United States Securities and Exchange Commission
                            Washington, D.C. 20549

                                   FORM 20-F

        [ ] REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF
                     THE SECURITIES EXCHANGE ACT OF 1934

                                      OR

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

                  For the fiscal year ended December 31, 2002

                                      OR

         [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
                       SECURITIES EXCHANGE ACT OF 1934
               For the transition period from________to________

                       Commission file number: 2-0-27648

                         VocalTec Communications Ltd.
 (Exact name of registrant as specified in its charter and translation
                                into English)

                                State of Israel
                (Jurisdiction of incorporation or organization)

                                2 Maskit Street
                            Herzliya Pituach 46733
                                    Israel
                   (Address of principal executive offices)

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

None.

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

Ordinary Shares, par value of NIS 0.01     Nasdaq
Title of each class                        Name of each exchange on which
                                           registered

Securities for which there are a reporting obligation pursuant to Section
15(d) of the Act:


                                      Page 1
<PAGE>

None.

The number of outstanding shares of each of the issuer's classes of capital or
common stock as of December 31, 2002

12,127,058 Ordinary shares, par value NIS 0.01 per share

Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past ninety (90) days.

         [ X ]  Yes
         [   ]  No

Indicate by check mark which financial statement item the registrant has
elected to follow.

         [   ]  Item 17
         [ X ]  Item 18

(APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE
PAST FIVE YEARS)

Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Sections 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court.

         [   ]  Yes
         [   ]  No



                                      Page 2
<PAGE>


                               PRELIMINARY NOTE


This annual report contains historical information and forward-looking
statements within the meaning of The Private Securities Litigation Reform Act
of 1995 with respect to VocalTec's business, financial condition and results
of operations. The words "anticipate," "believe," "estimate," "expect,"
"intend," "may," "plan," "project" and "should" and similar expressions, as
they relate to VocalTec or its management, are intended to identify
forward-looking statements. Such statements reflect the current views and
assumptions of VocalTec with respect to future events and are subject to risks
and uncertainties. Many factors could cause the actual results, performance or
achievements of VocalTec to be materially different from any future results,
performance or achievements that may be expressed or implied by such
forward-looking statements, including, among others, changes in the
telecommunications and VOIP markets and in general economic and business
conditions, loss of key customers and unpredicated sales cycles, competitive
pressures, inability to meet efficiency and cost reduction objectives, changes
in business strategy and various other factors, both referenced and not
referenced in this annual report. These risks are more fully described under
"Item 3 - Key Information - Risk Factors" of this annual report. Should one or
more of these risks or uncertainties materialize, or should underlying
assumptions prove incorrect, actual results may vary materially from those
described herein as anticipated, believed, estimated, expected, intended,
planned or projected. VocalTec does not intend or assume any obligation to
update these forward-looking statements.

In this annual report, all references to "VocalTec," "we," "us" or "our" are
to VocalTec Communications Ltd, a company organized under the laws of the
State of Israel, and its wholly-owned subsidiaries.

In this annual report, unless otherwise specified or unless the context
otherwise requires, all references to "$" or "dollars" are to U.S. dollars and
all references to "NIS" are to New Israeli Shekels. Except as otherwise
indicated, financial statements of, and information regarding, VocalTec are
presented in U.S. dollars.



                                    Page 3
<PAGE>


Index

PART ONE

Item 1.   Identity of Directors, Senior Management and Advisers  - Not
          applicable
Item 2.   Offer Statistics and Expected Timetable - Not applicable
Item 3.   Key Information
Item 4.   Information on the Company
Item 5.   Operating and Financial Review and Prospects
Item 6.   Directors, Senior Management and Employees
Item 7.   Major Shareholders and Related Party Transactions
Item 8.   Financial Information
Item 9.   The Offer and Listing
Item 10.  Additional Information
Item 11.  Quantitative and Qualitative Disclosure about Market Risk
Item 12.  Description of Securities Other than Equity Securities  - Not
          applicable

PART TWO

Item 13.  Defaults, Dividend Arrearages and Delinquencies
Item 14.  Material Modifications to the Rights of Security Holders and Use of
          Proceeds  - Not applicable
Item 15.  Controls and Procedures
Item 16.  [Reserved]

PART THREE

Item 17.  Financial Statements  - Not applicable
Item 18.  Financial Statements
Item 19.  Exhibits

SIGNATURES

CERTIFICATES

EXHIBIT INDEX


                                    Page 4
<PAGE>

PART ONE


ITEM 1.           IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS

Not applicable.


ITEM 2.           OFFER STATISTICS AND EXPECTED TIMETABLE

Not applicable.


ITEM 3.           KEY INFORMATION

3A.               SELECTED FINANCIAL DATA

Our historical Consolidated Financial Statements are prepared in accordance
with generally accepted accounting principles in the United States ("GAAP")
and are presented in U.S. dollars. The selected historical consolidated
financial information set forth below has been derived from the historical
Consolidated Financial Statements of VocalTec Communications Ltd. for the
years presented. Historical information as of and for the five years ended
December 31, 2002 is derived from our Consolidated Financial Statements, which
have been audited by Luboshitz Kasierer, our independent auditors, a member
firm of Ernst & Young International.

The information presented below is qualified by the more detailed historical
Consolidated Financial Statements set forth elsewhere in this document, and
should be read in conjunction with those Consolidated Financial Statements,
the notes thereto and the discussion under "Operating and Financial Review and
Prospects" included elsewhere in this report.


                                    Page 5
<PAGE>

<TABLE>
<CAPTION>

            Statement of Operations Data - Year Ended December 31st
             (in thousands of U.S. dollars, except per share data)
---------------------------------------------------------------------------------------------------------
                                              1998         1999         2000        2001         2002
                                              ----         ----         ----        ----         ----


<S>                                        <C>          <C>          <C>         <C>          <C>
Net sales                                  $24,650      $26,615      $37,499     $27,018      $15,588
---------------------------------------------------------------------------------------------------------
Cost of sales                                5,938        8,156       13,040       9,433       6,668
---------------------------------------------------------------------------------------------------------
Inventory write off                             0            0           0          1,441        870
---------------------------------------------------------------------------------------------------------
Gross profit                                18,712       18,459       24,459      16,144       8,050
---------------------------------------------------------------------------------------------------------
Research and development expenses, net      11,192       13,157       8,290        7,842       6,138
---------------------------------------------------------------------------------------------------------
Marketing and selling expenses, net         18,509       27,171       23,018      23,692       16,401
---------------------------------------------------------------------------------------------------------
General and administrative expenses          5,204        6,592       6,720        6,420       4,512
---------------------------------------------------------------------------------------------------------
Restructuring costs                             -           827          -          1,753       2,703
---------------------------------------------------------------------------------------------------------
Total operating expenses                    34,905       47,747       38,028      39,707       29,754
---------------------------------------------------------------------------------------------------------
Operating loss                             (16,193)     (29,288)     (13,569)    (23,563)     (21,704)
---------------------------------------------------------------------------------------------------------
Other income (expenses), net                (9,656)         -         57,744        941        10,220
---------------------------------------------------------------------------------------------------------
Financing income, net                         2668          902        3,184        1,872        409
---------------------------------------------------------------------------------------------------------
Income (loss) from continuing  operations  (23,181)     (28,386)      47,359     (20,750)     (11,075)
before tax benefit (income taxes)
---------------------------------------------------------------------------------------------------------
Tax benefit (income taxes)                      -            -        (9,013)        292        5,294
---------------------------------------------------------------------------------------------------------
Income (loss) from continuing  operations  (23,181)     (28,386)      38,346     (20,458)     (5,781)
after tax benefit (income taxes)
---------------------------------------------------------------------------------------------------------
Loss  from operations of discontinued           -            -        (9,510)      (8,966)      (588)
segment
---------------------------------------------------------------------------------------------------------
Loss on disposal of segment                     -            -           -         (2,359)     (1,786)
---------------------------------------------------------------------------------------------------------
Net income (loss)                          (23,181)     (28,386)      28,836     (31,783)     (8,155)
---------------------------------------------------------------------------------------------------------
Basic net income (loss) per share from       (2.08)       (2.47)        3.17       (1.69)       (0.48)
continuing operations
---------------------------------------------------------------------------------------------------------
Diluted net income (loss) per share from     (2.08)       (2.47)        2.89       (1.69)       (0.48)
continuing operations
---------------------------------------------------------------------------------------------------------
Basic net income (loss) per share            (2.08)       (2.47)        2.39       (2.62)       (0.68)
---------------------------------------------------------------------------------------------------------
Diluted net income (loss) per share          (2.08)       (2.47)        2.18       (2.62)       (0.68)
---------------------------------------------------------------------------------------------------------
Weighted  average  number of shares         11,145       11,498       12,082      12,127       12,127
outstanding used in computation (basic)
---------------------------------------------------------------------------------------------------------
Weighted average number of shares           11,145       11,498       13,252      12,127       12,127
outstanding used in computation (diluted)
---------------------------------------------------------------------------------------------------------

Balance Sheet Data - Year Ended December 31
(in thousands of U.S. dollars)

------------------------------------------ ------------ ------------- ----------- ------------ ------------
                                              1998          1999         2000        2001         2002
----------------------------------------------------------------------------------------------------------
Working capital                              $42,501      $35,975      $42,673      $17,117      $14,705
---------------------------------------------------------------------------------------------------------
Total assets                                 59,945        89,271       92,967      51,561       28,507
---------------------------------------------------------------------------------------------------------
Long-term Liabilities                         1,224        21,778       6,449        7,577        2,617
---------------------------------------------------------------------------------------------------------
Net assets                                   50,871        58,990       62,370      31,229       15,994
---------------------------------------------------------------------------------------------------------
Total shareholders' equity                   50,871        58,990       62,370      31,229       15,994
---------------------------------------------------------------------------------------------------------
Number of shares outstanding                 11,413        11,771       12,127      12,127       12,127
---------------------------------------------------------------------------------------------------------
</TABLE>


                                    Page 6
<PAGE>

3B.      CAPITALIZATION AND INDEBTEDNESS

Not applicable.

3C.      REASONS FOR THE OFFER AND USE OF PROCEEDS

Not applicable.

3D.      RISK FACTORS


Many factors could have an effect on our financial condition, cash flows and
results of operations. We are subject to various risks resulting from changing
economic, political, industry, business and financial conditions. The
principal factors are described below.

WE HAVE EXPERIENCED AND MAY CONTINUE TO EXPERIENCE SIGNIFICANT FLUCTUATIONS IN
OUR QUARTERLY RESULTS, WHICH MIGHT MAKE IT DIFFICULT FOR INVESTORS TO MAKE
RELIABLE PERIOD-TO-PERIOD COMPARISONS AND MAY CONTRIBUTE TO VOLATILITY IN THE
MARKET PRICE FOR OUR ORDINARY SHARES.

Our operating results have fluctuated and may continue to fluctuate from
period to period for a number of reasons. Over the past few years,
telecommunications carriers have reduced their capital expenditures as a
result of excess capacity, heavy debt, and significant operating losses. In
addition, many competitive local exchange carriers have gone bankrupt and no
longer exist. Along with the downturn in capital markets, these factors have
resulted in decreased market demand for our products. We have long sales
cycles and short delivery cycles, and as a result we do not usually have a
large order backlog. In addition, we have experienced unforecasted large
orders from our large customers throughout the year. This makes the
forecasting of net sales inherently uncertain. Significant annual and
quarterly fluctuations in our results of operations may be caused by, among
other factors, the timing and composition of orders from our customers,
reduced prices for our products, the economic viability and credit-worthiness
of our customers, and the collectability of our receivables, some of which are
recognized on a cash basis, the timing of new product announcements and
releases by both us and our competitors, and generally depressed economic
conditions in the telecommunications markets and in the Voice over Internet
Protocol (VoIP) industry in which we operate.

Our future results may also be affected by factors that include our ability to
continue to develop, introduce and deliver enhanced and new products in a
timely manner, to offer new products at competitive prices, to offer existing
products at lower prices and to anticipate customer demands. There can be no
assurance that sales in any particular quarter will not be lower than those of
the preceding quarters, including comparable quarters.

As a result, we believe that period-to-period comparisons of our results of
operations are not necessarily meaningful and should not be relied upon as
indications of future


                                    Page 7
<PAGE>

performance. The volatility in our operating results may also result in
significant volatility in our share price. Furthermore, our share price is
also subject to the price volatility experienced by many companies in the
telecommunications sector, VoIP industry and related sectors. It is also
possible that our quarterly results of operations may be below the
expectations of public market analysts and investors. If this happens, the
price of our ordinary shares is likely to decrease.

WE HAVE INCURRED SIGNIFICANT HISTORICAL OPERATING LOSSES AND MAY CONTINUE TO
INCUR OPERATING LOSSES.

Since our incorporation in 1989, we have had limited sales and have incurred
significant operating losses. In 2002, we had an operating loss of $21.7
million. In 2001, we had an operating loss of $23.6 million, and in 2000, we
had an operating loss of $13.6 million. Our future prospects must be
considered in light of the risks, expenses and difficulties currently
encountered by companies in the depressed telecommunications and VoIP
industries. To address these risks and achieve profitability and increased
sales levels, we must, among other things, establish and increase market
demand and acceptance of our products and systems, respond effectively to
competitive pressures, offer high quality customer service and support, and
timely introduce advanced versions, enhancements, and new products that meet
market needs.

We may continue to incur operating losses in 2003 and thereafter if revenues
are insufficient to cover sales and marketing, product development,
administrative and other expenses. If revenue levels do not sufficiently
increase, operating results will be adversely affected because any reduction
in expenses may not sufficiently cover reduction in revenues. There can be no
assurance that we will achieve or sustain significant sales or profitability
in the future.

CONTINUED DECREASED LEVELS OF CAPITAL SPENDING BY TELECOMMUNICATIONS COMPANIES
WILL ADVERSELY AFFECT OUR REVENUES AND OUR FUTURE GROWTH.

The turbulent economic events of the past several years have precluded the
establishment of potential new carrier customers. In addition, many existing
telecommunications providers, including many of our customers, have sustained
significant economic losses and been forced to reduce planned capital
expenditures for 2002 and beyond in order to reduce debt and operating
expenses. As part of such cost reduction measures, these carriers have been
canceling or delaying capacity upgrades, network expansions and the
implementation of new technologies, resulting in longer sales cycles and
greater uncertainty in the results of sales efforts. The sharp decline in the
number of new telecommunications carriers, the bankruptcies of numerous CLEC
carriers, and the reduction of capital expenditures by existing
telecommunications carriers have resulted in decreased market demand for our
products and longer sales and procurement cycles, and have adversely affected
our revenues. There can be no assurance of a recovery in the
telecommunications carrier sector, or that these events will not continue to
adversely affect our revenues and future growth.


                                    Page 8
<PAGE>

IF OUR RELATIONSHIPS WITH OUR KEY CUSTOMERS ARE TERMINATED, OUR REVENUES WILL
DECLINE AND OUR BUSINESS WILL BE ADVERSELY AFFECTED.

During 2002, our two main customers, Deutsche Telekom and its T-Systems
subsidiary and DataAccess (India) Limited, each accounted for a significant
portion of our net sales. We expect that these customers will continue to
account for a signification portion of our net sales in 2003.

If for any reason, our relationship with Deutsche Telekom or DataAccess is
terminated, or if either of these key customers reduce purchases of our
products, or do not meet purchase commitments, then our business, financial
condition and results of operations would be materially adversely affected. In
addition, if any of our key customers decided to replace our existing
equipment in their networks with competitor's equipment, this would pose a
serious competitive problem. The impact of the termination or reduction of our
key customer relationships would be intensified if we are unable to increase
sales to other customers in order to offset this termination or reduction. In
2002, we experienced decreasing order volumes from ITXC, that had been a key
customer in previous years, and the decrease adversely affected our revenues
and results of operations.

WE WILL NOT ATTRACT AND RETAIN CUSTOMERS IF OUR SOLUTIONS DO NOT MEET MARKET
AND CUSTOMER REQUIREMENTS OR IF OUR PRODUCTS DO NOT ACHIEVE INDUSTRY STANDARD
CERTIFICATIONS IN EXISTING OR EMERGING MARKETS.

Maintaining and increasing our sales revenues is dependent upon the ability of
our products to meet market and customer requirements. To this end, we are
involved in a continuous process to evaluate changing market demands and
customer requirements, and to develop and introduce new products, features and
applications to meet such changing demands and requirements. A number of risks
are inherent in this process. We may not successfully anticipate market
requirements or complete the development or introduction of these products. In
addition, the development of new technologies and products is increasingly
complex and uncertain. This can result in delay in the introduction of new
technology and products, and requires close collaboration and continued
technological advancement involving multiple hardware and software design
teams and outside suppliers of key components. The failure of any one of these
elements could cause new products to fail to meet specifications, market
requirements or customer demands, or to miss delivery schedules. As the
variety and complexity of our product lines increase, the process of planning
production and inventory levels also becomes increasingly complex.

Our results could be adversely affected by factors such as development or
manufacturing delays, variations in product costs, and delays in customer
purchases of existing products in anticipation of the introduction of new
products and the rapidly changing landscape of emerging standards. In
addition, products in our inventory that are not timely sold may become
obsolete, resulting in inventory write-downs.

Further, telecommunications carriers outside the U.S. increasingly require
that VoIP products be designed to meet local homologation requirements to
demonstrate


                                    Page 9
<PAGE>

interoperability with existing networks of incumbent telecommunications
carriers, each of which may have different specifications. Failure to obtain
such homologation certifications or other industry standard certifications for
our products may result in decreased revenues, significant warranty, support
and repair costs, may divert the attention of our engineering personnel, and
cause significant customer relations problems.

IF VOIP MARKETS FOR OUR PRODUCTS AND TECHNOLOGY FAIL TO FURTHER DEVELOP AND
GROW BEYOND CURRENT LEVELS, OR OUR CURRENT OR NEW PRODUCTS FAIL TO ACHIEVE
MARKET ACCEPTANCE, OUR BUSINESS WILL BE ADVERSELY AFFECTED.

The markets for our products are relatively new, are rapidly evolving
technologically, and are characterized by competitors that have developed
similar products and services. In addition, VoIP has developed slower than
expected and conversion from Public Switch Telephone Network, or PSTN, to VoIP
is not as widespread as expected. Further, certain VoIP segments are taking
longer to develop than others. Sales of VoIP products have fluctuated and have
been generally unpredictable, as fluctuation in demand for voice
infrastructure products is dependent on the customers establishing and/or
expansion of their networks. As is typical in the case of an evolving
industry, demand and market acceptance for recently introduced technology
products and services are subject to a high level of uncertainty. Further,
there is continuing uncertainty as to whether and when the size of the VoIP
market will further increase, if at all. Broad market demand and acceptance of
our technology, products and solutions, including our new EssentraTM product
line, and interoperability of our products with other VoIP products are very
important to our success and to our ability to generate revenues. Market
demand and acceptance of our technology, products and solutions will be highly
dependent on functionality, interoperability, reliability, stability and
performance as well as on matters beyond our control such as the introduction
of competing products or technologies into the market before our new
technologies and products and the current weaknesses of the telecommunications
industry. There can be no assurance that packet based voice networks will
become widespread, that connections between Internet Protocol, or IP, networks
and the publicly switched telephone networks, or PSTN, will become widespread
or that our products and solutions, including our new Essentra softswitch,
will gain market acceptance. The adaptation process of connecting IP networks
and PSTNs can be time consuming and costly to both us and to our customers and
the acceptance of the product or system may depend, to a substantial extent,
on the success of the adaptation.

There can be no assurance that the market for our products and services will
grow above current levels or that our products and solutions will achieve
market acceptance. If the market does not grow above current levels, or if our
products and solutions do not achieve market acceptance, our business,
financial condition and results of operations will be materially adversely
affected.

WE MAY NEED TO RAISE ADDITIONAL FUNDS TO SUSTAIN OUR FUTURE OPERATIONS,
RESEARCH AND DEVELOPMENT AND SALES INFRASTRUCTURES. ADDITIONAL CAPITAL MAY NOT
BE AVAILABLE, OR IF RAISED MAY DILUTE OUR SHAREHOLDERS.

                                   Page 10
<PAGE>


We have recently sold all our remaining shares in ITXC Corp. and realized net
proceeds of approximately $13.1 million. Our total cash, cash equivalents and
short term deposits as of December 31, 2002, after giving effect to such sale
of ITXC shares was approximately $17.7 million. If we do not increase our
revenues, we may need to further reduce expenses and/or raise additional
capital or funds in order to cover the cost of our operations, research and
development, and sales infrastructures. Such additional funding, whether
obtained through public or private debt or equity financing, or from strategic
alliances may not be available when needed or may not be available on terms
acceptable to us, if at all. If additional funds are raised through the
issuance of equity securities, the value of our shares may decrease, the
percentage ownership of our then current shareholders may be diluted and such
equity securities may have rights, preferences or privileges senior or more
advantageous to those of the holders of our ordinary shares. If additional
funds are raised through debt instruments, we may become subject to various
covenants, restrictions, pledges and other security interests that typically
accompany such funding. The continuing downturn in capital markets and the
difficulties in raising funds faced by high technology companies is likely to
make it difficult to raise additional capital, which will adversely affect our
ability to sustain our current or future operations, research and development
and sales infrastructures, and to compete in the VoIP market. See "Item 5B -
Liquidity and Capital Resources" below.

THE MARKET PRICE OF OUR ORDINARY SHARES MAY BE VOLATILE AND YOU MAY NOT BE
ABLE TO RESELL YOUR SHARES AT OR ABOVE THE PRICE YOU PAID, OR AT ALL.

In addition to our significant operating losses, generally depressed economic
conditions in the telecommunications industry have adversely affected our
share price and trading volumes. In December 2002, the Nasdaq approved our
application to transfer the quotation of our ordinary shares to the Nasdaq
SmallCap Market from the Nasdaq National Market, where they continued to be
traded under the symbol "VOCL". Under the foreign issuer rules, we are exempt
from minimum bid price and market value of public float requirements. Our low
trading volumes may make it difficult for our shareholders to trade our
shares. If we are unable to continue to satisfy the listing requirements of
the Nasdaq SmallCap Market, our ordinary shares may be delisted from the
Nasdaq SmallCap Market and trading in our shares may be conducted in the
over-the-counter market in the so-called "pinksheets" or, if available, the
"OTC Bulletin Board Service" or, if available, another market.

Additional factors that could cause the market price of our stock to further
decrease significantly include the loss of any of our major customers or key
personnel, new product developments or enhancements by our competition, sales
of our securities by our shareholders, quarterly fluctuations in actual or
anticipated operating results, continued significant operating losses, market
conditions in the industry, analysts reports, announcements by competitors,
regulatory actions or other events or factors, including the risk factors
described herein and general economic conditions. In the past, following
decreases or volatility in the market price of a company's securities,
securities class action litigation has often been instituted. Such litigation
could result in substantial costs and

                                   Page 11
<PAGE>


a diversion of management's attention and resources, which would have a
material adverse effect on our business, operating results and financial
condition.

WE ARE SUBJECT TO STRONG COMPETITION. GREATER MARKET DEMAND AND ACCEPTANCE OF
OUR COMPETITORS' PRODUCTS AND TECHNOLOGY COULD RESULT IN REDUCED REVENUES OR
GROSS MARGINS.

The competition in the VoIP communications market is very strong. Our
competitors include telecommunications companies, data communication companies
and pure voice over IP companies. Many of our current and potential
competitors have greater name recognition, larger installed customer bases,
broader product offering and significantly greater financial, technical and
marketing resources than we do, including the means to offer vendor-sponsored
financing programs to prospective customers. If we do not offer
vendor-sponsored financing, prospective customers may purchase products from
competitors that offer this type of financing. If we have to lower our prices
below current levels, there can be no assurance that we will be able to
successfully launch our new products, compete successfully and effectively
against other companies' product offerings, or maintain revenues and gross
margins.

