. In order to remain
competitive we intend to increase our efforts to promote our services, and
we cannot be sure that we will be successful in doing this.

In addition to these competitive factors, recent and pending
deregulation in some of our markets may encourage new entrants. We cannot
assure you that additional competitors will not enter markets that we plan
to serve or that we will be able to compete effectively.

Decreasing Telecommunications Rates May Diminish or Eliminate Our Competitive
Pricing Advantage

Decreasing telecommunications rates may diminish or eliminate the
competitive pricing advantage of our services. International and domestic
telecommunications rates have decreased significantly over the last few
years in most of the markets in which we operate, and we anticipate that
rates will continue to be reduced in all of the markets in which we do
business or expect to do business. Users who select our services to take
advantage of the current pricing differential between traditional
telecommunications rates and our rates may switch to traditional
telecommunications carriers as such pricing differentials diminish or
disappear, and we will be unable to use such pricing differentials to
attract new customers in the future. In addition, our ability to market our
carrier transmission services to telecommunications carriers depends upon
the existence of spreads between the rates offered by us and the rates
offered by traditional telecommunications carriers, as well as a spread
between the retail and wholesale rates charged by the carriers from which
we obtain wholesale service. Continued rate decreases will require us to
lower our rates to remain competitive and will reduce or possibly eliminate
our gross profit from our carrier transmission services. If
telecommunications rates continue to decline, we may lose users for our
services.

Government Regulation and Legal Uncertainties Relating to IP Telephony Could
Harm Our Business

Historically, voice communications services have been provided by
regulated telecommunications common carriers. We offer voice communications
to the public for international and domestic calls using IP telephony, and
we do not operate as a licensed telecommunications common carrier in any
jurisdiction. Based on specific regulatory classifications and recent
regulatory decisions, we believe we qualify for certain exemptions from
telecommunications common carrier regulation in many of our markets.
However, the growth of IP telephony has led to close examination of its
regulatory treatment in many jurisdictions making the legal status of our
services uncertain and subject to change as a result of future regulatory
action, judicial decisions or legislation in any of the jurisdictions in
which we operate. Established regulated telecommunications carriers have
sought and may continue to seek regulatory actions to restrict the ability
of companies such as ours to provide services or to increase the cost of
providing such services. In addition, our services may be subject to
regulation if regulators distinguish phone-to- phone telephony service
using IP technologies over privately-managed networks such as our services
from integrated PC-to-PC and PC-originated voice services over the
Internet. Some regulators may decide to treat the former as regulated
common carrier services and the latter as unregulated enhanced or
information services.

Application of new regulatory restrictions or requirements to us
could increase our costs of doing business and prevent us from delivering
our services through our current arrangements. In such event, we would
consider a variety of alternative arrangements for providing our services,
including obtaining appropriate regulatory authorizations for our local
network partners or ourselves, changing our service arrangements for a
particular country or limiting our service offerings. Such regulations
could limit our service offerings, raise our costs and restrict our pricing
flexibility, and potentially limit our ability to compete effectively.
Further, regulations and laws which affect the growth of the Internet could
hinder our ability to provide our services over the Internet. For a more
detailed discussion of the regulation of IP telephony, see
"Business--Regulation of IP Telephony."

We May Not Be Able to Keep Pace with Rapid Technological Changes in the
Communications Industry

Our industry is subject to rapid technological change. We cannot
predict the effect of technological changes on our business. In addition,
widely accepted standards have not yet developed for the technologies we
use. We expect that new services and technologies will emerge in the market
in which we compete. These new services and technologies may be superior to
the services and technologies that we use, or these new services may render
our services and technologies obsolete.

To be successful, we must adapt to our rapidly changing market by
continually improving and expanding the scope of services we offer and by
developing new services and technologies to meet customer needs. Our
success will depend, in part, on our ability to license leading
technologies and respond to technological advances and emerging industry
standards on a cost-effective and timely basis. We will need to spend
significant amounts of capital to enhance and expand our services to keep
pace with changing technologies.

Risks Related to Our Relationship with Atarey

Atarey Controls All Matters Submitted to a Stockholder Vote

Atarey owns approximately 72% of the voting power and economic
interest in us. As long as Atarey continues to beneficially own shares of
capital stock representing more than 50% of the voting power of our
outstanding capital stock, Atarey will be able to exercise a controlling
influence over decisions affecting us, including:

o composition of our board of directors and, through it, our
direction and policies, including the appointment and
removal of officers
o mergers or other business combinations
o acquisitions or dispositions of assets by us
o future issuances of capital stock or other securities by us
o incurrence of debt by us
o amendments, waivers and modifications to any agreements
between us and Atarey
o payment of dividends on our capital stock
o approval of our business plans and general business
development

In addition, three of our eight directors are officers and/or
directors of Atarey, or otherwise affiliated with Atarey. As a result, the
ability of any of our other stockholders to influence the management of our
company is limited, which could have an adverse effect on the market price
of our stock.

Risks Related to Our Common Stock

A Third Party May Be Deterred from Acquiring Our Company

Atarey's majority ownership could delay, deter or prevent a third
party from attempting to acquire control of us. This may have the effect of
discouraging a third party from making a tender offer or otherwise
attempting to obtain control of us, even though such a change in ownership
would be economically beneficial to us and our stockholders.

Volatility of Our Stock Price Could Adversely Affect Our Stockholders

Since trading commenced in November 1999, the market price of our
common stock has been highly volatile and may continue to be volatile and
could be subject to wide fluctuations in response to factors such as:

o variations in our actual or anticipated quarterly operating
results or those of our competitors

o announcements by us or our competitors of technological
innovations

o introduction of new products or services by us or our
competitors

o changes in financial estimates by securities analysts

o conditions or trends in the Internet industry

o changes in the market valuations of other Internet companies

o announcements by us or our competitors of significant
acquisitions

o our entry into strategic partnerships or joint ventures

o sales of our common stock by Atarey

All of these factors are, in whole or part, beyond our control and
may materially adversely affect the market price of our common stock
regardless of our performance.

Investors may not be able to resell their shares of our common
stock following periods of volatility because of the market's adverse
reaction to such volatility. In addition, the stock market in general, and
the market for Internet-related and technology companies in particular, has
been highly volatile. We cannot assure you that our common stock will trade
at the same levels of other Internet stocks or that Internet stocks in
general will sustain their current market prices. We also cannot assure you
that our common stock will continue to be quoted on the Nasdaq National
Market if the price of our common stock falls below $1 for a period of 30
consecutive days.