We expect that additional companies will compete in the packet based voice
networks market. In the future, we may also develop and introduce other
products with new or additional telecommunications capabilities or services.
As a result of any such development or introductions, we may compete directly
with traditional telecommunications infrastructure providers. Additional
competitors may include companies that currently provide computer software
products and services, such as telephone, media, and cable television. The
ability of some of our competitors to bundle other enhanced services and other
products with VoIP products could give these competitors an advantage over us.

POLITICAL, ECONOMIC AND MILITARY CONDITIONS IN DOMESTIC OR FOREIGN LOCATIONS,
INCLUDING ISRAEL, COULD NEGATIVELY IMPACT OUR BUSINESS.

Significant portions of our operations are conducted outside the United
States, and our principal offices and research and development facilities are
located in the State of Israel. Although virtually all of our sales currently
are made to customers outside Israel, we are nonetheless directly influenced
by the political, economic, military and other conditions in and around Israel
and in other countries in which our business is located or in which our
products are sold, including the recent severe acute respiratory syndrome, or
SARS, outbreak. In particular, our sales and business in India may be
adversely affected by the recent hostilities between India and Pakistan. In
addition, any major hostilities involving Israel or the interruption or
curtailment of trade between Israel and its present trading partners could
have a material adverse effect on our business, financial conditions or
results of operations.

The general state of political and economic instability in the Middle East has
affected security and economic conditions in Israel. Throughout the years,
Israel experienced

                                   Page 12
<PAGE>


hostilities with its Arab neighbors, and several Arab countries still restrict
business with Israeli companies. Since October 2000, there has been a
significant increase in hostility and violence between Israel and the
Palestinians.

It is possible that the situation may deteriorate further and may impact our
operations in Israel. There can be no assurance that ongoing or revived
hostilities or other events related to Israel will not have a material adverse
effect on us or on our business. In addition, we could be adversely affected
by restrictive laws or policies directed towards Israel and Israeli
businesses.

SOME OF OUR DIRECTORS, OFFICERS AND EMPLOYEES ARE OBLIGATED TO PERFORM
MILITARY RESERVE DUTY.

Some of our Israeli directors, and many of our Israeli male officers and
employees are currently obligated to perform up to 36 days of annual reserve
duty. Additionally, all such persons are subject to being called to active
duty at any time under emergency circumstances, and recently some have been
called to active duty. We have operated effectively under these requirements
since we began operations. No assessment can be made, however, as to the full
impact of these requirements on our workforce or business if conditions should
change, and we cannot predict the effect on us of any expansion or reduction
of these obligations.

UNDETECTED ERRORS OR DEFECTS IN OUR PRODUCTS COULD INCREASE OUR COSTS AND HARM
OUR BUSINESS.

Products offered by us may contain undetected errors or defects when first
introduced or as new versions are released. The introduction of products with
reliability, quality or compatibility problems could result in reduced
revenues and orders, un-collectible accounts receivable, delays in collecting
accounts receivable and additional costs. There can be no assurance that,
despite testing by us or by our customers, errors will not be found in our
products after commencement of commercial deployment. Errors of this sort
could result in product redevelopment costs and loss of market demand, delay
in market acceptance, loss of revenues, loss of market share, loss of
potential new customers, and increased warranty and maintenance costs. In
addition, there can be no assurance that we will not experience significant
product returns in the future. Any such event could have a material adverse
effect on our business, financial condition or results of operations.

WE EXTEND CREDIT TO CUSTOMERS FOR PURCHASES OF OUR PRODUCTS AND MAY NOT BE
ABLE TO COLLECT ACCOUNTS RECEIVABLE.

Trade receivables as of December 31, 2002 amounted to approximately $0.7
million, net of allowances for doubtful accounts of approximately $0.9
million. Trade receivables as of April 25, 2003 amounted to approximately $1.2
million, net of allowances for doubtful accounts of approximately $0.9
million. A portion of our receivables result from credit extended to customers
for purchases of our products. There can be no assurance that any of our
accounts receivable will be completely collected. Any failure in the
collection of


                                   Page 13
<PAGE>

accounts receivables will adversely affect our cash flow position and will
result in decreased revenues.

OUR COSTS OF SALES HAVE INCREASED AND ARE EXPECTED TO CONTINUE INCREASING DUE
TO INCREASED COMPETITION, AND THE PROVISIONING OF TURNKEY SOLUTIONS. THIS HAS
AND WILL CONTINUE TO NEGATIVELY IMPACT OUR OPERATING MARGINS AND INVENTORY
LEVELS.

Our costs of sales have increased due to the higher costs of new products and
the lower products prices due to increased competition. Further, most of our
customers and potential customers are demanding end-to-end turnkey solutions
consisting of all necessary hardware and software for their VoIP
communications solutions. Accordingly, we purchase hardware components, such
as servers and circuit boards to integrate into our solutions from a small
number of manufacturers some of which may not always have sufficient
quantities of inventory available to timely fill our orders. We also rely on
partial outsourcing for the integration and assembly of our turnkey solutions.
We do not have long-term contracts with some of our suppliers and integrators,
and they are not obligated to provide us with products or services for any
specified period of time. If any of our hardware manufacturers or integrators
cease production, cease operations or fail to make timely delivery of orders,
we may not be able to meet our delivery obligations to our customers, and may
lose revenues and suffer damage to our customer relationships. The need to
stock up on such components would increase our inventories and costs of sales,
and would negatively impact our gross margins. Any continuation or
intensification of these trends would negatively affect our results of
operations and could delay or prevent us from achieving profitability.

WE ARE DEPENDENT UPON THE CONTINUED EMPLOYMENT OF KEY PERSONNEL.

Our future success depends to a significant extent upon the continued active
participation of Dr. Elon Ganor, our Chairman of the Board of Directors and
CEO. The loss of his services could have a material adverse effect on our
business. In addition to Dr. Ganor, the success of our company depends upon
the continued services of our senior executive officers. These officers,
including Dr. Ganor, are not bound by employment agreements for any specific
term. The loss of the services of any of our officers may adversely affect the
development and sales of our products, and the management of our company. Our
future is also dependent upon our continuing ability to attract and retain
highly qualified personnel, to perform research and development, commercialize
products, and perform the sales and marketing functions required to bring
these products to the market. Despite weakened global market conditions, there
is still some demand and competition for highly qualified technical personnel
in Israel. There can be no assurance that we will continue to attract and
retain such personnel.

WE MAY BE UNABLE TO ADEQUATELY PROTECT OUR PROPRIETARY RIGHTS, WHICH MAY LIMIT
OUR ABILITY TO COMPETE EFFECTIVELY.

Our success is dependent, to a certain extent, upon our proprietary
technology. We currently rely on a combination of trade secret, patent,
copyright and trademark law,

                                   Page 14
<PAGE>


together with non-disclosure, contractual licensing restrictions, and
invention assignment agreements, to establish and protect the proprietary
rights and technology used in our products. There can be no assurance,
however, that such measures will provide commercially significant protection
for our proprietary technology, that competitors will not develop products
with features based upon, or otherwise similar to, our products or that we
will be able to prevent competitors from selling similar products.

In addition, the software market has traditionally experienced widespread
unauthorized reproduction of products in violation of manufacturers'
intellectual property rights. Such activity is difficult to detect and legal
proceedings to enforce the manufacturers' intellectual property rights are
often burdensome and involve a high degree of uncertainty and costs.
Unauthorized use and reproduction of the registration codes contained in our
various software products has occurred from time to time and may continue to
occur in the future. There can be no assurance that our software products will
not experience unauthorized use or reproduction on a massive scale, which will
adversely affect our business, financial condition and results of operations.

LITIGATION AND OTHER DISPUTES REGARDING OUR INTELLECTUAL PROPERTY COULD PROVE
COSTLY AND THEREBY ADVERSELY IMPACT OUR FINANCIAL POSITION AND COULD ALSO
RESULT IN AN INJUNCTION OR JUDGMENT AGAINST US, WHICH COULD ADVERSELY AFFECT
OUR BUSINESS.

Third parties have asserted patent infringement and other claims against us
from time to time. A number of these claims were directed at certain basic and
fundamental components of our products. There can be no assurance that third
parties will not assert such claims against us in the future or that such
present and future claims will not be successful. Patents relating to basic
technologies in the communications and multimedia areas have been recently
allowed and patents may be filed in the future which relate to basic
technologies incorporated in our products. We would incur substantial costs
and would experience diversion of management resources with respect to the
defense of any claims relating to proprietary rights, and this could have a
material adverse effect on our business, financial condition and results of
operations. Furthermore, parties making such claims could secure a judgment
awarding substantial damages, as well as injunctive or other equitable relief
which could effectively block our ability to make, use, sell, distribute or
otherwise license our products in the United States or abroad. Such a judgment
could have a material adverse effect on our business, financial condition and
results of operations. Generally, litigation, which could be costly and time
consuming, may be necessary to determine the scope and validity of others'
proprietary rights or to enforce any patents issued to us, in either case, in
judicial or administrative proceedings. In the event a claim relating to
proprietary technology or information is asserted against us, we may seek
licenses for such intellectual property. There can be no assurance, however,
that licenses could be obtained on commercially reasonable terms, if at all,
or that the terms of any offered licenses will be acceptable to us. The
failure to obtain the necessary licenses or other rights could preclude the
sale, manufacture or distribution of our products and, therefore, could have a
material adverse effect on our business, financial condition or results of
operations. The cost of responding to any such claim may be material, whether
or not the assertion of such claim is valid.

                                   Page 15
<PAGE>

IF WE ARE UNABLE TO MAINTAIN OUR RELATIONSHIPS WITH OUR SUPPLIERS AND
DISTRIBUTORS, OR IF OUR SUPPLIERS' OR DISTRIBUTORS' BUSINESSES ARE ADVERSELY
AFFECTED BY DEVELOPMENTS UNRELATED TO US, OUR SALES COULD BE HARMED.

We are dependent on a number of suppliers for the manufacture, supply and
support of hardware components that are integrated into our solutions. In
addition, our marketing strategy includes sales through distributors and
resellers, as well as direct sales by our own sales force. There is no
assurance that we will be successful in extending the terms of our various
agreements or in establishing similar relationships with other entities if our
current agreements are not extended, and changes in our relationships with our
suppliers, distributors, value added resellers and agents, or other changes to
their respective businesses could have a material adverse effect on our
business, financial condition or results of operations.

OUR INTERNATIONAL OPERATIONS EXPOSE US TO THE RISKS INHERENT IN CONDUCTING
BUSINESS IN INTERNATIONAL MARKETS.

A substantial portion of our sales are in international markets. There are
certain risks inherent in conducting business in international markets,
including unexpected changes in regulatory requirements, export restrictions,
homologation certifications, tariffs and other trade barriers, difficulties in
staffing and managing foreign operations, longer payment cycles,
credit-worthiness of potential customers, political instability, and seasonal
reductions in business activities, all of which adversely impact the success
of our international operations. There can be no assurances that one or more
of such factors will not have a material adverse effect on our international
operations and, consequently, on our business, financial condition or results
of operations.

Any future mergers with or acquisitions of companies or technologies and the
resultant integration process may distract our management and disrupt our
business.

One of our business strategies is to pursue strategic partnerships, alliances,
mergers and/or acquisitions of complementary businesses, products and
technologies. Pursuit of such strategies requires significant investments in
management time and attention.

We have no current understandings, commitments or agreements with respect to
any mergers or acquisitions. However, mergers with or acquisitions of
companies involve a number of risks including the difficulty of assimilating
the operations and personnel of the merged or acquired companies and of
maintaining uniform standards, controls and policies. There can be no
assurance that technology or rights acquired by us will be incorporated
successfully into products we introduce or market, that such products will
achieve market acceptance or that we will not encounter other problems in
connection with such acquisitions. If we consummate one or more significant
acquisitions in which the consideration consists of ordinary shares,
shareholders would suffer significant dilution of their interests in us.

                                   Page 16
<PAGE>

OUR PRINCIPAL SHAREHOLDERS, INCLUDING OUR EXECUTIVE OFFICERS AND DIRECTORS,
ARE ABLE TO INFLUENCE MATTERS REQUIRING SHAREHOLDER APPROVAL.

As of April 25, 2003 our principal shareholders, including our directors and
certain executive officers, beneficially owned more than 38% of the
outstanding ordinary shares of our company. As a result, such shareholders
together have the ability to significantly influence the election of our
directors and most corporate actions.

CERTAIN PROVISIONS OF OUR ARTICLES OF ASSOCIATION AND UNDER ISRAELI LAW COULD
DELAY, HINDER OR PREVENT A CHANGE IN OUR CONTROL.

Our articles of association contain provisions which could make it more
difficult for a third party to acquire control of us, even if that change
would be beneficial to our shareholders. Specifically, our articles of
association provide that our board of directors is divided into three classes,
each serving three-year terms. In addition, certain provisions of the Israeli
Companies Law, which came into effect in February 2000, could also delay or
otherwise make more difficult a change in our control. The provision of the
Companies Law relating to mergers and acquisitions are discussed in greater
detail in "Item 10: Additional Information."

OUR UNITED STATES INVESTORS COULD SUFFER ADVERSE TAX CONSEQUENCES IF WE ARE
CHARACTERIZED AS A PASSIVE FOREIGN INVESTMENT COMPANY.

Depending on various factors described in Item 10E, we could be characterized,
for United States income tax purposes, as a passive foreign investment company
(''PFIC''). Such characterization could result in adverse United States tax
consequences to U.S. Holders (as defined in Item 10E). Our status as a PFIC
could cause, among other things, any gain recognized on the sale or
disposition of our ordinary shares to be treated as ordinary income for U.S.
Holders. Although we do not believe that we have been a PFIC for any tax year
through and including 2002, we may be deemed to have been a PFIC by the United
States Internal Revenue Service during 2001 and 2002 as a result of our
substantial holdings of cash, cash equivalents and securities combined with a
decline in our share price. Furthermore, even if we have not been a PFIC in
past years, there can be no assurance that we will not be a PFIC in the
future. For further discussion of the consequences of our possible PFIC
status, please refer to Item 10E.

The tax and other benefits available to us from Israeli government programs
may be discontinued or reduced at any time, which would likely increase our
taxes in the long term and our net research and development expenses.

We benefit from certain tax and other benefits, particularly as a result of
the "Approved Enterprise" status of certain existing facilities and approved
programs from the Government of Israel. In addition, we benefit from
participation by the Office of the Chief Scientist of the State of Israel (the
"Chief Scientist") in research and development projects. To be eligible for
these participations and tax benefits, we must continue to meet certain
conditions, including, with respect to the tax benefits, making certain
specified

                                   Page 17
<PAGE>


investments in fixed assets. There can be no assurance that such
participations and tax benefits will be continued at their current levels or
otherwise. The termination or reduction of certain tax benefits (particularly
benefits available to us as a result of the "Approved Enterprise" status of
certain of our existing facilities and approved programs) could have a
material adverse effect on our business, financial condition or results of
operations. The termination or reduction of the participation of the Chief
Scientist in research and development projects could increase our net research
and development expenses or limit or terminate certain research and
development projects.

WE MAY BE ADVERSELY AFFECTED IF THE RATE OF INFLATION IN ISRAEL EXCEEDS THE
RATE OF DEVALUATION OF THE NEW ISRAELI SHEKEL (NIS) AGAINST THE DOLLAR.

A significant portion of our sales are made outside of Israel in dollars and
we incur a significant portion of our expenses in NIS. The cost of our
operations in Israel, as expressed in dollars, is influenced by the extent to
which any increase in the rate of inflation is not offset by the devaluation
of the NIS in relation to the dollar. During the calendar years 2000, 2001 and
2002 the annual rate of inflation was 0%, 1.4%, and 6.5% respectively, while
the NIS was devalued against the dollar by approximately 2.7%, 9.3% and 7.3%,
respectively. The rate of inflation for 2003 as of April 25, 2003 was 0.8%,
and the NIS depreciated during 2003, until April 25, 2003, by approximately
3.3%. Although to date we have not purchased forward currency options to
decrease our exchange rate risk, we may do so in the future, to the extent we
deem it advisable.

SERVICE AND ENFORCEMENT OF LEGAL PROCESS ON US AND OUR DIRECTORS AND OFFICERS
MAY BE DIFFICULT TO OBTAIN.

Service of process upon our non-U.S. directors and officers may be difficult
to obtain within the United States. Furthermore, any judgment obtained in the
United States against us or these individuals may not be collectible within
the United States. There is doubt as to the enforceability of civil
liabilities under the Securities Act of 1933, as amended, and the Securities
Exchange Act of 1934, as amended, in original actions instituted in Israel.
However, subject to certain time limitations and other conditions, Israeli
courts may enforce final judgments of United States courts for liquidated
amounts in civil matters, including judgments based upon the civil liability
provisions of the Securities Act and the Securities Exchange Act.

COMMUNICATIONS REGULATIONS.

To date, neither the Federal Communications Commission ("FCC") nor the
communications authorities of other countries have subjected IP telephony
providers nor VOIP solutions providers to the regulations that apply to long
distance telecommunications carriers. At this time it is uncertain whether or
to what extent the FCC or the communications authorities of other countries
will impose access charges, universal service contributions, and other common
carrier regulations on IP telephony providers or to VOIP solutions providers.
There can be no assurance that future action by


                                   Page 18
<PAGE>

the FCC or other communications authorities will not have an impact on us,
directly or indirectly.


ITEM 4.  INFORMATION ON THE COMPANY

4A.      HISTORY AND DEVELOPMENT OF VOCALTEC COMMUNICATIONS LTD.

Our corporate name is VocalTec Communications Ltd. for both legal and
commercial purposes. We were incorporated as a company under the laws of the
State of Israel in 1989 and are subject to the Israeli Companies Law - 1999
("Companies Law"). Our principal executive offices are located at 2 Maskit
Street, Herzliya Pituach, 46733, Israel, and the telephone number at that
location is +972-9-970-7800. Our website is located at
http://www.vocaltec.com. Our wholly owned U.S. subsidiary, VocalTec
Communications Inc., is located at Two Executive Drive, Suite 592, Fort Lee,
NJ, USA 07024.

Our capital expenditures for fiscal years 2002, 2001, and 2000 amounted to
$0.8 million, $1.8 million, and $6.7 million, respectively. These expenditures
were primarily for hardware and software in our Israel and worldwide offices.

Capital expenditures for our Surf&Call business unit in 2001 were $130,000 or
7% of total capital expenditures, and $1.33 million or 20% of total capital
expenditures in 2000. In May 2002, we finalized the carve-out of our Surf&Call
operations into a separate corporate entity in which we hold a minority
interest, and therefore we did not incur any capital expenditures for
Surf&Call after such date.

During 2002, we implemented a number of organizational changes due to
substantial reduction in market demand, based on an ongoing review of our
operations. This initiative included reductions in worldwide headcount of 108
employees, or approximately 42% of our workforce, reduction in the office
facilities used for our activities, the closing of our sales offices in
France, Italy, Spain, Sweden, and Australia, and the carve-out of our
Surf&Call operations.

As of April 25, 2003, capital expenditures currently in progress consist of
approximately $0.1 million to be used in 2003 for research and development
activities.

Since 2000, we have been reducing our shareholdings in ITXC Corp, or ITXC. In
2000, we sold 779,743 shares of ITXC Corp. in the net amount of approximately
$61.2 million and recorded a net gain of approximately $60.7 million. In 2001,
we sold 180,000 shares of ITXC, and realized net proceeds of approximately $1
million. In 2002, we sold the remainder of our shares of ITXC, and realized
net proceeds of approximately $13.1 million.

In December 2002, the Nasdaq approved our application to transfer the
quotation of our ordinary shares to the Nasdaq SmallCap Market, where they
continued to be traded under the symbol "VOCL".


                                   Page 19
<PAGE>

4B.      BUSINESS OVERVIEW

We are a leading supplier of packet-based voice solutions for next generation
telecommunication networks suitable for the telecommunications and enterprise
markets. Our solutions incorporate carrier-class switching equipment and
software that enables voice to be delivered over packet-based networks,
including the Internet. Our solutions enable telecommunications carriers and
service providers to reduce both capital and operating expenses by utilizing a
more efficient network infrastructure to establish and operate voice networks.
In addition, our solutions provide a platform for telecommunications carriers
and service providers to increase their revenues through the delivery of
web-based voice and data services (such as voice virtual private networks)
helping them to retain and expand their customer base.

Our solutions can be rapidly deployed and easily expanded to accommodate
growth in traffic volume. Our products interoperate with many existing
networks, both traditional and VoIP, enabling best-of-breed solutions and
allowing customers to preserve their investment in their current networks. We
believe that our solutions offer a level of reliability and voice quality
equivalent to that of the PSTN.

Our customers include traditional local, international and wholesale long
distance telecommunication companies, competitive local exchange carriers
("CLECs"), alternative carriers, telephony wholesalers, Internet telephony
service providers ("ITSPs") and clearinghouses. We sell our products through a
direct sales force, as well as through resellers and distributors.

INDUSTRY BACKGROUND

Historically, voice and data have been transmitted over separate networks
using different technologies. Traditional voice carriers have typically built
telephone networks based on circuit switching. Circuit switching establishes
and maintains a dedicated path until a call is terminated. While a
circuit-switched system reliably transmits voice communications, circuit
switching does not efficiently use transmission capacity. Once a circuit is
dedicated, it is unavailable to transmit any other information, even when the
particular users of that circuit are not speaking or otherwise transmitting
information.

Packet switching, the technology used in data networks, is increasingly
replacing circuit switching. Packet-switching technologies, such as IP, divide
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, which waste unused capacity. As a result, substantially greater
traffic can be transmitted over a packet-switched network than over a
circuit-switched network. Driven by the Internet, the volume of data traffic
has already exceeded voice traffic, and is growing at a much faster rate.

                                   Page 20
<PAGE>

By combining their voice and data networks, carriers can realize significant
savings in equipment purchases and network operating costs. In addition, this
convergence allows carriers to bundle voice services together with web-based
and other data services to create attractive high margin revenue-generating
service offerings.

GLOBAL FORCES DRIVING THE GROWTH OF IP COMMUNICATIONS

Deregulation of the communications industry is breaking down the barriers that
restricted service providers to specific geographies, services and rates. This
has encouraged new entrants to the telecommunications market and existing
carriers to expand into new markets, usually internationally. Intense
competition between carriers continues to drive down service prices and erode
profit margins. In addition, many service providers are facing intense
competition and financial difficulties. Carriers are therefore looking for
differentiated service offerings to reduce their costs, establish new revenue
sources and retain and expand their customer base.

The expansion of the Internet has driven the growth of data traffic, the
volume of which now exceeds the volume of voice calls. These networks are more
flexible and efficient than traditional circuit switched networks, with
reduced operating and equipment costs. The architecture of packet-based
networks can also be leveraged to support voice services, enabling carriers to
avoid the costs involved in maintaining their traditional circuit switched
networks in parallel to their packet networks.

REQUIREMENTS FOR THE NEW VOICE INFRASTRUCTURE SOLUTIONS

For voice traffic to run over packet networks, voice infrastructure solutions
must satisfy a number of requirements that differ among carriers, including:

o  Carrier class equipment that complies with telecommunications carriers'
   quality standards.
o  Scalable solutions that support incremental growth from entry level
   deployments to massive global networks.
o  Solutions compatible with the existing infrastructure, supporting the full
   range of traditional telephone signaling variants (SS7).
o  Simple and rapid installation, deployment and support.

THE VOCALTEC SOLUTION

We develop, market and sell a variety of carrier-grade, solutions based on our
softswitch architecture and VoIP products.

We believe that our particular advantages are:

o  Modular solutions for all sizes of networks.
o  Extensive next generation network experience.


                                   Page 21
<PAGE>

o  Significant installed base with commercially deployed solutions in over 130
   countries.
o  Interoperability with many revenue-generating VoIP ports worldwide.
o  Multiple relationships with various solutions providers for the
   telecommunications markets.

Our solutions provide two types of offerings - network services, for basic
international and long distance telephony services and global hosted services
(or global managed services), for enhanced services.

NETWORK SERVICES

International Long Distance Services - This solution combines Class 4 tandem
switch features with enhanced VoIP-enabled services. It combines connectivity
to PSTN networks and VoIP networks with a wide variety of sophisticated
routing algorithms required to manage complex international routes and
networks operated by different carriers and required to support global hosted
services, such as voice virtual private network, or VPN. It provides
interoperability to ensure global service reach and comprehensive security
features necessary to protect carriers' managed networks.

National Long Distance Services - Optimized for the national long distance
market, this solution provides carrier-class reliability, end-to-end security,
scalability and high performance used to control large-scale, high-density
trunking gateways. It allows for PSTN quality voice services with full SS7
tunneling capabilities. Leveraging the inherent benefits of IP networks, this
solution reduces feature upgrade and service creation costs, lowers carriers'
maintenance and transport costs for long distance services, and enables a more
efficient network topology.

Exchange Carrier Services - This solution provides a cost-effective, scalable
platform for VoIP carriers seeking to offer minute-based exchange services to
affiliate service providers worldwide. This solution increases the minutes
passing through the network by offering global call coverage to affiliate
service providers. Carriers can utilize this solution to offer wholesale VoIP
services, such as purchasing and reselling of minutes, or connecting
affiliates to a united global carrier.

Trunk Replacement - This is a cost-effective VoIP solution for point-to-point
voice trunking. Our trunk replacement solution utilizes IP-based networks,
rather than the PSTN, to pass voice traffic between two Class 4 tandem
switches. This solution allows carriers to operate and manage one convergent
network for data and voice, while ensuring maximum bandwidth utilization
through standards-based voice compression.

Rural Telephony - A complete, field proven rural telephony solution based on
the integration of VoIP technology with Wireless Local Loop, or WLL, and
satellite remote gateways at the transport layer. This solution enables the
rapid deployment of basic telephony services, as well as the introduction of
enhanced services over time. Prepaid and postpaid billing, centralized
management and bandwidth optimization techniques



                                   Page 22
<PAGE>

address the key challenges of rural telephony, particularly in emerging
   economies. Standards-based VoIP interoperability with other
   vendors/services ensures maximum flexibility in building solutions.

GLOBAL HOSTED SERVICES

Voice VPN - This solution enables carriers to provide their enterprise
customers with private voice services that utilize shared IP networks and
integrate seamlessly with the customer's existing corporate dialing plans.
Comprehensive security features control access to corporate network resources.
For independent voice service providers, our Voice VPN solution results in
substantial cost savings over PSTN-based voice VPNs. Data service providers
can leverage this solution to add voice VPN services to their current IP-based
VPN data services.

Calling Card - A cost-effective, pre-paid/post-paid, centrally managed Calling
Card solution for VoIP calling over public or private networks. Service
providers can bypass circuit-switched networks, gain customers from countries
where they have no presence, enjoy low-cost termination rates and expand their
service destinations via VocalTec-certified partners. Advanced features
include real-time billing and a flexible interactive voice response supporting
multiple languages, currencies and call flows.

IP Centrex/Hosted PBX - Service providers can utilize this solution of offer
managed IP Centrex/Hosted PBX services to their enterprise customers.
Leveraging the benefits of IP networks, this integrated networks solution
supports converged voice and data services - both within the enterprise and on
the network access connection. The IP Centrex solution combines Class 5
telephony switches with location insensitivity, enabling quick rollout of
uniform services among all enterprise sites, centralized management control,
simplified move/add/changes, and elimination of intra-site toll charges.

Global Call Center - This network based call center solution enables service
providers to offer multi-channel customer interactions (regular telephone, IP
telephony, fax, email, voicemail, SMS) in a single high-capacity, multi-tenant
platform. Routing of calls to agents and Interactive Voice Response, or IVR,
can be performed at the network level, allowing the provider to disperse
agents at different locations to ensure maximum efficiency and global
coverage. It readily delivers the capacity, reliability and security required
by carriers and large enterprises.

PLATFORM COMPONENTS

ESSENTRA(TM) SOFTSWITCH ARCHITECTURE

Essentra SIP Server - This service integration layer enables carriers to build
scalable, reliable packet voice networks. Utilizing the open, standards-based
Session Initiation Protocol (SIP), the Essentra SIP Server provides a full
array of call routing capabilities to maximize network performance in both
small and large packet voice networks. By incorporating a SIP-based service
integration layer, all service/routing logic and network


                                   Page 23
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complexity is "hidden" from the networking layer, accelerating time to market
and simplifying network management.

Essentra MGC - Performing call control and signaling routing for PSTN and SS7
voice traffic, the Essentra MGC frees the media gateway to serve as a pure
voice transport device. By working opposite multiple high-density media
gateways simultaneously, the Essentra MGC maximizes network performance,
cost-effectiveness and scalability. This module supports MGCP and MEGACO/H.248
standards, enabling integration with any third party media gateway for
best-of-breed networks.

SG 131/231/520 Signaling Gateway - This high-density, carrier-grade component
enables IP-based services to terminate on SS7 networks, which is the standard
signaling protocol for intercarrier traffic. The SG 131/231/520 is an integral
part of VocalTec's proven SS7 solution, which includes full SS7 tunneling over
IP and support for over 50 SS7 national variants, enabling large-scale,
cost-efficient global deployments.

Essentra OSS Server - This centralized server performs remote element
management and configuration, accelerating service provisioning and reducing
costs. Using a web-based, intuitive GUI architecture, the OSS provides
role-based security, alarm handling, historical information, reversible mass
configurations and network provisioning. The OSS allows network administrators
to manage and monitor the Essentra modules, as well as adjacent network
elements (e.g., media gateways, application servers). Secured management
protocols using SNMPv3 and HTTPS provide additional administrative security.

VOCALTEC SOFTSWITCH ARCHITECTURE 1000

VocalTec Gatekeeper 1000 - Serving as the intelligent hub of the IP telephony
network, VGK 1000 provides a carrier-grade platform for centralized call
control, routing, addressing, security and accounting functions. VGK 1000
enables service providers to set up a robust and secure Internet telephony
service, suitable for large-scale public and corporate networks.

VNM100 Network Manager - This operations, administration, management and
provisioning tool offers centralized remote management of VOIP services and
network elements. VNM100 is fully interoperable with third party H.323
Gateways, supporting up to 300 real-time monitored H.323 devices and over 1000
network elements.

VOCALTEC GATEWAYS

Telephony gateways are the network elements that directly convert traditional
PSTN telephone traffic to VOIP data at the originating end of a VOIP phone
call or fax, and re-convert VOIP data into traditional PSTN telephone traffic
at the terminating end of the VOIP phone call or fax. VocalTec offers a
diverse range of low, medium and high-density H.323 gateways, enabling
carriers to select equipment that is best suited for a particular
installation. Our gateways include a flexible, customizable front-end IVR to


                                   Page 24
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support advanced subscriber services, such as calling card. In addition,
support for multiple telephony interface types and signaling protocols (e.g.,
SS7, PRI, E&M, analog) facilitates global deployments. VocalTec's Signaling
Gateway provides SS7 service switching point (SSP) functionality and supports
over 50 national SS7 variants.

CONTRACTS WITH SUPPLIERS

We are dependent on the following suppliers for the manufacture, supply and
support of hardware components that are integrated into our solutions:
Audiocodes Ltd. for the supply of VoIP DSP processor boards, gateways and
media gateways, ECI Telecom Ltd. (and its affiliates) for the supply of VoIP
DSP processor boards, Intel for the supply of signaling boards and components,
and Telica, Inc. for the supply of large-capacity media gateways.

MARKETING, SALES AND DISTRIBUTION

We market and distribute our products both directly and via multiple
distribution channels. We have designed our distribution strategy to address
the diverse markets we target, including telecommunications service providers,
ITSPs, CLECs and clearinghouses. Our marketing strategy includes direct sales
to telecommunication service providers, strategic partnerships, value added
resellers and integration arrangements with vendors of complementary hardware
and software products and services. Commencing in 1998, we expanded our
distribution network in order to accelerate market penetration and to combine
our marketing efforts with quality pre-sale and post-sale technical support to
our telecommunications service providers and other customers. In 1999 and 2000
we decided to expand our direct sales channels, and we currently have a direct
global sales organization with sales and support based in Israel, the United
States, India, Japan, Germany, China, Hong Kong, Singapore. See Item 5 -
Operating Review and Financial Prospects - for a breakdown of revenues by
geographic market.

We typically license and sell our solutions to end users and distributors
pursuant to purchase orders, distribution agreements and/or end user
agreements, as applicable. The sales cycles for our solutions are long due to
the nature of the products and solutions as well as due to the depressed
telecommunications markets and strong competition for sales of VoIP solutions.
Once purchased by our end user customers, our solutions require installation
in our customer's networks. After installation, we offer warranty and
maintenance services to support our customers.

In 2002, we developed and implemented a new marketing strategy in response to
the weak demand for telecommunications products in the developed countries,
and re-focused our marketing efforts on deregulating emerging markets. With
large new installations of our products for companies such as DataAccess in
India, and the Communications Authority of Thailand, our shift in strategic
focus on emerging markets so far appears to be working positively.

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<PAGE>

INDUSTRY STANDARDS

We recognize that standards are important for interoperability and for
providing the means for market growth. Since 1996, we have taken an active
role in international standards bodies. Our strong involvement and
contribution led our employees to hold official positions over the years in a
number of international standard bodies, including: ITU (International
Telecommunications Union), ETSI (the European Telecommunications Standards
Institute), IMTC (the International Multimedia Teleconferencing Consortium),
and IETF (the Internet Engineering Task Force).

We actively support important communications standards in our products,
including IETF SIP, ITU-T H.323, MGCP, SS7 and many others, and work closely
with our tier-1 carrier customers and equipment manufacturers in ensuring
standards are correctly and uniformly implemented.

CUSTOMER AND TECHNICAL SUPPORT

We believe that responsive, prompt and efficient customer and technical
support is essential to the success of obtaining and retaining customers.
During 2002, we consolidated our support facilities by closing our smaller
overseas offices, and we currently maintain a customer and technical support
infrastructure in the US, Europe and Asia. We offer support to our customers
and back office support to our resellers and distributors. Our technical
support agreements are based on a percentage charge of the cost of the system
purchased. We intend to continue to charge for such technical support in the
future. We also train certain distributors, resellers and subcontractors to
provide customers with first level technical support.

On a routine basis, our technical support staff provides feedback to our
marketing and research and development groups. This assists us in designing
products featuring ease of use and installation, to maintain compatibility
with third party products in order to minimize the requirements for service
and support, and to improve product quality.

RESEARCH AND DEVELOPMENT

See Item 5 - Operating Review and Financial Prospects - for a discussion on
research and development.

COMPETITION

Our market is intensely competitive and rapidly evolving, and is characterized
by evolving standards and new alliances. Our principal competitors include
Cisco Systems, Inc., Alcatel, Lucent Technologies Inc., Veraz, Inc., Siemens,
Nortel Networks Corporation, Nuera Communications, Comworks Technologies,
Sonus Networks Inc. and Clarent Corporation, which was recently acquired by
Verso Technology Inc..

We believe that in such a rapidly changing market, key competitive factors
include a


                                   Page 26
<PAGE>

broad base of users, strategic alliances, key reference customers,
interoperability, integration of products with complementary hardware and
software products and services, technological leadership, product performance
and ease of use, price, customer support, name recognition, distribution
channels and the ability to respond quickly to emerging opportunities.

4C.      ORGANIZATIONAL STRUCTURE

We are organized under the laws of the State of Israel. Our directly and
indirectly held principal operating wholly-owned subsidiaries and their
countries of incorporation are:

o  VocalTec Communications Inc. (United States)
o  VocalTec Communications Japan KK, (Japan)
o  VocalTec Communications Deutschland GmbH (Germany)
o  VocalTec Communications Hong Kong Limited (Hong Kong)
o  VocalTec Communications International B.V. (Netherlands)
o  VocalTec Communications Singapore Pte Ltd. (Singapore)
o  VocalTec Communications India Private Limited (India)

 We also have a VocalTec representative office in China.

4D.      PROPERTY, PLANTS AND EQUIPMENT

Our headquarters are located in Herzliya Pituach, Israel and occupy
approximately 40,700 square feet pursuant to a lease expiring in January 2005.
We currently pay total yearly rental and management fees of approximately
$0.73 million, which are linked to the Israeli Consumer Price Index. These
facilities are used for management, marketing, sales, research and development
and production. Of this amount, approximately 30,700 square feet are currently
being used by our company. We are subleasing approximately 2,500 square feet
to Surf&Call Solutions Ltd., and approximately 7,500 square feet to Pioneer
Administrative Services Ltd. as of March 1, 2003.

We maintain car leases, and our total liability for early termination of the
leases is up to an aggregate of approximately $142,000.

The following facilities accommodate our sales and customer support worldwide
and are being fully utilized. We believe they are all flexible enough to
accommodate expansion of operations.

In March of 2003, we renegotiated the lease for our subsidiary in the United
States, for smaller offices of approximately 3,870 square feet in Fort Lee,
New Jersey under a lease expiring in February 28, 2006. The annual rent for
these facilities is approximately $106,425.

Our subsidiary in Germany leases approximately 1,500 square feet in Bonn under
a lease expiring in June 2004. The annual rent for the facility is
approximately $26,500.

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<PAGE>

Our representative office in China leases approximately 2,200 square feet in
Beijing under a lease expiring in July 2003. The annual rent for the facility
is approximately $44,500.

Our subsidiary in Hong Kong leases approximately 970 square feet under a lease
expiring in June 2004. The annual rent for the facility is approximately
$37,000.


ITEM 5.           OPERATING AND FINANCIAL REVIEW AND PROSPECTS

The following discussion of our financial condition and results of operations
should be read in conjunction with our consolidated financial statements and
related notes included elsewhere in this annual report. This discussion
contains forward-looking statements that involve risks and uncertainties. Our
actual results may differ significantly from those projected in the
forward-looking statements. Factors that might cause future results to differ
significantly from those projected in the forward-looking statements include,
but are not limited to, those discussed below and elsewhere in this annual
report particularly those described above under "Item 3 - Key Information -
Risk Factors."

Our consolidated financial statements are stated in U.S. dollars and prepared
in accordance with U.S. GAAP. Our functional and reporting currency is the
U.S. dollar, which is the currency of the primary economic environment in
which our consolidated operations are conducted. Transactions and balances
originally denominated in dollars are presented at their original amounts.
Transactions and balances in currencies other than dollars (including NIS) are
remeasured in dollars in accordance with the principles set forth in FASB
Statement No. 52 -"Foreign Currency Translation".

OVERVIEW

The turbulent economic conditions worldwide over the past several years have
adversely affected the telecommunications industry in particular. As a result,
spending in the telecommunications industry decreased substantially in 2001
and 2002 over prior years. Although the VoIP sectors have grown in terms of
minutes according to independent market research, sales of VoIP products to
telecommunications service providers continue being generally unpredictable.
However, we have observed an increase in sales of VOIP products in certain
emerging and deregulating markets worldwide.

Our major product changes during the past three years included the
introduction of our softswitch technology and our gateway 2000, gateway 480
and Essentra product line. Our current competition and product lines are
described in Item 4B - "Business Overview".

Our Consolidated Financial Statements are prepared in accordance with U.S.
GAAP, and are the basis of our discussion and analysis of our financial
condition and results of operations. Our reported amounts of assets,
liabilities, revenues, expenses, and related


                                   Page 28
<PAGE>

disclosure of contingent assets and liabilities are based on certain estimates
and judgments made in the preparation of our financial statements, which
estimates and judgments are revised periodically as required. Our estimates
and assumptions are based on factors such as analysis of prior years'
experience, trends within our company, and within the telecommunications
industry, and general economic conditions. However, actual results may differ
from our estimates and assumptions as a result of varying market and economic
conditions, and may result in lower revenues and bigger operating losses.

CRITICAL ACCOUNTING POLICIES

We have identified below our critical accounting policies. These policies are
those that are both most important to the portrayal of our financial condition
and results of operations and require our management's most difficult,
subjective and complex judgments and estimates. Actual results may differ from
these estimates under different assumptions or conditions.

Revenue Recognition: We recognize revenue when (1) we and a customer enter
into a legally binding commitment to pay for products or services free of
contingencies or significant uncertainties, (2) we deliver the products or
fulfill our obligations to provide the services, (3) payment is fixed and
determinable, and (4) collection is probable. We assess each sale to ensure
that the above conditions are met. In contracts for which an acceptance
provision is required by the customer, the Company defers revenue (and the
related costs) until receiving the acceptance confirmation. Service and
maintenance revenues are recognized over the period during which such services
were rendered. Revenue earned on software arrangements involving multiple
elements is allocated to each element based on the relative fair value of the
elements. Fair value is determined based on vendor specific objective evidence
(VSOE) of the fair value of the elements. The VSOE of fair value of the
elements is based on the price charged for the undelivered element when sold
separately. This policy ensures that we report revenues in accordance with
U.S. GAAP. Factors that could materially adversely affect our revenue
recognition include longer payment terms, longer procurement cycles, financial
viability of our customer base, the mix of products and services provided,
failure to timely provide products and services to customers, and fewer large
customers. Revenues from software licenses that require significant
customization, integration and installation are recognized in accordance with
Statement of Position 81-1 "Accounting for Performance of Construction - Type
and Certain Production - Type Contracts (SOP 81-1), using contract accounting
on a percentage of completion method, based on the relationship of actual
costs incurred to total costs estimated to be incurred over the duration of
the contract and in accordance with the "Input Method". Provision for
estimated losses on uncompleted contracts are made in the period in which such
losses are first determined, in the amount of the estimated loss on the entire
contract. No such estimated losses were identified in the reported periods.

Allowance of Doubtful Accounts: We treat our estimated losses for customer
failure or inability to make payments as allowances for doubtful accounts.
These allowances are calculated based on ongoing assessments of our customer's
financial conditions. Should


                                   Page 29
<PAGE>

our customer's financial conditions deteriorate, we may be required to
increase allowance for doubtful accounts.

Restructuring Charges and Discontinued Operations: We separate the exit costs
related to the disposal of discontinued operations as "non-operating costs".
We present these costs as "discontinued operations" in our statements of
operations. We include both past actual expenses and accruals for expected
expenses, along with the write-off of fixed assets belonging to these
discontinued segments. Exit costs relating to continuing operations are
presented as "restructuring costs" within the operating expenses. In cases
where actual costs differ from projected costs, we adjust the costs
accordingly. These exit costs include, among other items, severance and notice
payments to employees and other contractual obligations. In June 2002, the
FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or
Disposal Activities," which addresses the recognition, measurement, and
reporting of costs associated with exit and disposal activities, including
restructuring activities. SFAS No. 146 requires that costs associated with
exit or disposal activities be recognized when they are incurred rather than
at the date of a commitment to an exit or disposal plan. SFAS No. 146 also
requires liabilities incurred in respect of such costs to be measured at fair
value. SFAS No. 146 is effective for all exit or disposal activities initiated
after December 31, 2002. The company will implement the rules set forth in
SFAS No. 146 if such exit costs or disposal activities will take place.

Tax Allowance Practices: Our subsidiaries operate world-wide under various tax
regimes, and as such, we are subject to the tax laws and regulations of many
countries. At the end of every accounting period, we estimate our existing and
future tax results, and create tax assets or liabilities, as applicable. As
part of this process, we generally consult with reputable tax advisors in
various overseas locations, and follow established tax precedents in our tax
allowance practices. The tax expenses and benefits of the company of this
process are reflected in our financial statements.

We believe we are conservative in the application of accounting rules relating
to future events in our consolidated financial statements. Predicted future
losses or expenses are generally reported immediately in our Consolidated
Financial Statements, while predicted incomes are reported upon actual
occurrence.


5A.  OPERATING RESULTS

NET SALES

Net sales consist of sales of VoIP turnkey solutions, products and related
support and maintenance services.

We recorded net sales in 2002 of $15.6 million, or 42%_lower than net sales in
2001 of $27 million. Net sales for 2002 were 58% lower than net sales in 2000
of $37.5 million. The decrease in net sales in 2002 was primarily attributable
to continued weak market


                                   Page 30
<PAGE>

demand, financial difficulties of telecommunications carriers and service
providers, excess PSTN capacity, longer sales cycles and turbulent global
economic conditions, all of which affected the telecommunications industry and
resulted in decreased capital expenditures by telecommunications customers.
The decline in 2002 was also affected by the fact that ITXC Corp., drastically
reduced purchases of our products, and ECI Telecom Ltd. did not make any
purchases of our products in 2002. We do not expect any sales to ECI in 2003,
and expect that sales to ITXC will be negligible.

Product revenues were $13.5 million, a decrease of 47% compared to year 2001
product revenues of $25.5 million, and a decrease of 61% compared to year 2000
product revenues of $34.9 million.

Services revenues from maintenance and other support services in 2002 were
$2.1 million, an increase of 36% compared to year 2001 services revenues of
$1.5 million, and a decrease of 21% compared to year 2000 services revenues of
$2.6 million. Services revenues increased in 2002 compared with 2001 due to
the award of several support contracts from our customers. Maintenance and
other support services exceed ten percent (10%) of our total revenues for
2002.

Sales of our turnkey solutions (consisting of software, hardware and services)
continue to comprise the most significant portion of sales in 2002. Other
revenues were generated by licenses, projects and support. We expect this
trend to continue.

As in 2000 and 2001, revenues from consulting for customization services in
2002 were negligible, because our sales mostly consist of turnkey projects
that do not have customization requirements.

We distribute substantially all of our products through a combination of
direct sales to telecommunications service providers, and indirectly via
strategic partners, alliances, distributors, dealers and agents.

Sales to Deutsche Telekom and its T-Systems subsidiary in 2002 and to
DataAccess (India) Limited each accounted for a significant portion of our net
sales in 2002. We have entered into a frame agreement with DataAccess in which
DataAccess committed to placing purchase orders in the amount of approximately
$8 million during 2003 and during the first quarter of 2004. We expect that in
2003 these customers will continue to account for a significant portion of our
net sales. If for any reason, our relationship with Deutsche Telekom or
DataAccess is terminated, or if either of these key customers reduces
purchases of our products, our business, financial condition and results of
operations will be materially adversely affected.

Geographic revenues as a percentage of overall revenues changed as follows:

   o  Sales in the Americas decreased to 10% of total revenues in 2002,
      compared to 35% of total revenues in 2001, and 22% in 2000.
   o  Sales in Europe increased to 48% of total revenues in 2002, compared


                                   Page 31
<PAGE>

      with 35% of total revenues in 2001, and 36% in 2000.
   o  Sales in Asia Pacific increased to 39% of total revenues in 2002,
      compared with 25% of total revenues in 2001, and 21% in 2000.
   o  Sales in the rest of the world decreased to 3% of total revenues in
      2002, compared with 6% of total revenues in 2001, and 20% in 2000.

The difference in 2002 percentages in geographic revenue distribution from
previous years is mainly a result of the increase in sales to Deutsche Telekom
in Europe in 2002, and of our increased marketing focus on deregulating
emerging markets in Asia. Sales in the Americas decreased significantly as a
result of lower sales to ITXC during 2002.

To date, most of our global sales have been in U.S. dollars and have not been
adversely affected by foreign currency fluctuations. If global business
conditions require us to sell our solutions in other local currencies, our
sales may be adversely affected by devaluation of local currencies against the
U.S. dollar.