We Do Not Intend to Pay Dividends

We have never declared or paid any cash dividends on our common
stock. We intend to retain any future earnings to finance our operations
and to expand our business and, therefore, do not expect to pay any cash
dividends in the foreseeable future.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS

The Securities and Exchange Commission's rule related to market
risk disclosure requires that we describe and quantify our potential losses
from market risk sensitive instruments attributable to reasonably possible
market changes. Market risk sensitive instruments include all financial or
commodity instruments and other financial instruments (such as investments
and debt) that are sensitive to future changes in interest rates, currency
exchange rates, commodity prices or other market factors. We believe our
exposure to market risk is immaterial. We currently do not invest in, or
otherwise hold, for trading or other purposes, any financial instruments
subject to market risk.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The Company's Consolidated Financial Statements required by this
Item are included in Item 14 of this report.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

None.


PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

The information required by this Item is incorporated herein by
reference to the sections entitled "Management" and "Principal
Stockholders" in the proxy statement for our 2002 Annual Meeting of
Stockholders.

ITEM 11. EXECUTIVE COMPENSATION

The information required by this Item is incorporated herein by
reference to the section entitled "Executive Compensation" in the proxy
statement for our 2002 Annual Meeting of Stockholders.

ITEM 12. SECURITY OWNERSHIP OF MANAGEMENT AND PRINCIPAL STOCKHOLDERS

The information required by this Item is incorporated herein by
reference to the section entitled "Principal Stockholders" in the proxy
statement for our 2002 Annual Meeting of Stockholders.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The information required by this Item is incorporated herein by
reference to the section entitled "Related Party Transactions" in the proxy
statement for our 2002 Annual Meeting of Stockholders.


PART IV

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

(a)(1) Financial Statements.

The Consolidated Financial Statements filed as part of this Annual
Report on Form 10-K are identified in the Index to Consolidated Financial
Statements on page F-1 hereto.

(a)(2) Financial Statement Schedules.

Financial Statement Schedules have been omitted because the
information required to be set forth therein is not applicable or is shown
on the financial statements or notes thereto.

(a)(3) Exhibits.

The following exhibits are filed herewith or are incorporated by
reference to exhibits previously filed with the Securities and Exchange
Commission.

Exhibit Description
Number
3.1.1* Form of Restated Certificate of Incorporation of deltathree, Inc.
3.1.2*** Form of Amendment to Restated Certificate of Incorporation of
deltathree, Inc.
3.2* Form of Amended and Restated By-laws of deltathree, Inc.
4.1* Specimen Certificate of Common Stock.
4.2* Specimen Certificate of Class B Common Stock.
10.1* Form of deltathree, Inc. 1999 Stock Incentive Plan.
10.2* Form of deltathree, Inc. 1999 Employee Stock Purchase Plan.
10.3* Form of deltathree, Inc. 1999 Performance Incentive Plan.
10.4* Form of deltathree, Inc. 1999 Directors' Plan.
10.5* Employment Agreement, effective as of April 1, 1999, between
Noam Bardin and deltathree, Inc.
10.6** Amendment No. 1 to Employment Agreement, effective as of June 1,
2000, between Noam Bardin and deltathree, Inc.
10.7* Employment Agreement, effective as of April 1, 1999, between
Shimmy Zimels and deltathree, Inc.
10.8** Amendment No. 1 to Employment Agreement, effective as of June
1, 2000, between Shimmy Zimels and deltathree, Inc.
10.9** Employment Agreement, effective as of August 28, 2000, between
Paul White and deltathree, Inc.


_________________

* Incorporated by reference to the Company's registration statement
on Form S-1 (Registration No. 333-86503).

** Incorporated by reference to the Company's quarterly report on
Form 10-Q filed on November 14, 2000.

*** Incorporated by reference to the Company's annual report on Form
10-K/A filed on April 30, 2001.

(b) Reports on Form 8-K.

During fiscal 2001, we filed the following reports on Form 8-K:

On May 4, 2001, we filed a current report on Form 8-K to report
under Item 5 the appointment of a new Board of Directors and an
amendment to our By-Laws to reduce the size of the Board of
Directors pursuant to actions taken by RSL COM.

On July 10, 2001, we filed a current report on Form 8-K to report
under Item 1 a change in control resulting from Atarey's purchase
of majority ownership in our company from RSL COM and appointing
new directors to our Board of Directors.

On September 24, 2001, we filed a current report on Form 8-K to
report under Item 5 that we were in the final stages of
negotiation of an Integration and Marketing Agreement with
Microsoft Corporation.




INDEPENDENT AUDITORS' REPORT


To the stockholders of Deltathree, Inc.

We have audited the accompanying consolidated balance sheets of
Deltathree, Inc. ("the Company") as of December 31, 2001 and 2000 and the
related consolidated statements of operations, changes in stockholders'
equity and cash flows for each of the three years in the period ended
December 31, 2001. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to
express an opinion on these consolidated financial statements based on our
audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used
and significant estimates made by management, as well as evaluating the
overall financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly,
in all material respects, the consolidated financial position of the
Company as of December 31, 2001 and 2000, and the consolidated results of
its operations and cash flows for each of the three years in the period
ended December 31, 2001 in conformity with generally accepted accounting
principles.



Brightman Almagor & Co.
Certified Public Accountants
A member of Deloitte & Touche

Tel Aviv, Israel
February 11, 2002



DELTATHREE, INC.
CONSOLIDATED BALANCE SHEETS





December 31,
2001 2000
---- ----
(US$ in thousands)

ASSETS
Current assets:

Cash and cash equivalents $13,583 $ 20,857
Short-term investments 14,192 30,542
Accounts receivable, net (Note 3) 1,092 3,245
Due from affiliates (Note 4) -- 331
Prepaid expenses and other current assets (Note 5) 1,264 2,084
------- --------

Total current assets 30,131 57,059
------- --------

Property and equipment:
Telecommunications equipment 14,068 14,686
Furniture, fixtures and other 591 2,169
Leasehold improvements 4,631 4,927
Computers hardware & software 6,751 4,579

26,041 26,361
Less accumulated depreciation (10,406) (4,091)
------- --------
Property and equipment, net 15,635 22,270
------- --------

Goodwill, net (Note 6) -- 6,425
------- --------

Deposits 103 415
------- --------

Total assets $45,869 $ 86,169
------- --------


LIABILITIES AND STOCKHOLDER'S EQUITY

Current liabilities:
Accounts payable $3,417 5,236 $
Due to affiliates (Note 4) -- 2,721
Deferred revenues 505 251
Other current liabilities (Note 7) 2,835 5,313
------- --------

Total current liabilities 6,757 13,521
------- --------

Long-term liabilities:
Severance pay obligations (Note 8) 191 169
------- --------