COST OF SALES

Cost of sales was $7.5 million or 48% of net sales in 2002, including an
inventory write-off in the amount of $0.9 million. Cost of sales in 2001 was
$10.9 million or 40% of net sales, including an inventory write-off in the
amount of $1.4 million, compared with $13 million or 35% of net sales in 2000.
Cost of goods for products in 2002 was $6.0 million, compared to $8.9 million
in year 2001 and $12.2 million in 2000. Cost of services revenues was $0.7
million in 2002, compared with $0.5 million in 2001 and $0.9 million in 2000.

Cost of goods for products primarily include the cost of hardware that we must
purchase to provide as part of our turnkey solutions, third party billing
software, reserves for products and components in inventory, royalties to
third parties, and other expenses associated with the provisioning of
products. Cost of services primarily consist of salaries and travel expenses
for rendering maintenance services to customers.

In 2001 and 2002, cost of sales decreased in absolute numbers but increased as
a percentage of sales due to increased competition in the VOIP market
resulting in lower prices for VOIP products. The cost of sales as a percentage
of net sales may increase in the future due to increasingly competitive
prices, and increased inventory-related costs. In years 2001 and 2002, we
wrote off obsolete inventory product components in the amount of $1.4 million
and $0.9 million, respectively.

In 2002, gross margins were 52% and 57% excluding inventory write-offs. In
2001, gross margins, including an inventory write-off for obsolete stock, was
60%, and excluding the inventory write-off was 65%. In 2000, gross margins
were 65%. The decrease in 2002 was due in large part to price pressure
generated by overall market weakness and intense competition. The decrease in
gross margins over the past three years is also as a result of the shift to a
full software-hardware solution which increased our cost of goods sold.

                                   Page 32
<PAGE>

We believe that the gross margin may further decrease in future periods due to
increased competition which may cause us to reduce prices of certain of our
products and services, increased amounts paid for licensed technology to be
incorporated in future products, a larger percentage of hardware components in
our solutions, price increases in the cost of such hardware components, as
well as higher standard requirements from our customers. In addition, we
expect that our gross margins will be affected in future periods by the mix of
hardware, software and services sold.

OPERATING EXPENSES

Research and development costs, net. Research and development costs, net were
$6.1 million in 2002 or 39% of net sales, compared with $7.8 million, or 29%
of net sales in 2001, and $8.3 million, or 22% of net sales in 2000. Although
the actual amount spent on research and development costs decreased from
previous years due to the decrease in research and development personnel
resulting from the restructuring we effectuated in 2002, it grew as a
percentage of sales due to decreased revenues. Research and development costs,
net consist principally of salaries and benefits for software engineers,
related facilities costs and activities and expenses associated with computer
equipment used in software development. None of our software development costs
have been capitalized during any of the reported periods as the amount of
software development costs eligible for capitalization at this stage has
historically been insignificant.

We believe that continued investment in research and development is essential
to remain competitive in the marketplace and is directly related to the timely
developments of new and enhanced products.

Our research and development efforts have been financed from internal
resources and through programs sponsored by the Government of Israel through
the Chief Scientist, as well as the European Commission through the Fifth
Framework Programme.

We participate in a royalty-bearing program sponsored by the Chief Scientist
in Israel. Pursuant to the terms of the royalty-bearing program of the Chief
Scientist, we are required to pay a royalty of between 3% and 3.5% of net
sales of products and related services developed in any project partially
funded by the Chief Scientist, up to an amount of 100% of the grant obtained.
For grants received under programs approved subsequent to January 1, 1999,
royalties are payable up to 100% of the grant obtained plus interest at LIBOR.
We expect to participate only in royalty bearing programs but we cannot make
any assurances that we will be awarded any future grants.

Our research and development expenses in 2002 were net of participation from
the Chief Scientist. In 2002 participation from the Chief Scientist was $1.7
million, of which $1.6 million attributed to the 2002 approved plan and
additional $0.1 million from the 2001 plan. All of these participations are
related to royalty bearing programs. Total cash receipts from the chief
scientist in 2002 were $1.8 million of which $0.4 million were from the 2001
plan.

                                   Page 33
<PAGE>

In 2002, we paid royalties to the Chief Scientist in an aggregate amount of
approximately $0.6 million. We currently have an additional $0.1 million in
accrued obligations to pay for royalties previously incurred under royalty
bearing programs of the Chief Scientist.

In 2001, Chief Scientist participation was in the amount of $2.5 million. $1.7
million of that amount was related to 2001 plan while the other $0.8 million
was due to 2000 plan all of which related to royalty bearing programs. Total
cash grants received from the chief scientist in 2001 were $2.5 million, of
which $1.4 million related to 2001 plan and $1.1 million to 2000 plan.

In 2001, we paid royalties to the Chief Scientist in an aggregate amount of
approximately $0.9 million.

In 2000, total research and development expenses were net of participation
from the Chief Scientist of $2.1 million. Royalty bearing participation due to
2000 plan and 1999 plan was $1.4 million and $0.6 million respectively while
additional $0.1 million were royalty free and resulted from the MAGNET program
(see "research and development consortia" below). Total cash grants received
from the Chief Scientist were $1.0 million and $1.4 million for 2000 and 1999
royalty bearing plans respectively and additional $0.5 million related to the
MAGNET program.

In 2000, we paid royalties to the Chief Scientist in an aggregate amount of
approximately $0.2 million and had, at year-end, an additional $0.6 million in
accrued obligations to pay for royalties previously incurred under royalty
bearing programs of the Chief Scientist.

In January 2000 we joined the Fifth Framework Programme of the European
Commission for a non-royalty bearing program. During the first quarter in
2003, we received 105,000 Euros from the program, and expect to receive up to
75,000 Euros in addition during the remainder of 2003. In 2002, total research
and development grants from the Fifth Framework Programme were 50,000 Euros,
compared with 100,000 Euros in 2001. In 2000, total research and development
grants from the Fifth Framework Programme were 250,000 Euros.

Research and Development Consortia

In addition to the above royalty-bearing grants from the Chief Scientist, we
have received grants from the Chief Scientist in connection with a generic
research consortium which is comprised of several high technology companies in
Israel, under the MAGNET program. The consortium is known as the Multimedia
OnLine Services Technologies Consortium, (the "MOST Consortium"), and is
devoted to generic technology research for on-line broadband multimedia
services. In general, any member of the MOST Consortium who develops
technology within the framework of the MOST Consortium retains the
intellectual property rights to the technology developed and all members of
the MOST Consortium have the right to utilize and implement any such
technology without having to pay royalties to the developing MOST Consortium
member. The Chief Scientist contributes 66% of the approved budget for the
MOST Consortium and the members of

                                   Page 34
<PAGE>

the MOST Consortium contribute the remaining 34%. No royalties are payable to
the Government of Israel with respect to this funding. Expenses in excess of
the approved budget are borne by the MOST Consortium members. The MAGNET
program ended in 2000.

We are a member in the International Packet Communication Consortium, formerly
known as the International Softswitch Consortium, a nonprofit organization
aimed at improving existing and new products related to the communications
industry by promoting interoperable Internet protocol-based, real-time
interactive communications and related applications. The Consortium endorses
and supports foundation protocol and interface specifications, facilitates the
creation of an open architecture testing environment, sponsors
interoperability events, and provides information to its members relating to
the foregoing.

Marketing and selling expenses

In 2002, marketing and selling expenses were $16.4 million or 105% of net
sales in 2002, compared with $23.7 million, or 88% of net sales in 2001, and
$23 million, or 61% of net sales in 2000. Marketing and selling expenses
include salaries and benefits, sales commissions, travel expenses and related
facilities costs for our sales, marketing, and distribution personnel, as well
as reserves for potential damages to, loss of, or obsoleteness of trial
systems. Marketing and selling expenses also include the costs of programs
aimed at increasing revenue, such as advertising, trade shows and other market
development programs.

As in 2001, the decrease in marketing and selling expenses in absolute terms
in 2002 was the result of the further reductions in sales and marketing staff
in certain territories. Despite the decrease in absolute terms, there was an
increase as a percentage of sales. This is due to the relative levels of
expenses and revenues, as marketing and sales expenses were not reduced in the
same proportion that our revenues decreased, in order to avoid harming future
revenue opportunities.

General and administrative expenses.

General and administrative expenses consist principally of salaries and
benefits, outside legal, accounting and consultant fees, travel expenses, and
related facility costs for management, finance, logistics, human resources,
legal, information services, and administrative personnel. General and
administrative expenses also include expenses associated with computing
equipment and software used in the administration operations. General and
administrative expenses were $4.5 million or 29% of net sales in 2002,
compared with $6.4 million or 24% of net sales in 2001, and $6.7 million, or
18% of net sales in 2000. General and administrative expenses in 2002
decreased in absolute numbers due to the decrease in personnel and in office
expenses resulting from the restructuring we effectuated in 2002, but
increased as a percentage of sales due to reduced revenues over previous
years.

                                   Page 35
<PAGE>

Restructuring costs.

During 2002, we implemented a number of organizational changes due to
substantial reduction in market demand, including a reduction in worldwide
headcount of 108 employees, or approximately 42% of our workforce, reductions
in the office facilities used for our activities, renegotiation of some of our
office leases, moving to smaller office premises, and the closing of our sales
offices in France, Italy, Spain, Sweden, and Australia. We recorded $1.3
million for severance and termination payments and other benefits. The total
cost associated with these charges was $2.7 million, paid mostly in cash.

During 2001, organizational changes included a reduction in worldwide
headcount of 140 employees, or approximately 40% of our workforce and
reduction in the office facilities used for our activities. The total cost
associated with these charges was $1.8 million, paid mostly in cash, ($0.3
million of restructuring costs related to Surf & Call segment were
reclassified to discontinued operations).

OTHER INCOME (EXPENSE), NET

During 2002, we sold 4,608,165 shares of ITXC, representing the remainder of
our holdings in ITXC, and realized net proceeds of approximately $13.1
million. In 2001, we sold 180,000 shares of ITXC Corp, and realized net
proceeds of approximately $1.0 million. In 2000, we sold 779,743 shares of
ITXC Corp. in the net amount of approximately $61.2 million and recorded a net
gain of approximately $60.7 million, while we had other expenses of
approximately $3 million.

FINANCING  INCOME, NET

Financing income, net was $0.4 million, or 3% of net sales in 2002, compared
with $1.9 million, or 7% of net sales in 2001, and $3.2 million, or 8% in
2000. The decrease in financing income in 2002 was a result of lower cash
balances and lower interest rates on deposits as well as fluctuations of other
currencies against the U.S. dollar. The increase in financing income in 2000
compared to 1999 was primarily due to the interest income earned on cash and
short-term investments resulting from the net proceeds of the sale of ITXC
shares. See "Item 5B - Liquidity and Capital Resources" below.

TAX REFUNDS AND TAX BENEFITS

Net tax benefits in 2002 were $5.0 million, including a tax refund in the U.S.
of $3.8 million. We paid taxes in the amount of $1.0 million for our various
subsidiaries. The 2002 tax refund resulted from carry-back losses in 2001
against federal tax payments made in 2000. In addition, since the company sold
its remaining shares in ITXC in 2002, it re-assessed its tax liability due to
the change in circumstances and, as a result, decreased its tax liability by
approximately $2.5 million.

Net tax benefits in 2001 amounted to $0.3 million, comprised of $0.6 million
in net tax


                                   Page 36
<PAGE>

benefit, less $0.3 million tax paid for our various subsidiaries. Taxes on
income in 2000 were $9 million, and income (before income taxes) was $47.4
million. These taxes were primarily for the gain on sale of ITXC shares, after
deduction of net operating loss carryforwards for tax purposes.

We currently have two Approved Enterprise programs under the Law for the
Encouragement of Capital Investments, 1959. Such programs are eligible for
certain tax benefits for the first several years in which they generate
taxable income. Income derived from an Approved Enterprise is subject to a
zero tax rate for two years and up to an additional eight years of reduced
corporate tax rate until the earlier of (i) seven to ten consecutive years,
commencing the year in which the specific Approved Enterprise first generates
taxable income, (ii) twelve years from commencement of production or (iii)
fourteen years from the date of approval of the Approved Enterprise status.
Some of our production and development facilities have been granted Approved
Enterprise status. To date, neither of our Approved Enterprise programs has
generated any taxable income.

As of December 31, 2002, we had net operating loss carryforwards in Israel of
approximately $70 million for tax purposes, and net operating loss carry
forwards in the U.S. of approximately $0.1 million. These net operating losses
may be carried forward and offset against future taxable income under
applicable tax laws. Tax benefits which apply to us under Israeli law do not
apply to any income generated by any of our other subsidiaries.

DISCONTINUED OPERATIONS

In June 2001 we made a strategic decision to cease operations of our wholly
owned subsidiary, TrulyGlobal Inc., after being unsuccessful in obtaining
external financing, and we decided to merge TrulyGlobal's operations with
VocalTec Communications, Inc. Expenses incurred by TrulyGlobal until June 30,
2001 were $4.4 million. The loss on the disposal of segment of $2.4 million
included the disposal of fixed assets, the fulfillment of contractual
obligations, severance payments and notice payments for those TrulyGlobal
employees that were not retained by VocalTec. The merger was formally
completed in November 2001, and our profit and loss figures for 2000 reflect
this transaction according to U.S. GAAP.

In May 2002, we finalized the carve-out of our Surf&Call operations into a
separate corporate entity, Surf&Call Solutions Ltd., in which we hold a
minority interest with the remaining equity being held by a group of previous
employees of the Surf&Call unit. Operating loss posted by the Surf & Call
segment until March 31, 2001 were $0.6 million, while expenses on disposal of
the segment were $1.8 million, including a $0.55 million convertible loan
write-off and the write-off in the amount of $0.76 million for transferred
equipment. The results of operations of Surf&Call were reclassified to be
reported as discontinued operations in 2001 and 2000, and affected various
items in our Income Statement for 2001 and 2000, although the net loss for
2001 and 2000 was unchanged.

                                   Page 37
<PAGE>

Under the terms and conditions of the carve-out, VocalTec contributed to the
new company certain technology used by the Surf&Call unit. Further, VocalTec
transferred to the new company existing equipment of the Surf&Call unit valued
at $0.76 million in exchange for a long-term note in such amount. VocalTec
also provided a credit to purchase software products valued at up to $1.0
million. VocalTec made available to the new company a convertible loan in the
amount of $0.55 million, and VocalTec agreed to provide certain administrative
services to the new company in consideration for agreed-upon fees. In
addition, we also transferred approximately fifteen employees to the
newly-formed company. We received a minority interest and warrants in the
newly-formed company granting us voting powers of 19.9%. We assigned to the
new company all of our rights and obligations relating to the Surf&Call
products under certain existing customer contracts. VocalTec and the new
company serve as resellers of each other's products.

NET INCOME (LOSS)

Net loss from continuing operations in 2002 was $5.8 million, representing 37%
of net sales or $0.48 per share. Net loss was $8.2 million representing 52% of
net sales, or $0.68 per share, including a charge for restructuring costs of
$2.7 million, or $0.22 per share, a charge for discontinued operations of $2.4
million representing $0.20 per share, a gain from our sale of ITXC shares of
$10.3 million or $0.85 per share, a tax benefit of $5.3 million or $0.44 per
share, and a charge due to an inventory write-off of $0.9 million or $0.07 per
share.

Net loss from continuing operations in 2001 was $20.5 million, representing
76% of net sales or $1.69 per share. Net loss was $31.8 million representing
118% of net sales, or $2.62 per share, including a charge for restructuring
costs of $1.8 million, or $0.14 per share, a charge for discontinued
operations of $11.3 million or $0.93 per share, a gain from our sale of ITXC
shares of $0.94 million or $0.08 per share, a tax benefit of $0.3 million or
$0.02 per share, and a charge due to an inventory write-off of $1.4 million or
$0.12 per share.

Net income from continuing operations in 2000 was $38.3 million representing
102% of net sales, representing $3.17 per share. Net income in 2000 was $28.8
million or 77% of net sales, or $2.39 per share, including a charge for
discontinued operations of $9.5 million or $0.78 per share. This includes
income from our sale of ITXC shares of $61 million or $5.03 per share. The net
loss excluding the income from the sale of shares, less taxes and other
expenses was $13.4 million, or $1.11 per share representing 36% of net sales.

Our net revenues for the first quarter of 2003 were $6.2 million, and our net
loss was $1.3 million. This increase in revenues in the first quarter from
previous quarters resulted primarily from increased purchases by the T-Systems
subsidiary of the Deutsche Telekom Group.

In 2000 we began segment reporting for three business units: our core unit
VocalTec,


                                   Page 38
<PAGE>

TrulyGlobal, and Surf&Call, as described below. In May 2002 we carved out our
Surf&Call business unit into a separate corporate entity, and in November 2001
we merged the operations of our TrulyGlobal subsidiary into VocalTec. As a
result, there is no segment reporting in year 2002.

Our financial statements are reported in dollars and the vast majority of our
sales are made in U.S. dollars. Most of our expenses are in New Israeli
Shekels (NIS) and dollars. The cost of our operations in Israel, as expressed
in dollars, is influenced by the extent to which any increase/decrease in the
rate of inflation in Israel is not offset by the appreciation/depreciation of
the NIS in relation to the dollar. In 2002, the rate of inflation in Israel
was 6.5%. The rate of depreciation of the NIS in relation to the dollar was
7.3%. The depreciation of the NIS in relation to the dollar led to a lower
dollar cost of operations in Israel.

LIQUIDITY AND CAPITAL RESOURCES

During the past three years, we covered our cash flow requirements using
operating revenues, proceeds from gradual sales of our holdings of ITXC
shares, grants from the Chief Scientist and other cash reserves.

As of December 31, 2002, we had approximately $17.7 million in cash, cash
equivalents and short-term investments, comprised of $10 million in cash and
cash equivalents and $7.7 million in short-term investments, and as of March
31, 2003, we had approximately $15.2 million in cash, cash equivalents and
short-term investments. As of December 31, 2001 we had approximately $18.4
million in cash, cash equivalents and short-term investments, comprised of
$9.9 million in cash and cash equivalents and $8.5 million in short-term
investments. Some of our short-term investments consist of commercial papers
currently rated A2/P2. We generally hold commercial papers until maturity. In
addition, some of our cash is invested in time deposits, under which penalties
are imposed if withdrawn before maturity.

As of December 31, 2002, we had working capital of approximately $14.7 million
compared with working capital of $17.1 million on December 31, 2001. The net
decrease in working capital during 2002 is net of proceeds from the sale of
ITXC shares, and resulted primarily from our operating loss and various
one-time charges. The decrease in cash and cash investments was a direct
result of our usage of cash to cover our operating loss for the year, as net
sales and gross margins decreased in 2002 and were insufficient to cover
operating expenses.

Net cash used in operating activities was $12.5 million, $30.3 million, and
$19.6 million for the years ending December 31, 2002, 2001, and 2000,
respectively. The principal use of cash in each of these years was to fund our
losses from operations. Amounts paid as income tax payments were $0.4 million
in 2002, $0.1 million in 2001 and $6.4 million in 2000.

                                   Page 39
<PAGE>

Net cash provided by investment activities was $12.6 million, $22.7 million,
and $22.8 million for the years ending December 31, 2002, 2001, and 2000,
respectively. Net cash provided by investing activities generally consists of
short-term investments which matured during the relevant year. In years
between 2000 and 2002, net cash provided by investments included proceeds from
the sale of ITXC shares. In 2002 and 2001, net cash from short-term
investments amounted to $0.8 million and $23.2 million, respectively. In 2000,
we deposited $1.0 million in a long-term deposit account which matured in
2001. In 2000, cash deposited as short-term investments was $29.9 million.
Proceeds from the sale of ITXC shares were $13.1 million in 2002, $1.0 million
in 2001, and $61.2 million in 2000. In years 2001 and 2000, our investments in
the shares of other companies amounted to $0.7 million, and $0.8 million,
respectively. In 2002, we extended a convertible loan to Surf&Call in the
amount of $0.6 million as part of the carve-out of Surf&Call (see Item 5A -
Operating Results). Cash used for purchase of equipment was $0.8 million,
$1.8, million, and $6.7 million for 2002, 2001 and 2000, respectively.
Proceeds from the sale of equipment were $0.1 million in 2002, and were
negligible in 2001.

In 2000, cash flows used for financing activities amounted to $17.6 million.
An outstanding bank loan in the amount of $20.0 million received in 1999 was
repaid in full in year 2000. The remaining cash flows from financing
activities resulted from proceeds from the exercise of options under our stock
option plans. As of December 31, 2002, we had bank guarantees in the amount of
approximately $0.9 million.

We anticipate that operating expenses may exceed revenues, net of cost of
sales in 2003 and possibly beyond if we do not sufficiently increase sales.
Throughout 2002 and 2001, we undertook a series of cost reduction measures and
may need to consider additional cost reduction measures in the future to
further reduce our operating expenses. We believe that current cash and cash
equivalents balances, and cash flows from operations and grants from the Chief
Scientist will be sufficient to meet our anticipated cash needs for working
capital and capital expenditures for at least the next 12 months. However, if
our revenues were to decrease, whether due to a continued slowdown in the
telecommunications industry, as a result of evolving industry standards and
rapid technological changes that could result in our products being no longer
in demand, the reduction in our product prices, or our failure to retain our
customers, we may need to reduce our operating expenses or use more of our
cash reserves to fund operating expenses. Similarly, in the event that the
amounts we receive from research and development grants decline, we may need
to reduce operating expenses and utilize more of our cash reserves for our
operations. If such measures are insufficient, we may attempt to establish
lines of credit or sell additional equity securities or debt securities. The
continued weakness in the capital markets and the difficulties in raising
funds faced by high technology companies that offer innovative technologies
but have not yet achieved stable revenue streams is likely to make it
difficult or impossible to raise additional capital, which will adversely
affect our ability to sustain our current or future operations, research and
development and sales infrastructures, and to compete in the VoIP market.
Additional funding may not be available on favorable terms or at all.

                                   Page 40
<PAGE>

In 2002 and to date, we have not incurred any debt.

Capital expenditures in 2002 were approximately $0.8 million compared with
$1.8 million in 2001 and $6.7 million in 2000. The increase in 2000 was
primarily due to investments in computer and other related equipment for
expected growth and the establishment of our three business units. We
anticipate that capital expenditures in 2003 will be between $0.7 million and
$1.0 million. See Item 4A for further details.

The cost of our solutions increased during 2002 and 2001 from previous years
as a result of a larger percentage of hardware components in our solutions, as
well as due to price increases in the cost of such hardware components. We
expect this trend to continue.

In the beginning of 2002 we received an IRS income tax refund in the amount of
$4.4 million, for 2000 and 2001. These refunds relate to taxes paid on capital
gains for year 2000, offset by losses incurred in years 2000 and 2001 which
were carried-back. In the event that we continue to generate losses during
2002, we may be entitled to additional tax refunds under applicable US tax
laws. See Item 5A "Tax Refunds and Tax Benefits".

We maintain annual car leases in the amount of approximately $1.0 million, and
our total liability for early termination of the leases is in the amount of up
to $142,000.

INVENTORY AND RECEIVABLES

Inventories at the end of 2002 were $4.1 million compared with $3.6 million at
the end of 2001 and $5.4 million at the end of 2000. The increase in inventory
in 2002 was due to large quantities of inventory delivered to customers for
deals that we expect to recognize revenues during 2003. The decrease in 2001
compared with 2000 was due to lower inventory levels and an accrual for
inventory write-off of $1.4 million.

Trade receivables are from purchases of our products primarily by
telecommunications companies and service providers. Trade receivables are
presented at gross value, less reserves for unrecognized sales, and less
reserves for doubtful accounts. Trade receivables net were approximately $0.7
million at the end of 2002, compared with $5.4 million at the end of 2001, and
$8.4 million at the end of 2000.The reduction is due to the decline in our net
sales and increased collection of customer payments prior to shipping
products. The decrease in 2001 compared to 2000 was primarily due to lower net
sales and more efficient collection processes. Net trade receivables increased
slightly as a percentage of net sales in 2001. There can be no assurance that
our reserves for bad debts are adequate due to the short history and lack of
collection experience we have with these types of providers.

Other receivables were $2 million at the end of 2002 compared with $2.5
million at the end of 2001 and $3.9 million at the end of 2000. The decreases
in 2002 and 2001 were due to lower interests on deposits, and accelerated
actual grant payments received from the Chief Scientist. The increase in 2000
was due to an increase in accrued interest on deposits, pre-paid expenses and
leasing deposits and was offset by a decrease in the Chief

                                   Page 41
<PAGE>

Scientist receivables.

RECENT ACCOUNTING PRONOUNCEMENTS


In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities," which addresses the recognition,
measurement, and reporting of costs associated with exit and disposal
activities, including restructuring activities. SFAS No. 146 requires that
costs associated with exit or disposal activities be recognized when they are
incurred rather than at the date of a commitment to an exit or disposal plan.
SFAS No. 146 also requires liabilities incurred in respect of such costs to be
measured at fair value. SFAS No. 146 is effective for all exit or disposal
activities initiated after December 31, 2002. The Company does not expect the
adoption of SFAS No. 146 to have a material impact on the Company's results of
operations or financial position.


5C. RESEARCH AND DEVELOPMENT, PATENTS AND LICENSES

INTELLECTUAL PROPERTY

We believe that the improvement of existing products, our technologies and the
development of new products are important in establishing and maintaining a
competitive advantage. We believe that the value of our products is dependent,
to a certain extent, upon the maintenance of patent, trade secret or copyright
protection of our proprietary software and technologies. We rely on a
combination of trade secrets, copyright, trademark and patent law, together
with non-disclosure and invention assignment agreements, to establish and
protect the technology used in our products.

We have filed numerous patent applications in the United States and other
countries with respect to certain technologies employed in our products. Some
of those applications have already registered and we own those registered
patents. In addition, we have filed trademark applications in the United
States and other countries with respect to trademarks associated with us, and
our products. Some of those applications have already been registered and we
own those registered trademarks.

Generally, we enter into non-disclosure and invention assignment agreements
with our employees, and into non-disclosure agreements with our consultants,
subcontractors and distributors. However, there can be no assurance that such
measures will protect our proprietary technology, that competitors will not
develop products with features based upon, or otherwise similar to, our
products or that we will be able to enjoin competitors from selling similar
products.

Although we do not believe that our products infringe on any valid claim of a
patent owned by any third party, third parties have asserted infringement and
other claims against us from time to time. These claims have been directed at
certain basic and


                                   Page 42
<PAGE>

fundamental components of our products, those of which were not abandoned were
resolved by successfully implementing a licensing agreement. There can be no
assurance that third parties will not assert such claims against us in the
future or that such claims will not be successful.

On February 15, 2000, Multi-Tech Systems, Inc., filed a complaint in the
United States District Court for the District of Minnesota, in which it
alleged that we and our wholly owned subsidiary, VocalTec Communications Inc.,
as well as other named defendants, are infringing four of Multi-Tech's
Patents. In October 2001, we settled the suit on terms and conditions not
materially adverse to VocalTec. The settlement, terms and conditions are
subject to confidentiality obligations between VocalTec and Multi-Tech.

We could incur substantial costs and diversion of management resources with
respect to the defense of any claims relating to proprietary rights that could
have a material adverse effect on our business, financial condition or results
of operations. If any such claims or actions are asserted or prosecuted
against us, we may seek to obtain a license under a third party's intellectual
property rights. There can be no assurance, however, that under such
circumstances a license would be available on reasonable terms or at all. In
the event a party that is successful in asserting a claim against us does not
grant a license, such party could secure a judgment resulting in the award of
damages, as well as injunctive or other equitable relief which could
effectively block us from manufacturing, using, selling, or otherwise
distributing its products.

VocalTec, Essentra, VocalTec Telephony Gateway, Internet Phone, Internet Phone
Lite, Internet Voice Mail, VocalTec Conference Server, VocalTec Network
Manager, VocalTec Gatekeeper, I2N, PassaPort, PassaFax, Surf&Call, Surf &
Share, Internet Phone Call Waiting, VocalTec Surf&Call Center, VocalTec
Unipop, Gateswitch, are all trademarks or registered trademarks of VocalTec.
All other trademarks or registered trademarks used in this Annual Report on
Form 20-F are the property of their respective owners.

RESEARCH AND DEVELOPMENT

We believe that our ability to enhance our current products, develop and
introduce new products on a timely basis, maintain technological
competitiveness and meet customer requirements is essential to our future
success. Accordingly, we devote and intend to continue to devote a significant
portion of our personnel and financial resources to research and development.
We also intend to continue seeking and maintaining close relationships with
our customers in order to remain responsive to their needs. We have a
multi-disciplinary research and development team that specializes in audio and
voice processing, computer and networking software, embedded software,
hardware integration, and communications protocols and drivers. We seek to
employ highly qualified technical personnel in order to maintain our
technological expertise. In 2002, we invested $4.9 million compared with $8.8
million ($6.4 million without Surf&Call) in 2001 in our research and
development efforts for salaried personnel, and $8.4 million in 2000.

                                   Page 43
<PAGE>

Our research and development personnel regularly examine and test new software
and communication and networking technologies in order to evaluate their
applicability to our products. Our research and development personnel are also
involved in creating and improving standards within the international
standard, setting bodies, so as to lead the industry into compliance with
interoperable and robust solutions that will enable mainstream acceptance of
new technologies and products.

We intend to continue to develop solutions to provide carrier-grade VoIP
telephony equipment and solutions. However, we can provide no assurance that
we will successfully develop new or enhanced products.

SEE ITEM 5A "OPERATING RESULTS - RESEARCH AND DEVELOPMENT COSTS, NET".

5D. TREND INFORMATION

The turbulent economic events commencing in 2000 have resulted in an economic
decline in all sectors of the telecommunications industry. Along with the
downturn in capital markets, these events have precluded the establishment and
financing of new potential customer carriers. In addition, existing
telecommunications providers, including some of our customers, have sustained
significant economic losses and have ceased operations or have been forced to
reduce capital expenditures for 2002 and beyond in order to reduce debt and
operating expenses. As part of such cost reduction measures, these carriers
are delaying capacity upgrades, network expansions and the implementation of
new technologies. The downturn in capital markets and continued reduction of
capital expenditures by telecommunications carriers have resulted in decreased
market demand for our products, and have adversely affected our revenues.

Notwithstanding the general decline in many sectors of the telecommunications
industry over the past three years, long distance (international and domestic)
Voice over Packet minutes grew approximately 146% percent to 69 billion
minutes in 2002, according to Telegeography and Probe Research industry
sources. Packet telephony networks generate in 2002 approximately 12% of the
world's international traffic and 2% of the world's domestic long distance
traffic. This continuing growth comes from expansion in wholesale
international long distance networks, and the creation of new long distance
networks in deregulating and developing economies. This analysis is shared by
various industry firms such as Probe Research, Telegeography and iLocus. These
analysts expect that the market forces led by deregulation and competition
will continue to drive changes and innovation enabling faster, vibrant telecom
growth - mainly in emerging economies like India positioned for exponential
economic growth. On the basis of available market analyses and the company's
involvement in the VOIP industry, we believe that deregulation will result in
lower prices and government plans to increase the number of telephone lines
(teledensity), requiring more flexible, dynamic networks that enable quicker
deployment of new services and reduction in operational expenses to improve
margins and shorten return on investment periods.

                                   Page 44
<PAGE>

During 2002, we undertook cost reduction measures that resulted in
restructuring charges of approximately $2.7 million. Among the restructuring
measures in 2002, there was a reduction of approximately 42% of the total
workforce (including the carve out of Surf & Call employees, presented as
discontinued operations), and we closed our sales offices in Australia, Italy,
France, Spain and Sweden, among other measures.

During 2001, we undertook cost reduction measures that resulted in a
restructuring charge in the second quarter of approximately $1.6 million, and
in the fourth quarter of approximately $0.2 million. Among the restructuring
measures in 2001, there was a reduction of approximately 40% of the total
workforce at that time, and a salary reduction of an average of above 12%,
among other measures.


ITEM 6.           DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES

6A.        DIRECTORS AND SENIOR MANAGEMENT

The following sets forth certain information regarding our directors and
executive officers:

      Name                             Position
      Dr. Elon A. Ganor                Chairman of the Board of Directors
                                       and Chief Executive Officer
      Ami Tal                          Director and Executive Vice President
                                       of Global Sales
      Yoav Chelouche                   Director
      Lior Haramaty                    Director
      Douglas Dunn                     Director
      Hugo Goldman                     Chief Financial Officer

Set forth below, is a biographical summary of the business experience of each
of the directors and executive officers named above:

DR. ELON A. GANOR has served as the Chairman of our Board of Directors since
1993. From 1993 to October 1998, and since November 1999, Dr. Ganor also
served as our Chief Executive Officer. From 1990 to 1992, Dr. Ganor was
responsible for the sales and marketing of our products through his
association with a subsidiary of LaCresta, where he served as a vice
president. Before becoming a shareholder of our company, LaCresta acted as a
distributor of our products. Dr. Ganor is the brother-in-law of Ami Tal.

AMI TAL has served as Executive Vice President of Global Sales since November
1999, and as director since 1992. He served as Vice President of Operations
from April 1998 to November 1999, Chief Operating Officer from 1995 to May
2000 and Chief Financial Officer from 1992 to 1995. From 1990 to 1992, Mr. Tal
served as Vice President and head of the International Trading Division of
LaCresta. Mr. Tal is the brother-in-law of Dr. Ganor.


                                   Page 45
<PAGE>


LIOR HARAMATY is a co-founder of our company and was a major contributor in
creating and propelling the Internet Telephony industry. Mr. Haramaty served
as director since the company's inception in 1989 and held multiple executive
positions until mid 2000. Currently he serves as a consultant to various
companies, including StructuredWeb at which he also serves as a board member,
and is the co-founder and CEO of Designfenzider, a New York based design firm.

DOUGLAS DUNN has served as director since January 2000. Mr. Dunn, former Vice
President of Visual Communications and Multimedia Strategy at AT&T, has spent
26 years at the telecommunications and multimedia company where his business
acumen spanned both the commercial sector and research arenas at Bell
Laboratories. Mr. Dunn recently retired from his position as Dean of Carnegie
Mellon University's Graduate School of Industrial Administration.

YOAV CHELOUCHE has served as director since July 2000. Mr. Chelouche is the
Chairman of the Fantine Group. From November 1995 to mid-2001, Mr. Chelouche
was President and Chief Executive Officer of Scitex Corporation Ltd., and was
a director of Scitex from May 1996 to 2001. Since 1979, Mr. Chelouche has held
several positions within Scitex, including executive vice president of
marketing and business development. Mr. Chelouche qualifies as an External
Director according to the Israel Companies Law - 1999.

HUGO GOLDMAN has served as Chief Financial Officer since March 2001. Prior to
joining VocalTec and since December 1999, Mr. Goldman held various key
executive positions at Algorithmic Research, an Internet security company.
Previously, Mr. Goldman worked at Motorola Semiconductor Products Sector for
over sixteen years (1983-1999) in Israel and abroad, including in the position
of Chief Financial Officer of Motorola Semiconductor Israel. Prior to his long
tenure at Motorola, Mr. Goldman held audit management positions at Kesselman &
Kesselman (PriceWaterhouseCoopers) until 1983.

6B.        COMPENSATION OF DIRECTORS AND EXECUTIVE OFFICERS

The aggregate compensation paid to all our directors and officers as a group
during the fiscal year 2002 was approximately $1.3 million in salaries,
directors' fees, and bonuses, and 272,200 options. 172,200 of these options
were granted on February 8, 2002 at an exercise price of $1.82, and 100,000 of
these options were granted on October 21, 2002 at an exercise price of $0.57.
Options expire ten years after the date of the grant.

The aggregate total amounts set aside or accrued by the Company or its
subsidiaries to provide for severance payments is approximately $0.5 million.

6C.        BOARD PRACTICES

                                   Page 46
<PAGE>

The period during which our directors and senior management have each served
in their respective offices is set forth in "Item 6A - Directors and Senior
Management". There is no date of expiration of the current term of office of
any of the senior management members. The expiration date of the terms of
office of our directors are as follows: (a) for Yoav Chelouche in July 2003
and may be renewed for one additional three-year term; (b) Ami Tal's term as
director expires at the 2005 annual shareholder's meeting and may be renewed;
(c) Elon Ganor's term as director expires at the annual shareholders meeting
in 2003 and may be renewed; and (d) Lior Haramaty and Douglas Dunn, their
respective terms as directors expire at the annual shareholders meeting in
2004 and may be renewed.

There are no service contracts between us or any of our subsidiaries and our
directors in their capacity as directors providing for benefits upon
termination of employment, except for the termination provisions included in
the employment agreement of officers that also act as directors and that
concern solely their termination from their positions as employees. In October
2000, we entered into Indemnification Agreements with our directors and senior
management in order to assure continued service in an effective manner. The
indemnification agreements provide protection against personal liability due
to an act performed or failure to act in the capacity as a director or
officer.

Our audit committee is comprised of Douglas Dunn, Yoav Chelouche and until
April 2003 comprised also a third director that resigned for personal reasons.
We are currently in the process of identifying and electing a new director
that would replace such resigning director and would qualify as an external
director under the Companies Law and as an independent director under the
Nasdaq rules and would become a member of the audit committee. Mr. Lior
Haramaty will serve on our Audit Committee until such replacement is found.
While as of the date of this report, Mr. Haramaty does not qualify as an
independent director under Nasdaq rules, he may become qualified within a few
months, and our board believes that in these exceptional circumstances of the
resignation of a previous independent director, the appointment of Mr.
Haramaty to the Audit Committee is in the best interests of the company and
its shareholders. Our compensation committee is comprised of Elon Ganor, Yoav
Chelouche and Douglas Dunn. The purpose of the Audit Committee is to provide
assistance to the Board of Directors in fulfilling its legal and fiduciary
obligations with respect to matters involving the accounting, auditing,
financial reporting and internal control functions of VocalTec and its
subsidiaries as well as complying with the legal requirements under Israeli
law and the Sarbanes-Oxley Act of 2002. The following are examples of
functions within the authority of the Audit Committee:

o        To detect irregularities in the management of our business and our
         internal controls procedures through, among other things,
         consultation with our internal and external auditors and to suggest
         to the Board of Directors methods to correct those irregularities.

o        To decide whether to approve acts or transactions involving
         directors, executive officers, controlling shareholders and third
         parties in which directors, executive officers or controlling
         shareholders have an interest.

                                   Page 47
<PAGE>

o        To assist our Board of Directors in performing its duties to oversee
         our accounting and financial policies, internal controls, and
         financial reporting practices and to communicate on a regular basis
         with the company's outside auditors and review their operation and
         remuneration.

o        To maintain and facilitate communication between our Board of
         Directors and our financial management and our auditors.

6D.        EMPLOYEES

At December 31, 2002, we employed 148 full time employees, of which 48 were
employed in research and development (compared with 99 in 2001 and 142 in
2000), 65 were employed in sales and marketing (compared with 110 in 2001 and
152 in 2000),23 were employed in general and administrative (compared with 47
in 2001 and 86 in 2000), and 12 were employed in operations. Of these
employees, 107 were based in our facilities in Israel, 18 in the United
States, 18 in Asia Pacific and 5 in Europe. As of April 25, 2003 we employed a
total of 146 full time employees. We believe that our relations with our
employees are good. Neither our employees nor we are parties to any collective
bargaining agreements, except for provisions of such agreements that are
applicable to the industry by virtue of extension orders issued under
applicable Israeli laws. During 2002, we eliminated 108 positions as part of
our restructuring plans.

6E.        SHARE OWNERSHIP

As of April 25, 2003 each of the individuals listed in Item 6A beneficially
owned less than one (1%) percent of our ordinary shares, and each such
person's individual share ownership has not been previously disclosed to
shareholders or otherwise made public, with the exception of Lior Haramaty who
owns 425,000 shares and 85,000 options, and of Elon Ganor and Ami Tal who
beneficially own the 940,050 shares held by LaCresta International Trading
Inc., as well as 7,500 shares and 490,000 options held by Elon Ganor and
10,000 shares and 198,000 options held by Ami Tal.

We have established a number of employee option plans containing terms and
conditions for the vesting and exercising of options granted to employees for
the purchase of our ordinary shares.

The various employee stock option plans are as follows: (a) 1996 Stock Option
And Incentive Plan; (b) 1997 Stock Option And Incentive Plan; (c) 1998 Stock
Option And Incentive Plan; (d) 1999 Stock Option And Incentive Plan; (e) 2000
Master Stock Option Plan; and (f) 2003 Master Stock Option Plan containing a
pool of 1 million options, which we will be filing with the SEC as part of our
S-8 statement in the near future.

Options generally have a term of ten (10) years. Earlier termination may occur
if the employee's employment with us is terminated or if certain corporate
changes or transactions occur. Our Board of Directors determines the grant and
the exercise price at the time the options are granted upon recommendation of
the Compensation Committee.


                                   Page 48
<PAGE>

The exercise price per share is usually granted at the approximate fair market
value of the shares on the date of grant, as determined by the closing price
for our ordinary shares as reported by the Nasdaq SmallCap Market on the date
of grant for incentive stock options.

Each stock option agreement specifies the date and period over which the
option becomes exercisable. Options granted by us generally vest over a period
of four years, either in equal quarterly installments of 6.25% of the option
shares, starting three months after the date of grant, or 25% of the option
shares are vested one year following option grant, and the remaining 75% vest
in equal quarterly installments of 6.25% over the remaining three years.
Vesting is conditional upon employee remaining continuously employed by
VocalTec or its subsidiaries.

The recent downtrend in the conditions of the financial markets and their
effect on the share price of the company adversely affected the value of some
of the stock options granted to employees of the Company. Since we believe
that there is great significance in maintaining the equity incentive of our
employees, we implemented a stock option exchange program in August 2001 under
which employees had an opportunity to cancel their outstanding stock options
that were issued under the Company's stock option plans in exchange for new
options granted in February 2002. Employees who elected to participate in the
exchange were issued 0.8 new options in exchange for each cancelled old option
at a new exercise price determined as of the date of grant of the new options.
The new options vest and are exercisable during a period of two and one half
(2 1/2) years from the date of grant, in accordance with the following
schedule: (a) 34% of the new options vest six months after the date of grant
of the new options; and (b) 8.25% of each such new options grant vest every
three months thereafter.


ITEM 7.    MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS

7A.        MAJOR SHAREHOLDERS

The following table sets forth, as of May 8, 2003, the number of our
ordinary shares, which constitute our only voting securities, beneficially
owned by (i) all shareholders known to us to own more than five percent (5%)
of our outstanding ordinary shares, and (ii) all of our directors and
executive officers as a group.

<TABLE>
<CAPTION>

                                                          Ordinary Shares Beneficially Owned
                                                          ----------------------------------
Name and Address                                                Number          Percent
----------------                                                ------          -------
<S>                                                           <C>                 <C>
Deutsche Telekom A.G.                                         2,300,000           19%
Friedrich-Ebert-Allee 140
D-53113 Bonn, Germany
---------------------------------------------------------------------------------------------
LaCresta International Trading Inc. (1)                       1,366,250           11%
c/o L.C.I.T. S.A Dufourstrasse 131
P.O.B. 219 Zurich 8034, Switzerland
---------------------------------------------------------------------------------------------



                                   Page 49
<PAGE>


Officers and directors as a group (2)                         2,090,062           17%
(7  persons)
---------------------------------------------------------------------------------------------
</TABLE>

(1)      Dr. Elon Ganor, who is VocalTec's Chairman of the Board and Chief
         Executive Officer, and Ami Tal, who is VocalTec's Executive Vice
         President of Global Sales and a Director, each own 50% of the
         outstanding voting shares of LaCresta. Dr. Ganor and Mr. Tal are
         brothers-in-law.

         Includes, in addition to the ordinary shares held by LaCresta of
         record, (i) 290,500 options for ordinary shares held by Dr. Ganor
         that are exercisable within 60 days of the date stated above and
         (ii) 118,200 options for ordinary shares held by Mr. Tal that are
         exercisable within 60 days of the date stated above, and (ii) 10,000
         shares held by Mr. Tal and 7,500 shares held by Dr. Ganor.

(2)      Includes (i) 707,512 ordinary shares for which options granted to
         officers and directors of our Company are exercisable within 60 days
         of the date stated above, and (ii) 940,050 ordinary shares held by
         LaCresta, which may be deemed to be beneficially owned by Dr. Ganor
         and Mr. Tal, and (iii) 10,000 shares held by Mr. Tal and 7,500 shares
         held by Dr. Ganor; and (iv) 425,000 ordinary shares held by Mr. Lior
         Haramaty. Does not include 529,688 ordinary shares for which options
         granted to officers and directors of our company are outstanding but
         are not currently or within 60 days exercisable.

There has not been any significant change in the percentage ownership held by
any major shareholders during the past three years. Our major shareholders do
not have different voting rights from each other or other shareholders.

To our knowledge, (A) we are not directly or indirectly owned or controlled
(i) by another corporation or (ii) by any foreign government or (iii) by any
other natural or legal persons and (B) there are no arrangements, the
operation of which may at a subsequent date result in a change in control of
VocalTec.

For information as to the portion of each class of securities held in the
United States and the number of record holders see "Item 9 - The Offer and
Listing".

7B.        RELATED PARTY TRANSACTIONS

A credit line in an amount of up to $25 million exists between VocalTec
Communications Inc., as lender, and VocalTec Communications Ltd., as borrower,
at the three months Libor interest rate. The largest amount outstanding during
2002 under this credit line was in the amount of $16.9 million. To date,
approximately $18 million of the credit line has been used.

The company has engaged in various commercial transactions with its
subsidiaries and associates, as follows:

o        In November 2001, we entered into a Reseller Agreement with Deutsche
         Telekom A.G., in which Deutsche Telekom was appointed as a strategic
         reseller of our products. The Reseller Agreement was assigned to
         Deutsche Telekom's T-Systems International subsidiary, following
         changes in the organizational structure of Deutsche Telekom.

                                   Page 50
<PAGE>

o        In May 2002, we finalized the carve-out of our Surf&Call operations
         into a separate corporate entity, Surf&Call Solutions Ltd., in which
         we hold a minority interest with the remaining equity being held by a
         group of previous employees of the Surf&Call unit. Under the terms
         and conditions of the carve-out, VocalTec contributed to the new
         company certain technology used by the Surf&Call unit. Further,
         VocalTec transferred to the new company existing equipment of the
         Surf&Call unit valued at $0.76 million in exchange for a long-term
         note in such amount. VocalTec also provided a credit to purchase
         software products valued at up to $1.0 million. VocalTec made
         available to the new company a convertible loan in the amount of
         $0.55 million, and VocalTec agreed to provide certain services to the
         new company in consideration for agreed-upon fees. In addition, we
         also transferred approximately fifteen employees to the newly-formed
         company. We received a minority interest and warrants in the
         newly-formed company. In addition, VocalTec assigned to the new
         company all of its rights and obligations relating to the Surf&Call
         products. under certain existing VocalTec customer contracts.
         VocalTec and the new company serve as resellers of each other's
         products.

o        We have been generating sales of our products to Deutsche Telekom's
         T-Systems subsidiary. During calendar year 2002, such sales
         significantly exceeded 10% of our net sales. Deutsche Telekom is a
         major shareholder of the company.

7C.      INTERESTS OF EXPERTS AND COUNSEL

Not applicable.