Total liabilities 6,948 13,690
------- --------
Commitments and contingencies (Note 9)

Stockholder's equity: (Note 10)
Share capital:
Class A Common stock, - par value
$0.001; authorized 200,000,000 shares; issued
and outstanding 29,143,206 at December 31, 2001;
9,465,099 at December 31, 2000 29 9
Class B Common stock - par value $0.001;
authorized 200,000,000; issued and outstanding
19,569,459 at December 31, 2000 -- 20
Preferred stock, par value $0.001;
authorized 25,000,000 shares; no shares
issued and outstanding at December 31, 2001 and 2000
Additional paid-in capital 166,801 166,733
Deferred compensation (270) (2,588)
Accumulated deficit (127,429) (91,695)
------- --------
39,131 72,479
Treasury stock at cost: 257,600 shares of Class
A Common Stock as of December 31, 2001 (210) --
------- --------

Total stockholder's equity 38,921 72,479
------- --------
Total liabilities and stockholder's equity $45,869 $ 86,169
======= ========

The accompanying notes are an integral part of these financial statements






DELTATHREE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS

Year ended December 31,
-----------------------
2001 2000 1999
---- ---- ----
(US$ in thousands, except share and
per share data)

Revenues: (Note 15)

Affiliates $ 1,669 $ 13,977 $ 7,431
Non-affiliates 13,991 16,399 3,621
-------- --------- --------
Total revenues 15,660 30,376 11,052

Costs and operating expenses:
Cost of revenues, net 13,486 24,932 9,723
Research and development expenses, net (Note 11) 5,648 6,625 1,233
Selling and marketing expenses 7,800 20,548 7,403
General and administrative expenses (exclusive of
non-cash compensation expense shown below) 6,982 6,694 2,754
Non-cash compensation expense 825 6,331 19,116
Depreciation and amortization 8,996 7,919 3,721
Write-down of fixed assets (Note 12) 1,003 -- --
Expenses due to cancellation of agreement with a supplier
(including non-cash compensation of $1,493) (Note 10b) 3,628 -- --
Impairment of goodwill (Note 13) 4,151 8,905 --
-------- --------- --------
Total costs and operating expenses 52,519 81,954 43,950
-------- --------- --------

Loss from operations (36,859) (51,578) (32,898)

Interest income (expense), net 1,677 3,632 (873)
-------- --------- --------
Loss before income taxes (35,182) (47,946) (33,771)

Income taxes (Note 14) 552 311 --
-------- --------- --------
Net loss $(35,734) $(48,257) $(33,771)
======== ========= ========
Net loss per share -
basic and diluted (in US$) $ (1.23) $ (1.67) $ (1.65)
-------- --------- --------

Weighted average number of shares outstanding -
basic and diluted (number of shares) 29,035,319 28,832,708 20,418,457
========== =========== ==========

The accompanying notes are an integral part of these financial statements






DELTATHREE, INC.
STATEMENTS OF CHANGES IN STOCKHOLDER'S EQUITY
(US$ in thousands, except share data)


Class A Class B Receivable
Common stock Common stock Additional for
------------ ------------ paid-in capital Deferred
Shares Amount Shares Amount capital deficit compensation
------ ------ ------ ------ ------- ------- ------------



Balance at January 1 , 1999 -- -- 19,569,459 $ 20 $ 23,084 $ -- $ (1,066)

Issuance of common stock in initial
public offering, net of expenses
(including over-allotment of 6,900,000 7 93,855
shares)
Issue of shares to employees 748,288 1 232 (232)
Issue of shares to Yahoo! 183,901 * 1,000 (1,000)
Issue of shares to CNET 1,085,943 1 11,000
Deferred compensation expense
to Yahoo! and CNET 4,397 (4,397)
Deferred compensation expense
to employees 24,323 (24,323)
Amortization of deferred
compensation expense 19,116
Net loss
---------- ----- ----------- ------ -------- -------- ---------
Balance at December 31, 1999 8,918,132 9 19,569,459 20 157,891 (1,232) (10,670)

Issuance of common stock in purchase
of subsidiary 227,738 10,500
Issuance expenses (272)
Cancellation of options (2,751) 2,751
Exercise of employee options 319,229 1,365 232
Offset of receivable against debt
to Yahoo! for services rendered 1,000
Amortization of deferred
compensation expense 5,331
Net loss
---------- ----- ----------- ------ -------- -------- ---------
Balance at December 31, 2000 9,465,099 9 19,569,459 20 166,733 -- (2,588)

Exercise of employee options 108,648 68
Purchase of treasury stock (257,600)
Cancellation of class B shares 19,569,459 20 (19,569,459) (20)
Amortization of deferred
compensation expense 2,318
Net loss
---------- ------ ----------- ------ -------- -------- ---------
Balance at December 31, 2001 28,885,606 29 $ -- -- $166,801 $ -- $ (270)
========== ====== =========== ====== ======== ======== =========







(Statements of Changes in Stockholders' Equity -- Continued)


Total
Treasury Stockholders
stock Accumulated Equity
(at cost) deficit (deficiency)
--------- ------- ------------


Balance at January 1 , 1999 $ -- $(9,667) $ 12,371

Issuance of common stock in initial
public offering, net of expenses
(including over-allotment of 93,862
shares)
Issue of shares to employees 1
Issue of shares to Yahoo! *
Issue of shares to CNET 11,001
Deferred compensation expense
to Yahoo! and CNET --
Deferred compensation expense
to employees --
Amortization of deferred
compensation expense 19,116
Net loss (33,771) (33,771)
-------- ---------- ----------
Balance at December 31, 1999 -- (43,438) 102,580

Issuance of common stock in purchase
of subsidiary 10,500
Issuance expenses (272)
Cancellation of options --
Exercise of employee options 1,597
Offset of receivable against debt
to Yahoo! for services rendered 1,000
Amortization of deferred
compensation expense 5,331
Net loss (48,257) (48,257)
-------- ---------- ----------
Balance at December 31, 2000 -- (91,695) 72,479


Exercise of employee options
Purchase of treasury stock (210) (210)
Cancellation of class B shares
Amortization of deferred
compensation expense 2,318
Net loss (35,734) (35,734)
-------- ---------- ----------
Balance at December 31, 2001 $ (210) $(127,429) $ 38,921
======== ========== ==========

* - Less than US$ 1 thousand.


The accompanying notes are an integral part of these financial statements








DELTATHREE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS


Year ended December 31,
2001 2000 1999
---- ---- ----
(US$ in thousands)
------------------

Cash flows from operating activities:

Net loss $ (35,734) $ (48,257) $ (33,771)
Adjustments to reconcile net loss to net cash used
in operating activities:
Depreciation and amortization 8,996 7,919 3,721
Write-down of fixed assets 1,003 -- --
Impairment of goodwill 4,151 8,905 --
Amortization of deferred compensation 2,318 6,331 19,116
Capital gain, net 1 11 --
Minority interest -- -- (21)
Increase (decrease) in liability for severance pay, net 22 (39) (25)
Provision for losses on accounts receivable 1,104 199 (275)
Changes in assets and liabilities:
Decrease (increase) in accounts receivable 1,272 (2,541) (85)
Increase in other current assets and
due from affiliates 928 (168) (2,037)
Increase (decrease) in accounts payable (3,053) 2,656 (793)
Decrease in deferred revenues 254 (287) (1,072)
Increase in current liabilities and due to
affiliates (3,965) 1,860 5,467
---------- ----------- ----------
13,028 24,846 23,996
---------- ----------- ----------
Net cash used in operating activities (22,703) (23,411) (9,775)
---------- ----------- ----------
Cash flows from investing activities:
Purchase of property and equipment (1,558) (13,585) (2,848)
Proceeds from sale of property and equipment 467 54 --
Proceeds from sale of investment -- 150 --
Increase (decrease) in deposits (30) 385 (685)
---------- ----------- ----------
Net cash used in investing activities (1,121) (12,996) (3,533)
---------- ----------- ----------
Cash flows from financing activities:
Decrease (increase) in short-term investments 16,692 (19,266) (11,276)
Proceeds from issuance of capital stock -- -- 104,864
Proceeds (repayment) of short-term debt
from affiliates -- (14,752) 8,320
Expenses relating to share issuance in 1999 -- (272) --
Purchase of treasury stock (210) -- --
Proceeds from exercise of employee options 68 1,597 --
---------- ----------- ----------
Net cash provided by (used in) financing activities 16,550 (32,693) 101,908
---------- ----------- ----------
Increase (decrease) in cash and cash equivalents (7,274) (69,100) 88,600
Cash and cash equivalents at beginning of year 20,857 89,957 1,357
---------- ----------- ----------
Cash and cash equivalents at end of year $ 13,583 20,857 $ 89,957
========== =========== ==========
Supplemental disclosures of
cash flow information:
Cash paid for:
Interest $ -- $ 1,332 $ --
Taxes $ 552 $ 311 $ --

Supplemental schedule of
non cash investing and
financing activities:
Assets purchased in exchange for a receivable $ -- $ 2,500 $ --
Assets purchased in exchange for shares (See Note 13) $ -- $ 10,500 $ --


The accompanying notes are an integral part of these financial statements





DELTATHREE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1 - The Company


Deltathree, Inc. (the "Company"), a Delaware corporation, is a global
provider of integrated Voice over Internet Protocol (VoIP) telephony
services. The Company was founded in 1996 to capitalize on the growth
of the Internet as a communication tool by commercially offering
Internet Protocol (IP) telephony services. IP telephony is the real
time transmission of voice communications in the form of digitized
"packets" of information over the public Internet or a private network,
similar to the way in which e-mail and other data is transmitted. The
Company's business currently includes the transmission of voice and
data traffic for communications carriers, the provision of enhanced
Web-based and other communications services to individual consumers and
the provision of a total "Hosted Communication Solution" that enables
corporate customers and service providers to offer private label
telecommunications to their customer bases

Prior to 1999, the Company's business primarily consisted of carrying
and transmitting traffic for communications carriers over its network.
Beginning in 1999, the Company began to diversify its offering by
layering enhanced IP telephony services over its privately managed
network. These enhanced services were targeted at consumers and were
primarily accessible through a consumer-oriented Web site. During 2000,
the Company began offering services on a co-branded or private-label
basis to service providers and other businesses to assist them in
diversifying their product offerings to their customer bases.

The Company's headquarters are located in New York City, New York. The
Company's research and development activities are conducted in Israel by
its wholly owned subsidiary, DeltaThree Israel Ltd. ("Delta Ltd.").

Prior to its November 1999 initial public offering, the Company was a
wholly owned subsidiary of RSL Communications Ltd., a multinational
telecommunications company. RSL Communications Ltd. and its
subsidiaries and affiliates (excluding the Company) are collectively
referred to herein as "RSL COM" or "affiliates." Approximately 11%, 46
% and 67% of the Company's revenues for the year ended December 31,
2001, 2000 and 1999, respectively, were derived from transactions with
RSL COM.

Since the Company's initial public offering in November 1999, RSL COM
owned 100% of the outstanding Class B common stock (which carried ten
votes per share), which represented approximately 95.5% of the combined
voting power of all the Company's outstanding capital stock and
approximately 67.4% of the economic interest in the Company. In March
2001, RSL COM commenced insolvency proceedings in Bermuda. On June 28,
2001, RSL COM entered into a share purchase agreement with Atarey
Hasharon Chevra Lepituach Vehashkaot Benadlan (1991) Ltd., an Israeli
company ("Atarey"), to sell to Atarey all of the Class B Common Stock of
the Company owned by RSL COM. On June 29, 2001, the sale was
consummated, and all of RSL COM's shares of Class B Common Stock, were
automatically converted into shares of Class A Common Stock, which
carry one vote per share. As a result of the sales transaction, Atarey
is now the majority stockholder of the Company, owning approximately
72% of the outstanding Class A Common Stock of the Company.
Simultaneously with the completion of the transaction on June 29, 2001,
all of the contracts and inter-company agreements by and between RSL
COM (and all of its subsidiaries) and the Company were terminated. At
the same time, the Company severed its reliance on RSL COM as its
primary pan-European wholesale telecommunications carrier, and shifted
to other service providers.