ITEM 8.  FINANCIAL INFORMATION

8A.      CONSOLIDATED STATEMENTS AND OTHER FINANCIAL INFORMATION

Our consolidated financial statements are set forth elsewhere in this
document.

EXPORT SALES

Export sales were $15.5 million or 99% of net sales in 2002, compared with
$25.9 million, or 96% of net sales in 2001, and $32.9 million, or 88% of net
sales, in 2000.

LEGAL PROCEEDINGS

From time to time, we are involved in various routine legal proceedings
incident to the ordinary course of our business. We do not believe that the
outcome of these pending legal proceeding will have a material adverse effect
on our business or consolidated


                                   Page 51
<PAGE>

financial condition.

DIVIDENDS

We have never declared or paid cash dividends on the ordinary shares. We
intend to retain our earnings for future growth and therefore do not
anticipate paying any cash dividends in the foreseeable future.

8B.        SIGNIFICANT CHANGES

Except as disclosed elsewhere in this annual report, there have been no other
significant changes since December 31, 2002.


ITEM 9.    THE OFFER AND LISTING

9A.        OFFER AND LISTING DETAILS

Through May 8, 2003 for the periods indicated, the high and low reported
trading prices of our ordinary shares as reported by Nasdaq were as follows:

                                              HIGH             LOW
                                              ----             ---
1998                                         24.62             5.56
1999                                         19.75             8.03
2000                                         53.25             3.50
2001                                         8.12              0.60
2002                                         3.02              0.26

2001
First quarter                                8.12              3.00
Second quarter                               4.00              1.86
Third quarter                                2.15              0.60
Fourth quarter                               3.68              1.01

2002
First quarter                                3.02              1.50
Second quarter                               1.82              0.83
Third quarter                                1.10              0.38
Fourth quarter                               1.34              0.26

Last six months

November 2002                                1.34              0.44
December 2002                                1.06              0.41
January 2003                                 0.69              0.47



                                   Page 52
<PAGE>

February 2003                                0.77              0.51
March 2003                                   0.69              0.50
April 2003                                   0.97              0.56
May 2003 (through May 8)                     1.36              0.95

As of May 8, 2003, 12,127,058 of our ordinary shares were issued and
outstanding. At such date, the last reported sale price of the ordinary shares
was $1.17 per share, and the ordinary shares were held by 123 record holders.
Of those 123 record holders, 94 are shown on our records as having United
States addresses. The number of record holders in the United States is not
representative of the number of beneficial holders nor is it representative of
where such beneficial holders are resident since many of these ordinary shares
were held of record by brokers or other nominees. As of April 25, 2003 we
believe approximately 53% of our outstanding ordinary shares were held in the
United States.

9B.        PLAN OF DISTRIBUTION

Not applicable.

9C.        MARKETS

Our ordinary shares have been quoted on the Nasdaq National Stock Market, Inc.
since February 7, 1996 under the symbol "VOCLF," which was changed to "VOCL"
on April 20, 1999. Our ordinary shares have also been quoted on the Easdaq
Stock Market since October 17, 2000, under the symbol "VOCL". In December
2002, NASDAQ approved our application to transfer to the NASDAQ SmallCap
Market, where the company's shares continued to be listed under the trading
symbol "VOCL". We may be eligible to be uplisted back to the Nasdaq National
Market if we meet the Nasdaq's uplisting criteria.

9D.        SELLING SHAREHOLDERS

Not applicable.

9E.        DILUTION

Not applicable.


9F.        EXPENSES OF THE ISSUE

Not applicable.


ITEM 10.   ADDITIONAL INFORMATION

10A.       SHARE CAPITAL

                                   Page 53
<PAGE>

Not applicable

10B.       MEMORANDUM AND ARTICLES OF ASSOCIATION

VocalTec is a public company organized in the State of Israel under the
Companies Law. We are registered with the Registrar of Companies of the State
of Israel and have been assigned company number 52-004262-3.

OBJECTS AND PURPOSES

The objects and purposes of our company appear in Section 2 of our Memorandum
of Association and include marketing, importing and acquiring computers,
software for computers and related items; manufacturing, marketing and selling
software for computers and related items; and the design, development and
manufacture of software for computers.

RIGHTS, PREFERENCES AND RESTRICTIONS UPON SHARES

Our articles of association authorize one class of shares, which are our
ordinary shares. We may declare a dividend to be paid to the holders of our
ordinary shares according to their rights and interests in our profits. Our
board may declare interim dividends and a final dividend for any fiscal year
only out of retained earnings, or earnings derived over the two most recent
fiscal years, whichever is higher. Our articles provide that our board may
declare and pay dividends without any future action by our shareholders. All
unclaimed dividends may be invested or otherwise used by the board for our
benefit until those dividends are claimed. In the event an unclaimed dividend
is claimed, only the principal amount of the dividend will be paid to the
person entitled to the dividend. Subject to the creation of any special rights
regarding the distribution of dividends, any dividends we declare will be
distributed to shareholders in proportion to their holdings.

If we liquidate, after satisfying liabilities to creditors, our assets will be
distributed to the holders of ordinary shares in proportion to their holdings.

Holders of ordinary shares have one vote for each paid-up ordinary share held
on all matters submitted to a vote of our shareholders. These voting rights
may be affected by the grant of any special voting rights to the holders of a
class of shares with preferential rights that may be authorized in the future.

Our articles provide that directors are elected by an ordinary resolution of a
general meeting of our shareholders. Our ordinary shares do not have
cumulative voting rights in the election of directors. Accordingly, the
holders of ordinary shares representing more than 50% of the voting power in
our company have the power to elect all directors. However, our board of
directors is divided into three classes: (a) one class to hold office until
our annual meeting of shareholders to be held in 2003, (b) another class to
hold office until our annual meeting of shareholders to be held in 2004 and
(c) a third class to hold office until our annual meeting of shareholders to
be held in 2005.

                                   Page 54
<PAGE>

We may, subject to the applicable provisions of the Companies Law, issue
redeemable shares and subsequently redeem them. In addition, our board may
make calls for upon shareholders in respect of any sum which has not been paid
up in respect of any shares held by those shareholders.

Under the Companies Law, the disclosure requirements that apply to an office
holder and are described below under "Approval of Specified Related Party
Transactions Under Israeli Law" also apply to a controlling shareholder of a
public company. A shareholder that holds more than 50% of the voting rights in
a public company is deemed to be a controlling shareholder. Extraordinary
transactions with a controlling shareholder or in which a controlling
shareholder has a personal interest, and the terms of compensation of a
controlling shareholder who is an office holder, require the approval of the
audit committee, the board of directors and the shareholders of the company.
The shareholder approval requires that: (a) the majority of shares voted at
the meeting, including at least one third of the shares of disinterested
shareholders voted at the meeting, vote in favor of the transaction; or (b)
the total number of shares of disinterested shareholders voted against the
transaction does not exceed one percent of the aggregate voting rights in the
company.

The Companies Law also requires a shareholder to act in good faith towards a
company in which he holds shares and towards other shareholders and to refrain
from abusing his power in the company, including in connection with voting at
a shareholders' meeting on:


      o  Any amendment to the articles of association;
      o  An increase in the company's authorized capital;
      o  A merger; or
      o  Approval of some of the acts and transactions that require
         shareholder approval.

A shareholder has the general duty to refrain from depriving other
shareholders of their rights. Any controlling shareholder, any shareholder
that knows that it possesses the power to determine the outcome of a
shareholder vote and any shareholder that, under the provisions of the
articles of associations, has the power to appoint an office holder in the
company, is under a duty to act in fairness towards the company. The Companies
Law does not describe the substance of this duty.

MODIFICATIONS OF SHARE RIGHTS

Under our articles of association, the rights attached to any class may be
varied by adoption of the necessary amendment of the articles, provided that
the holders of shares of the affected class approve the change by a class
meeting in which the holders of at least 75% of the voting power represented
at the meeting and voting on the issue approve the change. Our articles differ
from the Companies Law in this respect as under the law, changes in the rights
of shareholders require the consent of at least 50% of the voting power of the
affected class represented at the meeting and voting on the change.

                                   Page 55
<PAGE>

SHAREHOLDERS MEETINGS AND RESOLUTIONS

We are required to hold an annual general meeting of our shareholders once
every calendar year, but no later than 15 months after the date of the
previous annual general meeting. All meetings other than the annual general
meeting of shareholders are referred to as extraordinary general meetings.
Extraordinary general meetings may be called by our board whenever it sees
fit, at such time and place, within or without the State of Israel, as it may
be determined. In addition, the Companies Law provides that the board of a
public company is required to convene an extraordinary meeting upon the
request of (a) any two directors of the company or one quarter of the
company's board of directors or (b) one or more shareholders holding, in the
aggregate, (i) five percent of the outstanding shares of the company and one
percent of the voting power in the company or (ii) five percent of the voting
power in the company.

The quorum required for a meeting of shareholders consists of at least two
shareholders present in person or by proxy who hold or represent between them
at least 33.3% of our issued share capital. A meeting adjourned for lack of
quorum is adjourned to the same day in the following week at the same time and
place or any time and place as the chairman of the meeting decides. At such
reconvened meeting, the required quorum consists of any two shareholders
present in person or by proxy.

Notwithstanding the foregoing, our articles provide that a resolution in
writing signed by all our shareholders then entitled to attend and vote at
general meetings or to which all such shareholders have given their written
consent (by letter, telegram, facsimile or otherwise) shall be deemed to have
been unanimously adopted by a duly convened general meeting.

Our articles enable our board to fix a record date to allow us to determine
the shareholders entitled to notice of, or to vote at, any general meeting of
our shareholders. The record date may not be more than 40 days and not less
than four days before the date of the meeting. Each shareholder of record as
of the record date determined by the board may vote the shares then held by
that shareholder unless all calls and other sums then payable by the
shareholder in respect of its shares have not been paid.

LIMITATION ON OWNERSHIP OF SECURITIES

The ownership and voting of our ordinary shares by non-residents of Israel are
not restricted in any way by our articles or by the laws of the State of
Israel, except for shareholders who are subjects of countries that are enemies
of the State of Israel.

MERGERS AND ACQUISITIONS; ANTI-TAKEOVER PROVISION

The Companies Law includes provisions allowing corporate mergers. These
provisions require that the board of directors of each company that is party
to the merger approve the transaction. In addition, the shareholders of each
company must approve the merger by a


                                   Page 56
<PAGE>

vote of the majority of the company's shares, present and voting on the
proposed merger at a shareholders' meeting. In determining whether the
requisite majority has approved the merger, shares held by the other party to
the merger or any person holding at least 25% of such other party are excluded
from the vote.

The Companies Law does not require court approval of a merger other than in
specified situations. However, upon the request of a creditor of either party
to the proposed merger, a court may delay or prevent the merger if it
concludes that there exists a reasonable concern that as a result of the
merger, the surviving company will be unable to satisfy the obligations of any
of the parties of the merger to their creditors.

A merger may not be completed unless at least 70 days have passed from the
time that a request for the approval of the merger has been filed with the
Israeli registrar of companies. This request may be filed once a shareholder
meeting has been called to approve the merger.

The Companies Law also provides that the acquisition of shares in a public
company on the open market must be made by means of a tender offer if, as a
result of the acquisition, the purchaser would become a 25% shareholder of the
company. The rule does not apply if there already is another 25% shareholder
of the company. Similarly, the law provides that an acquisition of shares in a
public company must be made by means of a tender offer if, as a result of the
acquisition, the purchaser would become a 45% shareholder of the company,
unless there already is a 50% shareholder of the company. These rules do not
apply if the acquisition is made by way of a merger as opposed to a tender
offer.

If, following any acquisition of shares, the purchaser would hold 90% of more
of the shares of the company, that acquisition must be made by means of a
tender offer for all of the target company's shares. An acquirer who wishes to
eliminate all minority shareholders must do so by means of a tender offer and
acquire 95% of all shares not held by or for the benefit of the acquirer prior
to the acquisition. However, in the event that the tender offer to acquire
that 95% is not successful, the acquirer may not acquire tendered shares if by
doing so the acquirer would own more than 90% of the shares of the target
company.

Our articles contain provisions that could delay, defer or prevent a change in
our control. These provisions include advance notice requirements and
staggered board provision. Under the advance notice requirements, shareholders
seeking to propose items for inclusion on the agenda for a general meeting of
shareholders, must submit those items in writing to our corporate secretary
not less than 60 days (or not less than 90 days for the nomination of
candidates for election of directors) and not more than 120 days prior to the
particular meeting. The staggered board provisions of our articles are
described above under the caption "Rights, preferences and restrictions upon
shares."

BOARD PRACTICES

Under our articles of association, our board can, at its discretion, cause us
to borrow


                                   Page 57
<PAGE>

money or secure the payment of any sum upon terms and conditions it deems fit.
The board can utilize this power through various methods, including the
issuance of bonds or debentures, or mortgages, charges or other securities on
the whole company or any part of it.

Our directors are not subject to any age limit requirement, nor are they
disqualified from serving on the board because of a failure to own VocalTec
shares.

Directors are classified into three classes. Each class has a nearly equal
number of directors, as determined by the Board of Directors. The terms for
these classes of directors will expire at the annual shareholder meetings of
2003, 2004 and 2005. At each shareholder meeting, the successors of each class
of directors whose terms expire are elected to hold office for a term expiring
at the annual shareholders meeting held in the third year following the year
of their election. The classified board structure may not be amended without
the approval of the greater of (i) holders of not less than 75% of the voting
power represented at a meeting in person or by proxy and voting thereon, or
(ii) holders of a majority of the outstanding voting power of all shares of
the Company.

EXTERNAL DIRECTORS

We are subject to the provisions of the Companies Law. Under the Companies
Law, companies incorporated under the laws of the State of Israel whose shares
have been offered to the public in or outside of Israel are required to
appoint two external directors. The Companies Law provides that a person may
not be appointed as an external director if the person or the person's
relative, partner, employer or any entity under the person's control, has, as
of the date of the person's appointment to serve as external director, or had,
during the two years preceding that date, any affiliation with the company,
any entity controlling the company or any entity controlled by the company or
by the controlling entity of the company. The term affiliation includes:

    o    an employment relationship;

    o    a business or professional relationship maintained on a regular basis;

    o    control; and

    o    service as an office holder.

In addition, no person can serve as an external director if the person's
position or other business activities create, or may create, a conflict of
interest with the person's responsibilities as an external director or may
otherwise interfere with the person's ability to serve as an external
director. Until the lapse of two years from termination of office, a company
may not engage an external director to serve as an office holder and cannot
employ or receive services from that person, either directly or indirectly,
including through a corporation controlled by that person.

                                   Page 58
<PAGE>

External directors are to be elected by a majority vote at a shareholders'
meeting, provided that either: (a) the majority of shares voted at the
meeting, including at least one third of the shares of non-controlling
shareholders voted at the meeting, vote in favor of the election; or (b) the
total number of shares of non-controlling shareholders voted against the
election of the external director does not exceed one percent of the aggregate
voting rights in the company.

The initial term of an external director is three years and may be extended
for an additional three years. External directors may be removed only by the
same percentage of shareholders as is required for their election, or by a
court, and then only if the external directors cease to meet the statutory
qualifications for their appointment or if they violate their duty of loyalty
to the company. Each committee of a company's board of directors is required
to include at least one external director.

INDEPENDENT DIRECTORS

We are subject to the rules of the Nasdaq applicable to listed companies.
Under the Nasdaq rules, we are required to appoint a minimum of three
independent directors. The independence standard under the Nasdaq rules
excludes current employees, former employees of a company or of any of its
affiliates for a period of three years after cessation of employment, as well
as any immediate family member of an executive officer of a company or of any
of its affiliates. Until April 2003, three of our current directors met the
independence standard of the Nasdaq rules. As a result of the resignation of
one of our independent directors in April 2003 due to personal reasons, we are
currently in the process of searching and electing a new director who will
qualify as an independent director.

AUDIT COMMITTEE

Under the Companies Law, the board of directors of any publicly traded company
must also appoint an audit committee, comprised of at least three directors
including all of the external directors, but excluding:

    o    the chairman of the board of directors;

    o    any controlling shareholder or a relative of a controlling shareholder;
         and

    o    any director employed by the company or who provides services to the
         company on a regular basis.

The role of the audit committee under the Companies Law is to detect
irregularities in the management of the company's business through, among
other things, consultation with the Company's internal or external auditor and
to suggest to the board methods to correct those irregularities. In addition,
the approval of the audit committee is required to effect specified actions
and transactions with office holders, controlling shareholders and third
parties in which they have an interest.

                                   Page 59
<PAGE>

An audit committee may not approve an action or a transaction with an office
holder or a controlling shareholder or an entity in which they have a personal
interest unless at the time of approval the two external directors are serving
as members of the audit committee. In addition, at least one of the external
directors must be present at the meeting in which an approval was granted. We
appointed the external directors elected under the Companies Law to our audit
committee. Our current audit committee consists of Yoav Chelouche and Douglas
Dunn, and, we believe, is independent under Nasdaq rules. We are currently in
the process of searching for a new external director to replace Ms. Shainski,
who resigned from her position as director in April 2003. Mr. Lior Haramaty
will serve on our Audit Committee until Ms. Shainski's replacement is
finalized. While as of the date of this report, Mr. Haramaty does not qualify
as an independent director under Nasdaq rules, he may become qualified within
a few months, and our board believes that in these exceptional circumstances
of the resignation of a previous independent director, the appointment of Mr.
Haramaty to the Audit Committee is in the best interests of the company and
its shareholders.

INTERNAL AUDITOR

The Companies Law also requires us to appoint an internal auditor nominated by
the audit committee. The role of the internal auditor is to examine, among
other matters, whether the company's actions comply with the law and orderly
business procedure. Under the Companies Law, the internal auditor may not be
an interested party, an office holder, or an affiliate, or a relative of an
interested party, an office holder or affiliate, nor may the internal auditor
be the company's independent accountant or its representative. In October
2000, the company appointed the firm of Brukner Ingber as the company's
internal auditor in accordance with the requirements of the Companies Law.

APPROVAL OF SPECIFIED RELATED PARTY TRANSACTIONS UNDER ISRAELI LAW

The Companies Law imposes a duty of care and a duty of loyalty on all of a
company's office holders as defined below, including directors and executive
officers. The duty of care requires an office holder to act with the level of
care that a reasonable office holder in the same position would have acted
under the same circumstances. The duty of loyalty generally requires an office
holder to act in good faith and for the good of the company. An "office
holder" as defined in the Companies Law is a director, a general manager, a
chief executive officer, a deputy general manager, a vice general manager,
other managers directly subordinate to the general manager and any person who
fills one of the above positions without regard to title.

The Companies Law requires that an office holder of a company promptly
disclose any personal interest that he may have and all related material
information known to him, in connection with any existing or proposed
transaction by the company. Once an office holder complies with these
disclosure requirements, the board of directors may approve a transaction
between the company and the office holder, or a third party in which an office
holder has a personal interest, unless the articles of association provide
otherwise.


                                   Page 60
<PAGE>

A transaction that is adverse to the company's interest cannot be approved. If
the transaction is an extraordinary transaction under the Companies Law, then,
in addition to any approval stipulated by the articles of association, it also
requires audit committee approval before board approval and, in specified
circumstances, subsequent shareholder approval.

Under the Companies Law, the disclosure requirements that apply to an office
holder also apply to a controlling shareholder of a public company. A
controlling shareholder includes a shareholder that holds 25% or more of the
voting rights in a public company if no other shareholder owns more than 50%
of the voting rights in the company. Extraordinary transactions with a
controlling shareholder or in which a controlling shareholder has a personal
interest, and the terms of compensation of a controlling shareholder who is an
office holder, require the approval of the audit committee, the board of
directors and the shareholders of the company. The shareholder approval
requires that: (a) the majority of shares voted at the meeting, including at
least one third of the shares of disinterested shareholders voted at the
meeting, vote in favor of the transaction; or (b) the total number of shares
of disinterested shareholders voted against the transaction does not exceed
one percent of the aggregate voting rights in the company.

For information concerning the direct and indirect personal interests of
certain of our office holders and principal shareholders in specified
transactions with us, see "Item 7A - Major Shareholders".

EXCULPATION, INSURANCE AND INDEMNIFICATION OF DIRECTORS AND OFFICERS

Under the Companies Law, an Israeli company may not exempt an office holder
from liability with respect to a breach of his duty of loyalty, but may exempt
in advance an office holder from his liability to the company, in whole or in
part, with respect to a breach of his duty of care. Under the Companies Law, a
company may not indemnify an office holder, nor enter into an insurance
contract that would provide coverage for any monetary liability incurred as a
result of any of the following:

    o    a breach by the office holder of his duty of loyalty unless the
         office holder acted in good faith and had a reasonable basis to
         believe that the act would not prejudice the company;

    o    a breach by the office holder of his duty of care if such breach was
         done intentionally or in disregard of the circumstances of the breach
         or its consequences;

    o    any act or omission done with the intent to derive an illegal personal
         benefit; or

    o    any fine levied against the office holder as a result of a criminal
         offense.

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OFFICE HOLDER INSURANCE

Our Articles of Association provide that, subject to the provisions of the
Companies Law, we may enter into a contract for the insurance of the liability
of any of our office holders with respect to:

    o    a breach of his duty of care to us or to another person;

    o    a breach of his duty of loyalty to us, provided that the office
         holder acted in good faith and had reasonable cause to assume that
         his act would not prejudice our interests; or

    o    a financial liability imposed upon him in favor of another person
         concerning an act performed by him in his capacity as an office
         holder.

INDEMNIFICATION OF OFFICE HOLDERS

Our Articles of Association provide that we may indemnify an office holder
against:

    o    a financial liability imposed on him in favor of another person by
         any judgment, including a settlement or an arbitrator's award
         approved by a court concerning an act performed in his capacity as an
         office holder; and

    o    reasonable litigation expenses, including attorneys' fees, expended
         by the office holder or charged to him by a court, in proceedings we
         institute against him or instituted on our behalf or by another
         person, or in a criminal charge from which he was acquitted.

    Under the Companies Law, our Articles of Association may also include:

    o    a provision authorizing us to grant in advance an undertaking to
         indemnify an office holder, provided that the undertaking is limited
         to types of events which the board of directors deems to be
         anticipated and limited to an amount determined by the board of
         directors to be reasonable under the circumstances; and

    o    a provision authorizing us to retroactively indemnify an office holder.

REQUIRED APPROVALS

In addition, under the Companies Law, indemnification of, and procurement of
insurance coverage for our office holders must be approved by our audit
committee and our board of directors and, in specified circumstances, by our
shareholders.

10C.       MATERIAL CONTRACTS NOT IN THE ORDINARY COURSE OF BUSINESS

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Material contracts not in the ordinary course of business consist of the
employment agreements between our company and Elon Ganor, our CEO, and Mr. Ami
Tal, our Executive Vice President of Global Sales.

10D.       EXCHANGE CONTROLS

There are currently no Israeli currency control restrictions on payments of
dividends or other distributions with respect to our ordinary shares or the
proceeds from the sale of shares, except for the obligation of Israeli
residents to file reports with the Bank of Israel regarding certain
transactions. However, legislation remains in effect pursuant to which
currency controls can be imposed by administrative action at any time.

Non-residents of Israel who purchase our securities with non-Israeli currency
will be able to repatriate dividends (if any), liquidation distributions and
the proceeds of any sale of such securities, into non-Israeli currencies at
the rate of exchange prevailing at the time of repatriation, provided that any
applicable Israeli taxes have been paid (or withheld) on such amounts.

Neither our Articles of Association nor the laws of the State of Israel
restrict in any way the ownership or voting of ordinary shares by
non-residents of Israel, except with respect to citizens of countries that are
in a state of war with Israel.

10E.       Taxation and Government Programs

The following is a summary of the current tax structure, which is applicable
to companies in Israel, with special reference to its effect on our company,
and certain Israeli Government programs benefiting our company. The following
also contains a discussion of certain Israeli and U.S. tax consequences to
persons purchasing the ordinary shares. To the extent that the discussion is
based on new tax legislation, which has yet to be subject to judicial or
administrative interpretation, there can be no assurance that the views
expressed in the discussion will accord with any such interpretation in the
future. The discussion is not intended and should not be construed as legal or
professional tax advice and is not exhaustive of all possible tax
considerations.

The following summary is included herein as general information only and is
not intended as a substitute for careful tax planning. Accordingly, each
investor should consult his or her own tax advisor as to the particular tax
consequences to such investor of the purchase, ownership or sale of an
ordinary share, including the effect of applicable state, local, foreign or
other tax laws and possible changes in the tax laws.

ISRAEL CORPORATE TAX CONSIDERATIONS

GENERAL CORPORATE TAX STRUCTURE

The regular rate of corporate tax, which Israeli companies are subject to, is
currently


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36%. However, the effective rate of tax payable by a company (such as ours)
which derives income from an ''Approved Enterprise'' (as further discussed
below) may be considerably lower.

LAW FOR THE ENCOURAGEMENT OF CAPITAL INVESTMENTS, 1959

General. Certain of our production and development facilities have been
granted approved enterprise status pursuant to the Law for the Encouragement
of Capital Investments, 1959. Each approval for approved enterprise status
relates to a specific investment program, delineated both by the financial
scope of the investment, including sources of funds, and by the physical
characteristics of the facility or other assets. The tax benefits available
under any approval relate only to taxable income attributable to the specific
investment program and are contingent upon meeting the criteria set out in the
instrument of approval.

Subject to certain provisions concerning income and subject to the Alternative
Benefits (see below), any distributed dividends are deemed attributable to the
entire enterprise, and the effective tax rate and the effective withholding
tax rates represent the weighted combination of the various applicable tax
rates.

Tax Benefits. Income derived from an approved enterprise is subject to
corporate tax at the reduced rate of 25% subject to exceptions discussed
below, until the earlier of (a) seven consecutive years commencing in the year
in which the specific approved enterprise first generates taxable income
(which income is not offset by deductions attributable to the other sources),
(b) 12 years from the year of commencement of production or (c) 14 years from
the year of approval of the approved enterprise status.

A company owning an approved enterprise which was approved after April 1, 1986
may elect to forego the entitlement to grants or state guarantees and apply
for an alternative package of tax benefits. These benefits provide that
undistributed income from the approved enterprise is fully tax exempt from
corporate tax for a defined period. The tax holiday ranges between two and ten
years from the first year of taxable income subject to the limitations as
described above, depending principally upon the geographic location within
Israel and the type of the approved enterprise. Upon expiration of the tax
holiday, the approved enterprise is eligible for a beneficial tax rate (25% or
lower in the case of a FIC, as described below), for the remainder of the
otherwise applicable period of benefits, as described above.

The undistributed income derived from each of our approved enterprise programs
is tax-exempt for a two year period beginning with the first year in which it
generates otherwise taxable income and is subject to a reduced tax rate for
the remainder of the benefit period.

Dividends paid out of income derived by an approved enterprise and dividends
received from a company out of dividends it received from an approved
enterprise are generally subject to withholding tax at the rate of 15%
(deductible at the source). In the case of companies which do not qualify as a
FIC, and which are at least 25% owned by non-


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Israeli residents, the reduced rate of 15% is limited to dividends and
distributions out of income derived during the benefits period and actually
paid at any time up to 12 years thereafter. In addition, a company which
elects the alternative benefits package and which, at any time, pays a
dividend out of income derived from its approved enterprise during the tax
holiday period, will be subject to corporate tax at the otherwise applicable
rate of 25% (or lower in the case of a FIC) on the grossed up income out of
which such dividend has been paid, and an additional 15% withholding tax in
respect of the amount distributed. We have elected the alternative benefits
with respect to our current approved enterprise, including the exemption
pursuant to which we will enjoy a tax holiday for a period of two years and
reduced tax rates for an additional period of up to eight years (depending on
the percentage of foreign stock ownership in our company).

The tax benefits available to an Approved Enterprise relate only to taxable
income attributable to that specific enterprise and are contingent upon the
fulfillment of the conditions stipulated by the Investment Law, the
regulations published thereunder and the instruments of approval for the
specific investments in the Approved Enterprises. In the event of our failure
to comply with these conditions, the tax and other benefits could be canceled,
in whole or in part, and we might be required to refund the amount of the
canceled benefits, together with the addition of CPI linkage difference and
interest. We believe that our Approved Enterprise substantially complies with
all such conditions at present, but there can be no assurance that it will
continue to do so.

A company which qualifies as a foreign investment company (FIC) is a company,
like us, whereby more than 25% of the share capital (in terms of shares,
rights to profit, voting and appointment of directors), and of the combined
share and loan capital, is owned, directly or indirectly, by non-residents of
Israel, is entitled to further tax benefits relating to its approved
enterprises. Such a company will be eligible for an extension of the period of
tax benefits for its approved enterprises (up to ten years) and further tax
benefits, should the level of its foreign investment rise above 49%.

Notwithstanding the foregoing, proceeds received from the sale of our products
may be deemed to be royalties under the domestic law of the country of
residence of the purchaser/licensee or under an applicable tax treaty and as
such subject to withholding tax in such country. For instance, proceeds
received by our company from the sale of our software in the United States
might be treated as royalties and as such subjected to U.S. withholding tax of
either 10% or 15%, pursuant to the U.S.-Israel Tax Treaty.

Where withholding tax is paid by our company to the country of residence of
the purchaser/licensee, such tax would generally be creditable by our company
for Israeli income tax purposes, pursuant to any relevant income tax treaty
and under Israeli law against income derived from the same source. However,
where we do not have taxable income for Israeli tax purposes because of the
application of a tax holiday available to Approved Enterprise for example or
because of losses for tax purposes, we would have no Israeli tax liability
against which to credit the foreign withholding tax. Furthermore, under
Israeli law, we cannot carry forward such unused credit for benefit in future
tax years.

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From time to time, the Government of Israel has discussed reducing the
benefits available to companies under the Investment Law and currently such
proposal is pending. The termination or substantial reduction of any of the
benefits available under the Investment Law could have a material adverse
effect on future investments by our company in Israel.

Grants under the Law for the Encouragement of Industrial Research and
Development, 1984

Israeli tax laws have allowed, under certain conditions, a tax deduction in
the year incurred for expenditures (including capital expenditures) in
scientific research and development projects, if the expenditures are approved
or funded by the relevant Israeli Government Ministry (determined by the field
of research) and the research and development is for the promotion of the
enterprise and is carried out by or on behalf of the company seeking such
deduction. Expenditures not approved as above or funded are deductible over a
three-year period.

Under the law for the Encouragement of Industrial Research and Development,
1984 (the ''Research Law''), research and development programs that meet
specified criteria and are approved by a committee of the Chief Scientist, are
eligible for grants of up to 50% of the program's expenses, as defined by the
committee. Under the provisions of Israeli law in effect until 1996, royalties
of 2%-3% of the revenues derived in connection with products developed
according to, or as a result of, a research and development program funded by
the Chief Scientist must be paid to the State of Israel. Pursuant to an
amendment effected in 1996 effective with respect to Chief Scientist programs
funded in or after 1994, royalties generally at the rate of 3% during the
first three years, 4% over the following three years and 5% in or after the
seventh year of the revenues derived in connection with products developed
according to such programs are payable to the State of Israel. The maximum
aggregate royalties will not exceed 100% (for funding prior to 1994,
100%-150%) of the dollar-linked value of the total grants received. Pursuant
to an amendment effected in 2000, effective with respect to Chief Scientist
programs funded in or after 2000, the royalty rates described above were
updated to 3% during the first three years and 3.5% in or after the fourth
year, of the revenues derived in connection with products developed under such
programs. Pursuant to an amendment effected on January 1, 1999, effective with
respect to Chief Scientist programs approved in or after 1999, funds received
from the Chief Scientist shall bear annual interest at a rate equal to LIBOR
for twelve months.

Generally, the Research Law requires that the manufacture of any product
developed as a result of research and development funded by the Israeli
Government shall take place in Israel. It also provides that know-how from the
research and development that is used to produce the product, may not be
transferred to third parties without the approval of a research committee.
Such approval is not required for the export of any products resulting from
such research or development.

However, under the Regulations, in the event that any of the manufacturing
volume is not


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performed in Israel, if approved by the Chief Scientist, we would be required
to pay an increased royalty and the payback sum is 120%, 150% or 300% of the
grant if the manufacturing volume that is performed outside of Israel is less
than 50%, between 50% and 90% and more than 90%, respectively.

In 2002, the Research Law was amended to, among other things, enable companies
applying for grants from the Office of the Chief Scientist to seek prior
approval for conducting manufacturing activities outside of Israel without
being subject to increased royalties. However, this amendment will not apply
to any of our existing grants. In addition, the amendment provides that one of
the factors to be taken into consideration by the Office of the Chief
Scientist in deciding whether to approve a grant application is the percentage
of the manufacturing of the relevant product that will be conducted outside of
Israel. Accordingly, should we seek additional grants from the Office of the
Chief Scientist in connection with which we also seek prior approval for
manufacturing products outside of Israel, we may not receive such grant or may
receive a grant in an amount that is less than the amount we sought.

LAW FOR THE ENCOURAGEMENT OF INDUSTRY (TAXES), 1969

Pursuant to the Law for the Encouragement of Industry (Taxes), 1969, a company
qualifies as an ''Industrial Company'' if it is a resident of Israel and at
least 90% of its gross income in any tax year (exclusive of income from
certain loans, capital gains, interest and dividends) is derived from an
''industrial enterprise'' it owns. An ''industrial enterprise'' is defined as
an enterprise whose major activity, in a given tax year, is industrial
production activity.

We believe that we qualify as an Industrial Company. Accordingly, we are
entitled to certain tax benefits, including a deduction of 12.5% per annum on
the purchase of patents or certain other intangible property rights (other
than goodwill) over a period of eight years beginning with the year in which
such rights were first used.

The tax laws and regulations dealing with the adjustment of taxable income for
local inflation provide that an industrial enterprise, like us, is eligible
for special rates of depreciation deductions. These rates vary in the case of
plant and machinery according to the number of shifts in which the equipment
is being operated and range from 20% to 40% on a straight-line basis, or 30%
to 50% on a declining balance basis (instead of the regular rates which are
applied on a straight-line basis).

Moreover, industrial enterprises which are approved enterprises (see below)
can choose between (a) the special rates referred to above and (b) accelerated
regular rates of depreciation applied on a straight-line basis with respect to
property and equipment, generally ranging from 200% (with respect to
equipment) to 400% (with respect to buildings) of the ordinary depreciation
rates during the first five years of service of these assets, provided that
the depreciation on a building may not exceed 20% per annum. In no event may
the total depreciation exceed 100% of the cost of the asset.

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Eligibility for benefits under the Encouragement of Industry Law is not
contingent upon the approval of any governmental authority. No assurance can
be given that we will continue to qualify as an Industrial Company, or will
avail ourselves of any benefits under this law in the future or that
Industrial Companies will continue to enjoy such tax benefits in the future.

TAXATION UNDER INFLATIONARY CONDITIONS

The Income Tax Law (Inflationary Adjustments), 1985 (''Inflationary
Adjustments Law'') is intended to neutralize the erosion of capital
investments in business and to prevent tax benefits resulting from deduction
of inflationary interest expenses. This law applies a supplementary set of
inflationary adjustments to the normal taxable income computed under regular
historical cost principles.

The Inflationary Adjustments Law introduced a special tax adjustment for the
preservation of equity, based on changes in the CPI, whereby certain corporate
assets are classified broadly into fixed (inflation-resistant) assets and
non-fixed assets. Where shareholders' equity, (as defined in the Inflationary
Adjustment Law), exceeds the depreciated cost of fixed assets (as defined in
the Inflationary Adjustment Law), a tax deduction which takes into account the
effect of the annual rate of inflation on such excess is allowed (up to a
ceiling of 70% of taxable income for companies in any single year, with the
unused portion carried forward on a CPI-linked basis, without limit). If the
depreciated cost of such fixed assets exceeds shareholders' equity, then such
excess, multiplied by the annual inflation rate, is added to taxable income.

Under the Inflationary Adjustments Law, results for tax purposes are measured
in real terms, in accordance with the changes in the CPI. We are taxed under
this law. The discrepancy between the change in (i) the CPI and (ii) the
exchange rate of the Israeli currency to the dollar, each year and
cumulatively, may result in a significant difference between taxable income
and other items as denominated in dollars as reflected in our financial
statements (which are reported in dollars). In addition, subject to certain
limitations, depreciation of fixed assets and losses carried forward are
adjusted for inflation on the basis of changes in the Israeli CPI.

TAXATION OF OUR SHAREHOLDERS

CAPITAL GAINS AND INCOME TAXES; ESTATE AND GIFT TAX

Until January 1, 2003, the basic capital gains tax rate applicable to
corporations was 36% and the capital gains tax rate for individuals was based
on the individual's tax bracket up to 50%. Since January 1, 2003 the capital
gains tax rate for both individuals and corporations is 25%. Capital gains on
assets acquired prior to January 1, 2003 and disposed of after January 1, 2003
will be taxed on proportional basis such that the applicable tax rate before
and after January 1, 2003 will be applied to the portion of the holding period
before and after January 1, 2003. Specific tax rates apply to sales of
publicly traded securities as described below. These tax rates are subject to
the provisions


                                   Page 68
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of any applicable bilateral double taxation treaty. The treaty
concerning double taxation between the United States and Israel (the
"Treaty") is discussed below.

Israeli law generally imposes a capital gains tax on the sale of publicly
traded securities. Pursuant to changes made to the Israeli Income Tax
Ordinance in January 2003, capital gains on the sale of our ordinary shares
will generally be subject to Israeli capital gains tax, generally at a rate of
15%. However, as of January 1, 2003 nonresidents of Israel will be exempt from
capital gains tax in relation to the sale of our ordinary shares for so long
as (a) our ordinary shares are listed for trading on a stock exchange outside
of Israel, (b) the capital gains are not accrued or derived by the nonresident
shareholder's permanent enterprise in Israel, (c) the ordinary shares in
relation to which the capital gains are accrued or derived were acquired by
the nonresident shareholder after the initial listing of the ordinary shares
on a stock exchange outside of Israel and (d) neither the shareholder nor the
particular capital gain is otherwise subject to certain sections of the
Israeli Income Tax Ordinance. In addition, under the Treaty, a holder of
ordinary shares who is a United States resident will be exempt from Israeli
capital gains tax on the sale, exchange or other disposition of such ordinary
shares unless the holder owns, directly or indirectly, 10% or more of our
voting power during the 12 months preceding such sale, exchange or other
disposition.

Individuals who are non-residents of Israel are subject to a graduated income
tax on income accrued or derived from sources in Israel. On the distribution
of dividends other than stock dividends, income tax at the rate of 25% (15% in
the case of dividends distributed from the taxable income attributable to an
Approved Enterprise) is withheld at source, unless a different rate is
provided in a treaty between Israel and the shareholder's country of
residence. If the dividend recipient holds 10% of our voting stock for a
certain period prior to the declaration and payment of the dividend, we are
only required to withhold at a 12.5% rate. A non-resident of Israel who has
interest, dividend or royalty income derived from or accrued in Israel, from
which tax was withheld at source, is generally exempt from the duty to file
tax returns in Israel in respect of such income, provided such income was not
derived from a business conducted in Israel by the taxpayer.

Israel presently has no estate or gift tax.

UNITED STATES FEDERAL TAX INCOME CONSIDERATIONS

The following discussion of United States federal income tax considerations is
based on the United States Internal Revenue Code of 1986, as amended (the
"Code"), Treasury regulations, judicial decisions and published positions of
the United States Internal Revenue Service (the "IRS"), all as in effect on
the date hereof. This discussion does not address all aspects of United States
federal income taxation (including potential application of the alternative
minimum tax) that may be relevant to a particular shareholder based on such
shareholder's particular circumstances. In particular, the following
discussion does not address the United States federal income tax consequences
of purchasing, holding or disposing of our ordinary shares to shareholders who
own


                                   Page 69
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(directly, indirectly or through attribution) 10% or more of our outstanding
voting stock or who are broker-dealers, insurance companies, tax-exempt
organizations, financial institutions, non-resident aliens of the United
States or U.S. Holders (as defined below) whose functional currency is not the
U.S. dollar. The following discussion also does not address any aspect of
state, local or non-United States tax laws. Further, this summary generally
considers only a U.S. Holder that will own our ordinary shares as capital
assets (generally, assets held for investment). Each prospective investor is
advised to consult such person's tax advisor with respect to the specific
United States federal, state and local tax consequences to such person of
purchasing, holding or disposing of our ordinary shares.

TAXATION OF U.S. HOLDERS

For purposes of this discussion, a "U.S. Holder" means any beneficial owner of
our ordinary shares who, for United States federal income tax purposes, is:
(i) a citizen or resident of the United States: (ii) a corporation or
partnership organized under the laws of the United States or any state thereof
or the District of Columbia; (iii) an estate the income of which is included
in gross income for United States federal income tax purposes regardless of
source; or (iv) a trust, if a United States court is able to exercise primary
supervision over its administration and one or more United States fiduciaries
have the authority to control all of its substantial decisions. A "non-U.S.
Holder" is any beneficial owner other than a U.S. Holder. If a partnership
holds our ordinary shares, the United States federal income tax treatment of a
partner generally will depend upon the status of the partner and the
activities of the partnership. If you are a partner in a partnership holding
our ordinary shares, you should consult your tax advisor.

Distributions. We do not anticipate that we will make distributions to
shareholders in the foreseeable future. If we do make any such distributions,
the gross amount of such distributions (before reduction for any Israeli
withholding tax) will be included in the gross income of U.S. Holders to the
extent of our earnings and profits, as calculated under United States federal
income tax principles. Such dividends will not qualify for the dividends
received deduction available in certain circumstances to corporate holders.
Subject to the PFIC discussion below, to the extent that any such distribution
exceeds our earnings and profits, such distribution will be treated as a
non-taxable return of capital to the extent of the U.S. Holder's adjusted
basis in our ordinary shares and thereafter as taxable capital gain. For
United States federal income tax purposes, the amount of any dividend that we
pay in NIS to a U.S. Holder will equal the U.S. dollar value of such NIS at
the exchange rate in effect on the date the dividend is considered to be
received by the U.S. Holder, regardless of whether the NIS are actually
converted into U.S. dollars at that time. A U.S. Holder who receives a foreign
currency distribution and converts the foreign currency into U.S. dollars
subsequent to receipt will have foreign exchange gain or loss, based on any
appreciation or depreciation in the value of the foreign currency against the
U.S. dollar, which will generally be United States source ordinary income or
loss.

Credit for Israeli Taxes Withheld. Any dividends that we pay to a U.S. Holder
with


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respect to our ordinary shares generally will be treated for United States
federal income tax purposes as foreign-source income. Subject to certain
conditions and limitations, any Israeli taxes withheld or paid with respect to
dividends on our ordinary shares generally will be eligible for credit against
the U.S. Holder's United States federal income tax liability. Such limitations
include extensive separate computation rules under which foreign tax credits
allowable with respect to specific classes of foreign-source income cannot
exceed the United States federal income taxes otherwise payable with respect
to such classes of income. Subject to the particular circumstances of a U.S.
Holder, any dividends with respect to our ordinary shares generally will be
classified as "passive income" for foreign tax credit purposes.

Alternatively, a U.S. Holder may elect to claim a United States tax deduction
for any such Israeli tax, but only for a tax year in which the U.S. Holder
elects to do so with respect to all foreign income tax as paid. In addition, a
non-corporate U.S. Holder cannot elect to deduct Israeli taxes if such U.S.
Holder does not itemize deductions.

Dispositions. In general, any gain or loss recognized by a U.S. Holder on the
sale or other disposition of our ordinary shares will be United States-source
income or loss for purposes of the United States federal foreign tax credit
limitation. However, a U.S. Holder who is also a United States Treaty Resident
and who sells our ordinary shares in Israel may elect to treat gain from the
sale or other disposition of our ordinary shares as foreign-source income for
purposes of the United States federal foreign tax credit limitation. Under
current law, it is uncertain whether a similar election may be made to treat
losses from the sale or other dispositions of our ordinary shares as a
foreign-source for purposes of such tax credit limitation. U.S. Holders should
consult their tax advisors regarding the application of the United States
federal foreign tax credit limitation to gain or loss recognized on the
disposition of our ordinary shares and the treatment of any foreign currency
gain or loss on any NIS received in respect of the sale or other disposition
of our ordinary shares.

PASSIVE FOREIGN INVESTMENT COMPANY STATUS

Generally a non-United States corporation is treated as a PFIC for United
States federal income tax purposes if either (i) 75% or more of its gross
income (including the pro rata gross income of any company (United States or
non-United States) in which such corporation is considered to own 25% or more
of the stock by value) for the taxable year is passive income, generally
referred to as the "income test," or (ii) 50% or more of the average value of
its assets (including the pro rata value of the assets of any company in which
such corporation is considered to own 25% or more of the stock by value)
during the taxable year produce or are held for the production of passive
income in the taxable year, generally referred to as the "asset test".

We do not believe that we should be treated as a PFIC for any tax year through
and including the tax year ended December 31, 2002. Our conclusion in this
regard is based upon advice received from our accountants in 2002 that, given
the general decline in the value of the stock market, it would be unreasonable
to determine the value of our assets


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with reference to our market capitalization plus our liabilities, and that it
would instead be appropriate to measure the value of our assets with reference
to the value of our identifiable assets. Applying this methodology, we would
not have been a PFIC for 2001 or 2002.

Notwithstanding our conclusion, however, the statutory provisions, legislative
history and administrative pronouncements with respect to the principles under
which the asset test is to be implemented leave unanswered a number of
questions pertaining to the valuation of a publicly traded foreign
corporation's assets. In the absence of regulations, case law or other
guidance from the IRS that address these questions, there is uncertainty with
respect to the appropriate method for implementing the asset test.
Accordingly, the IRS may disagree with this conclusion, asserting that the
value of our assets should be determined by reference to the trading value of
our ordinary shares and that, therefore, we were characterized as a PFIC
during 2001 and 2002 based upon the trading value of our shares coupled with
the fact that a significant portion of our assets consisted of cash. Thus,
there can be no assurance that we were not a PFIC during 2001 or 2002.

In view of this uncertainty and the complexity of the issues surrounding our
possible treatment as a PFIC for 2001, 2002 and possibly for subsequent years,
U.S. Holders are urged to consult their tax advisors for guidance.

If we were deemed to be a PFIC for any taxable year during which a U.S. Holder
held ordinary shares and such holder failed to make either a "QEF election" or
a "mark-to-market election" (each as described below):

      o  gain recognized by the U.S. Holder upon the disposition of, as well
         as income recognized upon receiving certain dividends on, our
         ordinary shares would be taxable as ordinary income;

      o  the U.S. Holder would be required to allocate such dividend income
         and/or disposition gain ratably over such holder's entire holding
         period for such ordinary shares;

      o  the amount allocated to each year other than the year of the dividend
         payment or disposition would be subject to tax at the highest
         individual or corporate tax rate, as applicable, and an interest
         charge would be imposed with respect to the resulting tax liability;

      o  the U.S. Holder would be required to file an annual return on IRS
         Form 8621 regarding distributions received on, and gain recognized on
         dispositions of, our ordinary shares; and

      o  any U.S. Holder who acquired our ordinary shares upon the death of a
         U.S. Holder would not receive a step-up of the


                                   Page 72
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         income tax basis to fair market value of such shares. Instead, such
         U.S. Holder beneficiary would have a tax basis equal to the
         decedent's basis, if lower.