Note 2 - Summary of significant accounting policies

a. Principles of consolidation and basis of presentation

The consolidated financial statements include the accounts of
Deltathree, Inc. and its subsidiary. All significant inter-company
accounts and transactions have been eliminated in consolidation.

b. Use of estimates

The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates
and assumptions, primarily for allowances for doubtful accounts
receivable and the useful lives of fixed assets and intangible
assets, that affect the reported amounts of assets and liabilities
and disclosure of contingent assets and liabilities at the date of
the financial statements, and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ
from those estimates.

c. Cash and cash equivalents

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


Note 2 - Summary of significant accounting policies (contd.)

d. Revenue recognition and deferred revenue

The Company records revenue from Internet telephony services based on
minutes (or fractions thereof) of customer usage. The Company records
payments received in advance for prepaid services and services to be
supplied under contractual agreements as deferred revenue until such
related services are provided.

e. Cost of revenues

Cost of revenues is comprised primarily of access, transmission and
termination costs based on actual minutes in addition to monthly
circuit lease costs and is net of reimbursements from vendors.

f. Research and development expenses

Research and development expenses, net of reimbursements from
vendors, are expensed as incurred.

g. Advertising expenses

Advertising expenses are expensed as incurred. For the years ended
December 31, 2001, 2000 and 1999, advertising expenses were
approximately $ 7,000 $ 170,000 and $ 87,000, respectively.

h. Allowance for doubtful accounts

The Company estimates the allowance for doubtful accounts by
reviewing the status of significant past due receivables and
analyzing historical bad debt trends and the Company then reduces
accounts receivables by such allowance for doubtful accounts to
expected net realizable value.

i. Property and equipment and related depreciation

Property and equipment are stated at cost. Depreciation is calculated
using the straight-line method over the estimated useful lives of the
depreciable assets, which range from two to five years. Improvements
are capitalized, while repair and maintenance costs are charged to
operations as incurred.

j. Goodwill and related amortization

Goodwill represents the excess of cost over the fair value of the
Company's net assets, which were "pushed down" as a result of RSL COM's
acquisitions of the Company in 1997 and 1998, and was amortized using
the straight-line method over five years.

k. Impairment of long-lived assets

In accordance with SFAS 121, the Company's long-lived assets are
reviewed for impairment on a quarterly basis and whenever events or
changes in circumstances occur indicating that the net carrying
amount may not be recoverable. The Company reviews for impairment by
comparing the carrying value of the long-lived asset to the estimated
undiscounted future cash flows expected to result from the use of the
long-lived assets (and their eventual disposition). If the sum of the
expected undiscounted future cash flows is less than the carrying
amount of assets, the Company would recognize an impairment loss. The
impairment loss, if determined to be necessary, would be measured as
the amount by which the carrying amount of the long-lived asset
exceeds the fair value of the long-lived asset based on estimated
future discounted cash flows.

l. Income taxes

The Company accounts for income taxes under the provisions of
Statement of Financial Accounting Standards ("SFAS") No. 109,
"Accounting for Income Taxes". SFAS No. 109 establishes financial
accounting and reporting standards for the effect of income taxes
that result from activities during the current and preceding years.
SFAS No. 109 requires an asset and liability approach for financial
reporting for income taxes. The Company's foreign subsidiary files
separate income tax returns in the jurisdiction of their operations.

m. Net loss per share

Basic and diluted net loss per share have been computed in accordance
with SFAS No. 128, "Earnings Per Share", using the weighted average
number of common stock outstanding. Diluted earnings per share give
effect to all potential dilutive issuances of ordinary shares that
were outstanding during the period. A total of -168,212, 832,600 and
388,099 incremental shares were excluded from the calculation of
diluted net loss per ordinary share for 2001, 2000 and 1999
respectively.

n. Concentration of credit risk

The Company is subject to concentrations of credit risk, which
consist principally of trade accounts receivable and cash and cash
equivalents.

The Company maintains its cash with various financial institutions.
The Company performs periodic evaluations of the relative credit
standing of these institutions.

The majority of the Company's non-carrier customers prepay for their
services. The Company establishes an allowance for doubtful accounts
based upon factors surrounding the credit risk of customers,
historical trends and other information.

o. Fair value of financial instruments

The carrying amounts of cash and cash equivalents, accounts and other
receivables and accounts payable approximate fair value due to the
short-term maturity of these instruments. The carrying amounts of
outstanding borrowings approximate fair value due to their short-term
interest rate.

p. Derivatives

The Company adopted Statement of Financial Accounting Standard (SFAS)
No. 133, "Accounting for Derivative Instruments and Hedging
Activities," as amended, at the beginning of its fiscal year 2001.
The standard requires the Company to recognize all derivatives on the
balance sheet at fair value. Derivatives that are not hedges must be
adjusted to fair value through the statement of operations. If the
derivative is a hedge, depending on the nature of the hedge, changes
in the fair value of derivatives will either be offset against the
change in fair value of the hedged assets, liabilities or firm
commitments through earnings, or recognized in other comprehensive
income (loss) until the hedged item is recognized in earnings. The
ineffective portion of a derivative's change in fair value will be
immediately recognized in earnings. The Company's use of derivative
financial instruments is discussed in Note 5 to these Notes to the
Consolidated Financial Statements. The adoption of SFAS No. 133 did
not have a material effect on the financial statements of the
Company.

q. Effects of recently issued accounting standards

In July 2001, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standards No. 141 ("SFAS
141"), "Business Combinations." SFAS 141 requires the purchase method
of accounting for business combinations initiated after June 30, 2001
and eliminates the pooling-of-interests method. The Company does not
believe that the adoption of SFAS 141 will have a significant impact
on its financial statements.

In July 2001, the FASB issued Statement of Financial Accounting
Standards No. 142 ("SFAS 142"), "Goodwill and Other Intangible
Assets", which is effective January 1, 2002. SFAS 142 requires, among
other things, the discontinuance of goodwill amortization. In
addition, the standard includes provisions for the reclassification
of certain existing recognized intangibles as goodwill, reassessment
of the useful lives of existing recognized intangibles,
reclassification of certain intangibles out of previously reported
goodwill and the identification of reporting units for purposes of
assessing potential future impairments of goodwill. SFAS 142 also
requires the Company to complete a transitional goodwill impairment
test six months from the date of adoption. The Company does not
believe that the adoption of SFAS 142 will have a significant impact
on its financial statements.

In June 2001, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 143, "Accounting for
Asset Retirement Obligations" ("FAS 143"), which is effective for
years beginning after June 15, 2002, which will be the Company's
fiscal year 2003. FAS 143 addresses legal obligations associated with
the retirement of tangible long-lived assets that result from the
acquisition, construction, development or normal operation of a
long-lived asset. The standard requires that the fair value of a
liability for an asset retirement obligation be recognized in the
period in which it is incurred if a reasonable estimate of fair value
can be made. Any associated asset retirement costs are to be
capitalized as part of the carrying amount of the long-lived asset
and expensed over the life of the asset. The Company does not believe
that the adoption of SFAS 143 will have a significant impact on its
financial statements.

In August 2001, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 144, Accounting for
the Impairment or Disposal of Long-Lived Assets (FAS 144), which
addresses financial accounting and reporting for the impairment or
disposal of long-lived assets and supersedes SFAS No. 121, Accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed Of, and the accounting and reporting provisions of APB
Opinion No. 30, Reporting the Results of Operations, for a disposal
of a segment of a business. FAS 144 is effective for fiscal years
beginning after December 15, 2001, with earlier application
encouraged. The Company has not yet determined what the effect of FAS
144 will be on the earnings and financial position of the Company.

r. Stock-based compensation

The Company accounts for employee stock compensation arrangements in
accordance with the provisions of Financial Interpretation No. 44
"Accounting for Certain Transactions involving Stock Compensation"
and Accounting Principles Board ("APB") Opinion No. 25, "Accounting
for Stock Issued to Employees." and complies with the disclosure
provisions of SFAS No. 123 "Accounting for Stock-Based
Compensation,". Under APB No. 25, stock compensation is based on the
difference, if any, on the grant date, between the estimated fair
value of the Company's common stock and the exercise price.

s. Reclassifications

Certain previously reported amounts have been reclassified to conform
with the 2001 presentation.


Note 3 - Accounts receivable, net

Accounts receivable are stated net of an allowance for doubtful accounts of
$ 1,356,000 and $ 251,000 at December 31, 2001 and 2000, respectively.


Note 4 - Due from/to affiliates

The balances due from and due to affiliates as at December 31, 2000 were
for services rendered by and to the Company and were non-interest bearing.

Note 5 - Prepaid expenses and other current assets

Prepaid expenses and other current assets consist of the following:




December 31,
2001 2000
---- ----
(US$ in thousands)



Government of Israel (VAT refund and other) $ 57 $ 59
Deposits with suppliers 380 189
Prepaid expenses 714 1,141
Other 113 695
------- --------
Total prepaid expenses and other current assets $ 1,264 $ 2,084
======= ========



Note 6 - Goodwill, net

Goodwill consists of the following:




December 31,
2001 2000
---- ----
(US$ in thousands)


Goodwill from acquisition of the Company by RSL COM

(see Note 1 & 13) $ -- $15,158


Less - accumulated amortization -- (8,733)
------- --------
Total goodwill, net $ -- $ 6,425
======= ========



Note 7 - Other current liabilities



Other current liabilities consist of the following:
December 31,
2001 2000
---- ----
(US$ in thousands)


Accrued expenses $ 1,143 $ 3,461
Employees and related expenses 1,582 1,099
Other 110 753
------- --------
Total other current liabilities $ 2,835 $ 5,313
------- --------




Note 8 - Severance pay obligations

Delta Three Ltd., the Company's Israeli subsidiary, is subject to certain
Israeli law and labor agreements that determine the obligations of
Delta Three Ltd. to make severance payments to dismissed employees and to
employees leaving the Company under certain other circumstances. The
obligation for severance pay benefits, as determined by Israeli law, is
based upon length of service and the employee's most recent salary. This
obligation is partially funded through regular deposits made by Delta Three
Ltd. into unaffiliated companies for managers' insurance policies. Amounts
funded are controlled by the fund trustees and insurance companies and are
not under the control and management of Delta Three Ltd.

Expenses relating to employee termination benefits were $ 128,000, $
101,000 and $ 42,000 for the years ended December 31, 2001, 2000 and 1999,
respectively.

Note 9 - Commitments and contingencies

a. Services agreement with RSL COM

In July 1997, the Company entered into a three-year services agreement
with RSL COM which was subsequently amended and restated as of
September 1999 to extend to September 2004. Pursuant to this agreement,
RSL COM was required to use its reasonable best efforts to provide the
Company with certain office and equipment space and to assist the
Company in obtaining Internet, frame-relay and dedicated lines from
third parties. In addition, RSL COM was required under the agreement to
provide the Company with various communications services at rates set
forth in the agreement. The agreement also provided that the Company
was required, at RSL COM's request, to use up to 50% of its network
capacity to route RSL COM's international telecommunications traffic at
rates set forth in the agreement.

In June 2001, RSL COM sold its interests in the Company and all
inter-company agreements, including the service agreement were
terminated effective that date (see Note 1).

b. Other marketing and cooperation agreements

The Company has entered into marketing and cooperation agreements with
various other companies that maintain sites on the Web. Pursuant to
certain of these agreements, the Company is obligated to pay
commissions based on revenues derived from such Web links.

c. Indentures governing debt of RSL COM

The Company was subject to covenants by reason of its status as a
restricted subsidiary of RSL COM under the indentures governing a
substantial amount of RSL COM's debt. In June 2001, RSL COM sold its
interest in the Company and the restrictions on the Company expired
(see Note 1).

d. Lease commitments

The Company leases offices in New York City for the headquarters of
its United States operation with an initial cost of approximately
$650,000 increasing annually to $870,000 during the final year of the
lease. The lease extends until July 2010 with an option to extend the
lease for an additional five years.

The Company leased office space from RSL COM in New York at an annual
cost of $96,000. The lease was terminated in June 2000.

In addition, the Company leases offices in Israel at an annual cost of
$292,000. The lease term extends until February 2003, with an option
to extend the lease for an additional five years.

e. Legal proceedings

On October 8, 1999, Aerotel, Ltd. and Aerotel U.S.A. commenced a suit
against the Company, RSL COM and an RSL COM subsidiary in the United
States District Court for the Southern District of New York. Aerotel
alleges that the Company is infringing on a patent issued to Aerotel in
November 1987 by making, using, selling and offering for sale prepaid
telephone card products in the United States. Aerotel seeks an
injunction to stop the Company and its co-defendant from using the
technology covered by this patent, monetary damages in an unspecified
amount and reimbursement of attorneys' fees. The Company has answered
the complaint, and the parties are currently still engaged in a
pre-trial discovery. As the Company continues to evaluate these claims,
the Company believes that it has meritorious defenses to the claim and
it intends to defend the lawsuit vigorously. However, the outcome of
the litigation is inherently unpredictable and an unfavorable result
may have a material adverse effect on the Company's business, financial
condition and results of operations. Regardless of the ultimate
outcome, the litigation could result in substantial expenses to the
Company and significant diversion of efforts by the Company's
managerial and other personnel.

The Company, as well as certain of its former officers and directors,
has been named as a defendant in a number of purported securities class
actions in Federal District Court for the Southern District of New
York, arising out of the Company's initial public offering in November
1999 (the "IPO"). Various underwriters of the IPO also are named as
defendants in the actions. The complaints allege, among other things,
that the registration statement and prospectus filed with the
Securities and Exchange Commission for purposes of the IPO were false
and misleading because they failed to disclose that the underwriters
allegedly (i) solicited and received commissions from certain investors
in exchange for allocating to them shares of the Company stock in
connection with the IPO and (ii) entered into agreements with their
customers to allocate such stock to those customers in exchange for the
customers agreeing to purchase additional Company shares in the
aftermarket at predetermined prices. On August 8, 2001, the court
ordered that these actions, along with hundreds of IPO allocation cases
against other issuers, be transferred to Judge Scheindlin for
coordinated pre-trial proceedings. By order dated October 12, 2001,
Judge Scheindlin adjourned all defendants' time to respond to the
complaints until further order of the Court. These cases remain at a
preliminary stage and no discovery proceedings have taken place. The
Company believes that the claims asserted against it in these cases are
without merit and intends to defend vigorously against them.

Note 10 - Stockholders' equity

a. Share capital

Following the Company's initial public offering, effective December
1999, the Company's Class A common stock is listed on the NASDAQ
National Market. Holders of the Class A common stock are
entitled to one vote per share.

The Company also issued shares of Class B common stock to RSL COM,
(which carried ten votes per share). Each share of Class B common stock
was convertible into one share of Class A common stock at any time.

In June 2001, Atarey acquired the controlling interest in the Company.
As part of the transaction all shares of Class B common stock were
automatically converted to shares of Class A common stock (see Note 1).

b. CNET transaction

On October 20, 1999, the Company issued to CNET Investments, Inc.
("CNET") 1,085,943 shares of common stock and a warrant to purchase
466,028 shares of Class A common stock at an exercise price of $ 19.31
per share, or approximately $ 11.0 million in the aggregate, which was
received in cash by the Company upon the issuance of the shares. The
Company recorded approximately $ 2.7 million of deferred compensation
expense in 1999 related to the issuance of the shares representing the
difference between each of the purchase price of the Class A common
stock as compared to the initial public offering price of the Class A
common stock and the issuance of the warrant (using the Black-Scholes
option pricing model for determining the fair value of the warrant).
Amortization of the deferred compensation for the year ended December
31, 2000 amounted to $ 1,062,000. On July 6, 2001, CNET entered into a
share purchase agreement with Atarey (the "CNET Purchase Agreement").
Under the CNET Purchase Agreement, Atarey purchased all of the shares
owned by CNET in accordance with the "tag-along" rights granted to CNET
pursuant to their purchase.

In addition, the Company entered into a binding development and
promotion agreement with CNET in September 1999, which was amended
effective July 1, 2000, whereby CNET provided various promotions to the
Company to assist it in promoting its PC-to-Phone product and related
services. In consideration for these services, the Company was
obligated to pay CNET a total of $11,000,000. In May 2001 the agreement
with CNET was terminated. The Company incurred a one-time expense of
approximately $3,628,000 resulting from the cancellation of the
agreement. Expenses included a payment to terminate the contract of
$1,750,000, the acceleration of the amortization of compensation
charges deferred in previous years and other related expenses.

c. Stock Options

In April 1999, the Company agreed to grant options to purchase an
aggregate of 1,076,761 shares of the Company's Class A common stock at
an exercise price of $ 5.11 to executive officers of the Company. Such
options vest over a three-year period from the date of grant and are
exercisable for a period of seven years from the date of grant.

The Company recorded deferred compensation related to the stock options
of approximately $ 9,930,000 as of December 31, 1999, representing the
difference between the exercise price and the initial offering price of
$ 15. Such amount is included as a reduction of stockholders' equity
and is being amortized by charges to operations over the three-year
vesting period.

In November 1999, the Company adopted the 1999 Stock Incentive Plan
("the Plan"). Under the Plan, 4,000,000 shares of Class A were reserved
for issuance upon exercise of awards to be granted. In addition, the
Company's compensation committee may grant both incentive and
non-incentive stock options for shares of Class A common stock of the
Company. The options generally have a term of seven years and become
exercisable in three equal installments commencing on the first
anniversary of the date of the grant. The purchase price per share
payable upon exercise of an option is no less than the fair market
value of the share at the date of grant. As of December 31, 2001,
options to purchase 2,591,205 shares of Class A were outstanding with
exercise prices ranging between $ 0.004 and $15.00 per share.

A summary of the status of the Company's stock option plans as of
December 31, 2001 and 2000 and changes during the years then ended, is
presented below:




December 31, 2001 December 31, 2000 December 31, 1999
Weighted Weighted Weighted
average average average
Shares Exercise price Shares Exercise price Shares Exercise price
------ -------------- ------ -------------- ------ --------------


Options outstanding at
beginning of year 1,626,843 8.72 1,952,537 $ 7.54 -- $ --
Granted during the year 1,978,416 3.68 475,000 7.85 1,952,537 7.54
Exercised during the year 50,961 0.004 319,229 4.10 -- --
Forfeited during the year 963,093 8.77 481,465 6.54 -- --
---------- ------- ---------- ------ ---------- --------
Outstanding at end of year 2,591,205 4.24 1,626,843 8.72 1,952,537 7.54
========== ======= ========== ====== ========== ========
Weighted average fair value of
options granted during the year $ 2.39 $ 4.00 $ 9.00
========== ========== ==========


If compensation cost for the Company's stock options and restricted
units had been determined based on fair value at the grant date in
accordance with SFAS No. 123, the Company's pro forma net loss and pro
forma basic and diluted net loss per share would have been as follows:




December 31,
2001 2000 1999
---- ---- ----
(US$ in thousands)

Net loss:

As reported $ (35,734) $ (48,257) $ (33,771)
Pro forma $ (38,343) $ (50,453) $ (34,357)

Net loss per share - basic and diluted:
As reported $ (1.23) $ (1.67) $ (1.65)
Pro forma $ (1.35) $ (1.75) $ (1.68)



For the purpose of presenting pro forma information required under SFAS
123, the fair value option grant has been estimated on the date of
grant using the minimum value method for grants through the period of
November 22, 1999 (the date of the Company's initial public offering)
and the Black-Scholes option pricing model for grants made after the
Company became a public entity. The following assumptions were used for
the years 2001, 2000 and 1999: dividend yield of 0.00% for all periods;
risk-free interest rate of 6% for all periods; an expected life of
3-years for all periods; a volatility rate of 100%, 70% and 70%
respectively.

Because the determination of the fair value of all options granted
after the Company became a public entity included an expected
volatility factor, in addition to the factors described in the
preceding paragraph and since additional option grants are expected to
be made each year, the above pro forma disclosures are not
representative of the pro forma effects of reported net income for
future years.

e. Employee Stock Purchase Plan

During 1999, the Board of Directors approved an Employee Stock Purchase
Plan (the "ESPP"), effective beginning November 23, 1999. Under the
ESPP, the maximum number of shares to be made available under the ESPP
is 5% of the number of outstanding shares.

All full-time employees who have been employed by the Company for at
least one calendar quarter are eligible to participate in the ESPP.
Employee stock purchases are made through payroll deductions. Under the
terms of the ESPP, employees may not deduct an amount that exceeds
$25,000 in total value of stock in any one year. The purchase price of
the stock will be the lower of 85% of the fair market value on the
first trading day of the offering period or the last trading day of the
purchase period. The ESPP shall terminate upon the first to occur of
(i) December 31, 2009 or (ii) the date on which the ESPP is terminated
by the Board of Directors. During 2001, there were aggregate purchases
of 57,687 shares under the ESPP.


Note 11 - Research and development expenses, net

Research and development expenses consist of the following:



Year ended December 31,
2001 2000 1999
---- ---- ----
(US$ in thousands)
------------------

Salaries and related expenses $ 3,255 $ 5,388 $ 1,735
Consulting and advisory fees 655 -- 225
Travel 126 344 125
Other 1,612 893 253
-------- -------- -------
5,648 6,625 2,338

Less - reimbursement by Ericsson -- -- (1,105)
-------- -------- -------
Total research and development expenses $ 5,648 $ 6,625 $ 1,233
======== ======== =======




Note 12 - Write-down of fixed assets

The Company incurred a one-time expense of approximately $1,003,000 from
the write down of equipment that was purchased in previous periods to
support contracts and inter-company agreements between RSL COM and the
Company that were cancelled at the time of RSL COM's sale of their majority
ownership interest in the Company to Atarey in accordance with FAS 121
(See Note 1).

Note 13 - Impairment of goodwill

During the year 2001, the telecommunications industries experienced
significant and rapid contraction, which was accompanied by a decrease in
revenues. In the fourth quarter of fiscal 2001 the Company assessed the
value and future benefit of its goodwill pursuant to Accounting Principles
Board Opinion No. 17, Intangible Assets ("APB 17") and consequently made a
full write-off of the goodwill in the amount of $4,151,000.

In February 2000, the Company issued 227,738 shares of Class A common
stock, at an average market price of $46 per share, amounting to $
10,500,000 in the aggregate to acquire all the outstanding shares of
YourDay.com, Inc. In November 2000, the Company decided to de-emphasize its
consumer business, and communications portal, and focus on generating
revenues primarily through sales of its Hosted Communications Solution. As
a result, the Yourday.com technology was not incorporated into the
Company's offerings. Accordingly, the Company made a full write-off of the
Yourday.com technology in the amount of $ 8,905,000.


DELTATHREE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 14 - Income taxes

a. Tax loss carryforwards

As of December 31, 2001, the Company had net operating loss
carryforwards generated in the U.S. and Israel of approximately
$124,859,000 and $ 3,447,000, respectively. The Company's U.S. net
operating loss carryforwards will expire at various dates beginning in
2011 if not utilized. In addition, a portion of those net operating
loss carryforwards could be subject to limitation due to changes in
ownership of the Company. The Company's net operating losses generated
in Israel may be carried forward indefinitely.

b. In accordance with SFAS No. 109, the components of deferred income taxes
are as follows:




December 31,
2001 2000 1999
---- ---- ----
(US$ in thousands)


Net operating losses carryforwards $ 46,190 $ 34,822 $ 14,403
Less valuation allowance (46,190) (34,822) (14,403)
---------- ----------- ----------
Net deferred tax assets $ -- $ -- $ --
========== =========== ===========



As of December 31, 2001, 2000 and 1999, a valuation allowance of
$46,190,000, $34,822,000 and $ 14,403,000 respectively, is provided as
the realization of the deferred tax assets are not assured.

Note 15 - Segment reporting, geographical information and major customers

The Company operates in a single industry segment, IP communications
services, and makes business decisions and allocates resources accordingly.



December 31,
2001 2000 1999
---- ---- ----
(US$ in thousands)
------------------

Revenues by geographical location:

United States $ 9,123 $ 20,862 $ 7,521
Europe 2,654 5,289 1,326
Argentina -- 113
Far east 1,413 3,162 1,174
Other 2,470 1,063 918
-------- -------- --------
Total revenues $15,660 $ 30,376 $ 11,052
-------- -------- --------
Revenues from major customers:
Affiliates $1,669 $ 13,977 $ 7,431
======== ======== ========





December 31,
2001 2000
---- ----
(US$ in thousands)

Long-lived assets:

United States $ 11,864 $14,972
Israel 1,797 3,251
Europe 1,426 2,747
Other 548 1,300
-------- ------
Total long-lived assets $ 15,635 $22,270
======== =======



SIGNATURES

Pursuant to the requirements of Sections 13 or 15(d) of the
Securities Exchange Act of 1934, the Registrant has duly caused this annual
report to be signed on its behalf by the undersigned, thereunto duly
authorized, in the City of New York, New York on the 29th day of March,
2002.

DELTATHREE, INC.

By: /s/ Paul C. White
-----------------------
Paul C. White
Chief Financial Officer

KNOW ALL MEN BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Noam Bardin and Paul C. White his
true and lawful attorney-in-fact, each acting alone, with full power of
substitution and resubstitution for him and in his name, place and stead,
in any and all capacities to sign this Annual Report, and to file the same,
with all exhibits thereto, and other documents in connection therewith,
with the Securities and Exchange Commission, hereby ratifying and
confirming all that said attorney-in-fact or his substitutes, each acting
alone, may lawfully do or cause to be done by virtue thereof.

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




Signature Title Date
--------- ----- ----


/s/ Noam Bardin Chief Executive Officer, President March 29, 2002
- -------------------------------------------- and Director (Principal Executive
Noam Bardin Officer)



/s/ Paul C. White Chief Financial Officer (Principal March 29, 2002
- -------------------------------------------- Accounting and Financial Officer)
Paul C. White


/s/ Lenny Roth Chairman of the Board of Directors March 29, 2002
- --------------------------------------------
Lenny Roth


/s/ Ehud Erez Director March 29, 2002
- --------------------------------------------
Ehud Erez


/s/ Amir Gera Director March 29, 2002
- --------------------------------------------
Amir Gera


/s/ Issakhar Hacmun Director March 29, 2002
- --------------------------------------------
Issakhar Hacmun


/s/ Elie Housman Director March 29, 2002
- --------------------------------------------
Elie Housman


/s/ Joshua Maor Director March 29, 2002
- --------------------------------------------
Joshua Maor


/s/ Lior Samuelson Director March 29, 2002
- --------------------------------------------
Lior Samuelson


/s/ Shimmy Zimels Director March 29, 2002
- --------------------------------------------
Shimmy Zimels