Although a determination as to a corporation's PFIC status is made annually,
an initial determination that a corporation is a PFIC for any taxable year
generally will cause the above described consequences to apply for all future
years to U.S. Holders who held shares in the corporation at any time during a
year when the corporation was a PFIC and who did not timely make a QEF
election or mark-to-market election (each as discussed below) with respect to
such shares with their United States federal income tax return for the first
tax year in which such U.S. Holder owned the shares and the corporation was a
PFIC. This will be true even if the corporation ceases to be a PFIC in later
years. However, with respect to a PFIC that does not make any distributions or
deemed distributions, the above tax treatment would apply only to U.S. Holders
who realize gain on their disposition of shares in the PFIC.

In the event that we were deemed to be a PFIC for 2001 and 2002, if a U.S.
Holder made a timely and valid QEF election with respect to our ordinary
shares:

o    the U.S. Holder would be required for each taxable year for which we are
     a PFIC to include in income such holder's pro rata share of our (i)
     ordinary earnings as ordinary income and (ii) net capital gain as
     long-term capital gain, in each case computed under United States federal
     income tax principles, even if such earnings or gains have not been
     distributed, unless the shareholder makes an election to defer this tax
     liability and pays an interest charge;

o    the U.S. Holder would not be required to include any amount in income for
     any taxable year during which we do not have ordinary earnings or net
     capital gain; and

o    the U.S. Holder would not be required to include any amount in income for
     any taxable year for which we are not a PFIC.

The QEF election is made on a shareholder-by-shareholder basis. Thus, any U.S.
Holder of our ordinary shares can make its own decision whether to make a QEF
election. A QEF election applies to all shares of the PFIC held or
subsequently acquired by an electing U.S. Holder and can be revoked only with
the consent of the IRS. It should be noted that U.S. Holders may not make a
QEF election with respect to an option to acquire ordinary shares, and that
certain classes of investors (for example, consolidated groups and grantor
trusts) are subject to special rules regarding the QEF election. For those
U.S. Holders whose tax advisors believe that we were a PFIC for 2002 or for
any subsequent years and notify us in writing of their request for the
information required to effectuate the QEF Election, we may make such
information available to them.

In the event that we were deemed to be a PFIC for 2001 and/or 2002 and a U.S.
Holder failed to make a QEF election for the first taxable year that we were a
PFIC and such


                                   Page 73
<PAGE>

U.S. Holder owned our ordinary shares, the U.S. Holder could obtain
treatment similar to that afforded a shareholder who has made a timely
QEF election by making a QEF election and a deemed sale election or "purging
election" for the same taxable year. If a purging election is made, the U.S.
Holder will be treated if it had sold our ordinary shares for their fair
market value on the last day of the taxable year and will recognize gain, but
not loss, on such deemed sale in accordance with the general PFIC rules,
including the interest charge provisions described above. Thereafter, the U.S.
Holder's interest will be treated as an interest in a QEF.

Alternatively, a U.S. Holder of shares in a PFIC can elect to mark the shares
to market annually, recognizing as ordinary income or loss each year the
shares are held, as well as on the disposition of the shares, in an amount
equal to the difference between the U.S. Holder's adjusted tax basis in the
PFIC stock and its fair market value. Losses are allowed only to the extent of
net mark-to-market gains previously included in income by the U.S. Holder
under the election in prior taxable years. As with the QEF election, a U.S.
Holder who makes a mark-to-market election will not be subject to the ratable
allocations of gain, the interest charge, and the denial of basis step-up at
death described above. A mark-to-market election is irrevocable (except to the
extent that our ordinary shares are no longer marketable or the IRS consents
to a revocation of the election) and continues to apply even if the PFIC loses
its status as such.

U.S. HOLDERS OF OUR ORDINARY SHARES ARE URGED TO CONSULT THEIR TAX ADVISORS
ABOUT THE PFIC RULES, INCLUDING THE POSSIBILITY, AND ADVISABILITY OF, AND THE
PROCEDURE AND TIMING FOR MAKING A QEF OR MARK-TO-MARKET ELECTION IN CONNECTION
WITH THEIR HOLDING OF ORDINARY SHARES, INCLUDING OPTIONS TO ACQUIRE OUR
ORDINARY SHARES.

TAXATION OF NON-U.S. HOLDERS

Subject to the discussion below with respect to the United States backup
withholding tax, a non-U.S. Holder (i.e., any person other than a U.S. Holder)
generally will not be subject to United States federal income tax on dividends
from us, if any, or gain from the sale or other disposition of ordinary
shares, unless (i) such income is effectively connected with the conduct by
the non-U.S. Holder of a United States trade or business, and in the case of a
resident of a country which has an income tax treaty with the United States,
such income is attributable to a permanent establishment (or in the case of an
individual, a fixed place of business) in the United States; or (ii) with
respect to any gain on the sale or other disposition of ordinary shares
realized by an individual non-U.S. Holder, such individual non-U.S. Holder is
present in the United States for 183 days or more in the taxable year of the
sale or other disposition and meets certain other conditions.

BACKUP WITHHOLDING AND INFORMATION REPORTING

Under the Code, under certain circumstances, United States tax information
reporting and "backup withholding" of United States federal income tax on
dividends on, and the proceeds of dispositions of, our ordinary shares may
apply to both U.S. Holders and non-U.S. Holders. Backup withholding will not
apply, however, to a holder who furnishes a


                                   Page 74
<PAGE>

correct taxpayer identification number or certificate of foreign status and
makes any other required certification or who is otherwise exempt from backup
withholding. Generally, a U.S. Holder will provide such certification on IRS
Form W-9, and a non-U.S. Holder will provide such certification on IRS Form
W-8. Any amounts withheld under the United States backup withholding rules
will be allowed as a refund or credit against the U.S. Holder's or the
non-U.S. Holder's United States federal income tax liability, provided the
required information is furnished to the IRS.

10F.       DIVIDENDS AND PAYING AGENTS

Not applicable.

10G.       STATEMENT BY EXPERTS

Not applicable.

10H.       DOCUMENTS ON DISPLAY

We are subject to certain of the information reporting requirements of the
Securities Exchange Act of 1934, as amended. We, as a "foreign private issuer"
are exempt from the rules and regulations under the Securities Exchange Act
prescribing the furnishing and content of proxy statements, and our officers,
directors and principal shareholders are exempt from the reporting and
"short-swing" profit recovery provisions contained in Section 16 of the
Securities Exchange Act, with respect to their purchase and sale of our
shares. In addition, we are not required to file reports and financial
statements with the Securities and Exchange Commission as frequently or as
promptly as U.S. companies whose securities are registered under the
Securities Exchange Act. However, we will file with the Securities and
Exchange Commission an annual report on Form 20-F containing financial
statements audited by an independent accounting firm.

You may read and copy any document we file with the SEC at its public
reference facilities at, 450 Fifth Street, N.W., Washington, D.C. 20549 and at
the SEC's regional offices at 500 West Madison Street, Suite 1400, Chicago, IL
60661-2511. You may also obtain copies of the documents at prescribed rates by
writing to the Public Reference Section of the SEC at 450 Fifth Street, N.W.,
Washington, D.C. 20549. The SEC also maintains a web site that contains
reports, proxy and information statements and other information regarding
registrants that file electronically with the SEC. The address of this web
site is http://www.sec.gov. Please call the SEC at 1-800-SEC-0330 for further
information on the operation of the public reference facilities.

10I.       SUBSIDIARY INFORMATION

Not applicable.


                                   Page 75
<PAGE>

ITEM 11.   QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We do not use derivative financial instruments in our investment portfolio to
hedge foreign currency or other types of market risks. We place our
investments in instruments that meet high credit quality standards. We
generally invest cash in time deposit and commercial papers, at a minimum
rating of single "A2/P2." We do not expect any material loss with respect to
our investment portfolio.

The table below provides information about our investment portfolio. For
investment securities, the table presents principle cash flows and related
weighted average interest rates by expected maturity dates. Our investment
policy requires that all investments mature in two years or less.

Principal (National) Amounts by Expected Maturity in U.S. Dollars:


                    Fair Market Value on December 31, 2002
                     (in thousands, except interest rates)

           ----------------------------------------------------------
                      Dec 31, 2002 FY 2003
           ----------------------------------------------------------
           Total Portfolio                       17,736       17,736
           ----------------------------------------------------------
           Average Interest Rate                  1.53%        1.53%
           ----------------------------------------------------------
           Average Duration (Month)                 0.4          0.4
           ----------------------------------------------------------
           Cash Equivalents (up to three         17,258
           months maturity)
           ----------------------------------------------------------
           Average Interest Rate                  1.52%
           ----------------------------------------------------------
           Short Term Investments                   477
           (three-twelve months maturity)
           ----------------------------------------------------------
           Average Interest Rate                  1.95%
           ----------------------------------------------------------


ITEM 12.   DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES

Not applicable.

                                   Page 76
<PAGE>

                                   Part Two


Item 13.          DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES

The company is not in default of any payment of principal, interest, sinking
or purchase fund installment, or indebtedness of the company or any of its
subsidiaries exceeding 5% of total assets on a consolidated basis. There has
been no payment of dividends that is in arrears, and there has been no
material delinquency relating to any class of preferred stock in the company
or its subsidiaries.


Item 14.          MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND
                  USE OF PROCEEDS

There have been no material changes or limitations on the rights of the
holders of any class of registered shares caused by the changes in the terms
of the securities or the issuance or modification of a different class of
securities. There has been no material withdrawal or substitution of assets.


Item 15.          CONTROLS AND PROCEDURES

15A.  EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES

During the ninety-day period prior to the filing of this quarterly report, we
performed an evaluation under the supervision of our Chief Executive Officer
(CEO) and Chief Financial Officer (CFO), of the effectiveness of the design
and operation of our disclosure controls and procedures (as defined in Rules
13a-14(c) and 15d-14(c) under the Securities Exchange Act of 1934, as
amended). Following that evaluation, we concluded that based on the
evaluation, the design and operation of our disclosure controls and procedures
were effective in alerting them on a timely basis to material information
relating to us (including our consolidated subsidiaries) required to be
included in our reports files or submitted under the Securities Exchange Act
of 1934, as amended.

15B.  CHANGES IN INTERNAL CONTROLS

Since the date of the evaluation, there have been no significant changes in
our internal controls or in factors that could significantly affect internal
controls, and we have not identified any significant deficiencies or material
weaknesses in our internal controls.

                                   Page 77
<PAGE>

ITEM 16.          RESERVED

                                   Page 78
<PAGE>

                                  Part Three


ITEM 17.          FINANCIAL STATEMENTS

Not applicable.


ITEM 18.          FINANCIAL STATEMENTS

           CONSOLIDATED FINANCIAL STATEMENTS AS OF DECEMBER 31, 2002

                                   CONTENTS


                                   CONTENTS


                                                                          Page

REPORT OF INDEPENDENT AUDITORS                                             F2

CONSOLIDATED FINANCIAL STATEMENTS

  Consolidated Balance Sheets                                              F3

  Consolidated Statements of Operations                                    F4

  Statements of Changes in Shareholders' Equity                            F5

  Consolidated Statements of Cash Flows                                    F6

  Notes to the Consolidated Financial Statements                        F7 - F38



ITEM 19.          EXHIBITS

1. Articles of Association previously filed with the SEC on June 30, 2001 as
Exhibit 1 to the Company's Annual Report on Form 20-F for the year ended
December 31, 2000, which is incorporated herein by reference.

2.1 Form of Share Certificate of VocalTec Communications Ltd. previously filed
with the SEC on January 5, 1996 as Exhibit 4.1 to the Company's Registration
Statement on Form F-1, File Number 333-00120, which is incorporated herein by
reference.

4.1      (a)      VocalTec Communications Ltd. 1996 Stock Option Plan and
                  Incentive Plan previously filed with the SEC on August


                                   Page 79
<PAGE>

                  2, 1996 as an  exhibit  to the  Company's  Registration
                  Statement on Form S-8, File No. 2-0-27648, which is
                  incorporated herein by reference.

         (b)      VocalTec Communications Ltd. 1997 Stock Option and Incentive
                  Plan filed with the SEC on October 31, 1997 as an exhibit to
                  the Company's Registration Statement on Form S-8, File No.
                  333-100120, which is incorporated herein by reference.

         (c)      VocalTec Communications Ltd. 1998 and 1999 Stock Option Plan
                  and Incentive Plan previously filed with the SEC on August
                  2, 1999 as an exhibit to the Company's Registration
                  Statement on Form S-8, File No. 333-10648, which is
                  incorporated herein by reference.

         (d)      VocalTec Communications Ltd. 2000 Master Option Plan
                  previously filed with the SEC on June 30, 2001 as Exhibit
                  4.1(d) to the Company's Annual Report on Form 20-F for the
                  year ended December 31, 2000, which is incorporated herein
                  by reference.

         (e)      Summary of Lease Agreement for Herzliya Business Park,
                  Building D, by and between VocalTec Communications Ltd. and
                  Gemel Tsu'a Lehashka'ot Ltd. Herzeliya lease, dated July 20,
                  1998, previously filed with the SEC on June 30, 2001 as
                  Exhibit 4.1(e) to the Company's Annual Report on Form 20-F
                  for the year ended December 31, 2000, which is incorporated
                  herein by reference.

         (f)      Amendment to the Lease Agreement for Herzliya Business Park,
                  Building D, by and between VocalTec Communications Ltd. and
                  Gemel Tsu'a Lehashka'ot Ltd. Herzeliya lease, entered into
                  on June 19, 2002.

         (g)      Lease Agreement Fort Lee Executive Park, by and between
                  VocalTec Communications Inc. and Executive Park LLC., dated
                  March 7, 2003.

8. List of Subsidiaries.

10.1 Certification of CEO and CFO of VocalTec Communications Inc. pursuant to
18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.

                                   Page 80
<PAGE>

                                  SIGNATURES

The registrant hereby certifies that it meets all of the requirements for
filing on Form 20-F and it has duly caused and authorized the undersigned to
sign this annual report on its behalf.

By:                        /s/ Elon Ganor
Name:                      ELON GANOR
Title:                     CHAIRMAN OF THE BOARD OF DIRECTORS
                           AND CHIEF EXECUTIVE OFFICER


By:                        /s/ Hugo Goldman
Name:                      HUGO GOLDMAN
Title:                     CHIEF FINANCIAL OFFICER


VOCALTEC COMMUNICATIONS LTD.

Date: May 12, 2003

                                   Page 81
<PAGE>


                                 CERTIFICATION


I, Elon Ganor, certify that:

1. I have reviewed this annual report on Form 20-F of VocalTec Communications
Ltd.;

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

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

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

         a) designed such disclosure controls and procedures to ensure that
         material information relating to the registrant, including its
         consolidated subsidiaries, is made known to us by others within those
         entities, particularly during the period in which this annual report
         is being prepared;
         b) evaluated the effectiveness of the registrant's disclosure
         controls and procedures as of a date within 90 days prior to the
         filing date of this annual report (the "Evaluation Date"); and
         c) presented in this annual report our conclusions about the
         effectiveness of the disclosure controls and procedures based on our
         evaluation as of the Evaluation Date;

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

         a) all significant deficiencies in the design or operation of
         internal controls which could adversely affect the registrant's
         ability to record, process, summarize and report financial data and
         have identified for the registrant's auditors any material weaknesses
         in internal controls; and
         b) any fraud, whether or not material, that involves management or
         other employees who have a significant role in the registrant's
         internal controls; and

6. The registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal controls or
in other factors that could

                                   Page 82
<PAGE>


significantly affect internal controls subsequent to the date of our most
recent evaluation, including any corrective actions with regard to significant
deficiencies and material weaknesses.



Date: May 12, 2003


                                            /s/ Elon Ganor
                                            ---------------------------------
                                               Elon Ganor
                                            Chief Executive Officer




                                   Page 83
<PAGE>








                                 CERTIFICATION


I, Hugo Goldman, certify that:

1. I have reviewed this annual report on Form 20-F of VocalTec Communications
Ltd.;

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

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

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

         a) designed such disclosure controls and procedures to ensure that
         material information relating to the registrant, including its
         consolidated subsidiaries, is made known to us by others within those
         entities, particularly during the period in which this annual report
         is being prepared;
         b) evaluated the effectiveness of the registrant's disclosure
         controls and procedures as of a date within 90 days prior to the
         filing date of this annual report (the "Evaluation Date"); and
         c) presented in this annual report our conclusions about the
         effectiveness of the disclosure controls and procedures based on our
         evaluation as of the Evaluation Date;

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

         a) all significant deficiencies in the design or operation of
         internal controls which could adversely affect the registrant's
         ability to record, process, summarize and report financial data and
         have identified for the registrant's auditors any material weaknesses
         in internal controls; and
         b) any fraud, whether or not material, that involves management or
         other employees who have a significant role in the registrant's
         internal controls; and

6. The registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal controls or
in other factors that could


                                   Page 84
<PAGE>

significantly affect internal controls subsequent
to the date of our most recent evaluation, including any corrective actions
with regard to significant deficiencies and material weaknesses.



Date: May 12, 2003


                                             /s/ Hugo Goldman
                                             -------------------------------
                                               Hugo Goldman
                                             Chief Financial Officer




                                   Page 85
<PAGE>


                                 CERTIFICATION

         In connection with the Annual Report on Form 20-F of VocalTec
Communications Ltd. (the "Company") for the fiscal year ended December 31,
2002 as filed with the Securities and Exchange Commission on the date hereof
(the "Report"), Elon Ganor, as Chief Executive Officer of the Company, and
Hugo Goldman, as Chief Financial Officer of the Company, each hereby
certifies, pursuant to 18 U.S.C. ss. 1350, as adopted pursuant to ss. 906 of
the Sarbanes-Oxley Act of 2002, that, to the best of my knowledge:

         (1) The Report fully complies with the requirements of Section 13(a)
or 15(d) of the Securities Exchange Act of 1934; and

         (2) The information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations of the
Company.


/s/ Elon Ganor
_______________________________
Name: Elon Ganor
Title:  Chief Executive Officer
Date:   May 12, 2003


/s/ Hugo Goldman
_______________________________
Name: Hugo Goldman
Title:  Chief Financial Officer
Date:   May 12, 2003

This certification accompanies the Report pursuant to ss. 906 of the
Sarbanes-Oxley Act of 2002 and shall not, except to the extent required by the
Sarbanes-Oxley Act of 2002, be deemed filed by the Company for purposes of
ss.18 of the Securities Exchange Act of 1934, as amended.

A signed original of this written statement required by Section 906 has been
provided to VocalTec Communications Ltd. and will be retained by VocalTec
Communications Ltd. and furnished to the Securities and Exchange Commission or
its staff upon request.

                                   Page 86
<PAGE>
-------------------------------------------------------------------------------
               VOCALTEC COMMUNICATIONS LTD. AND ITS SUBSIDIARIES
-------------------------------------------------------------------------------


                       CONSOLIDATED FINANCIAL STATEMENTS
                            as of December 31, 2002



<PAGE>

-------------------------------------------------------------------------------
               VOCALTEC COMMUNICATIONS LTD. AND ITS SUBSIDIARIES
-------------------------------------------------------------------------------





           CONSOLIDATED FINANCIAL STATEMENTS AS OF DECEMBER 31, 2002

                                In U.S. dollars



                                   CONTENTS


                                                                          Page

REPORT OF INDEPENDENT AUDITORS                                             F2

CONSOLIDATED FINANCIAL STATEMENTS

  Consolidated Balance Sheets                                              F3

  Consolidated Statements of Operations                                    F4

  Statements of Changes in Shareholders' Equity                            F5

  Consolidated Statements of Cash Flows                                    F6

  Notes to the Consolidated Financial Statements                        F7 - F38




                                  # # # # # #


<PAGE>


                        REPORT OF INDEPENDENT AUDITORS



To the Shareholders of
VocalTec Communications Ltd. and its subsidiaries:


We have audited the accompanying consolidated balance sheets of VocalTec
Communications Ltd. and its subsidiaries (the "Company") as of December 31,
2002 and 2001, and the related consolidated statements of operations, changes
in shareholders' equity and cash flows for each of the three years in the
period ended December 31, 2002. Our audits also included the financial
statement schedule listed at Item 8A. These financial statements and schedule
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements and schedule based on our
audits.

We conducted our audits in accordance with auditing standards generally
accepted in the United States. 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, the consolidated financial statements referred to above,
present fairly, in all material respects, the financial position of the
Company and its subsidiaries as of December 31, 2002 and 2001, and the
consolidated results of their operations and cash flows for each of the three
years in the period ended December 31, 2002, in conformity with accounting
principles generally accepted in the United States. Also, in our opinion, the
related financial statements schedule, when considered in relation to the
basic financial statements taken as a whole, presents fairly in all material
respects the information set forth therein.



                                                     Luboshitz Kasierer
                                                   An Affiliate Member of
                                                 Ernst & Young International


Tel-Aviv, Israel
January 30, 2003



                                     -F2-
<PAGE>

               VOCALTEC COMMUNICATIONS LTD. AND ITS SUBSIDIARIES

                          CONSOLIDATED BALANCE SHEETS
               In thousands of U.S. dollars (except share data)

<TABLE>
<CAPTION>

                                                                                 December 31
                                                                           ----------------------------
                                                              Note              2002             2001
                                                              ----              ----             ----
CURRENT ASSETS
<S>                                                            <C>             <C>               <C>
  Cash and cash equivalents                                    (3)             10,016            9,860
  Short-term investments                                       (4)              7,720            8,496
  Trade receivables, net (*)                                   (5)                744            5,406
  Other receivables                                            (6)              2,035            2,502
  Inventories                                                  (7)              4,086            3,608
                                                                              -------          -------
       Total current assets                                                    24,601           29,872
                                                                              -------          -------

INVESTMENTS AND LONG-TERM DEPOSITS
  Investments in ITXC shares                                   (8)
    Available for sale                                                              -           12,955
    Cost                                                                            -            1,701
                                                                              -------          -------
                                                                                    -           14,656
  Other investment                                             (8)                  -              256
  Severance pay funds                                                           1,431            1,757
                                                                              -------          -------
                                                                                1,431           16,669
                                                                              -------          -------
EQUIPMENT, NET                                                 (9)              2,475            5,020
                                                                              -------          -------
                                                                               28,507           51,561
                                                                              =======          =======
CURRENT LIABILITIES
  Trade payables                                                                2,814            5,093
  Accrued expenses and other liabilities                      (10)              5,996            7,621
  Deferred revenues                                                             1,086               41
                                                                              -------          -------
                                                                                9,896           12,755
                                                                              -------          -------
LONG-TERM LIABILITIES
  Deferred income taxes                                       (20)                  -            4,745
  Accrued severance pay                                       (2N)              2,617            2,832
                                                                              -------          -------
                                                                                2,617            7,577
                                                                              -------          -------
  Total liabilities                                                            12,513           20,332
                                                                              -------          -------

COMMITMENTS AND CONTINGENCIES                                 (11)

SHAREHOLDERS' EQUITY                                          (12)
    Share capital
      Ordinary shares of NIS 0.01 par value:
       Authorized - 30,000,000 shares as of December 31,
       2002 and 2001;                                                              36               36
       Issued and outstanding - 12,127,058 shares
       as of December 31, 2002 and 2001
    Additional paid-in capital                                                 97,015           97,015
    Deferred compensation                                                           -              (38)
    Accumulated other comprehensive income                    (21)                  -            7,118
    Accumulated deficit                                                       (81,057)         (72,902)
                                                                              -------          -------
  Total shareholders' equity                                                   15,994           31,229
                                                                              -------          -------
                                                                               28,507           51,561
                                                                              =======          =======

(*)    Includes  trade  receivables  from  related  parties in the amount of $0 and $2,938 in 2002 and
       2001, respectively.

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


                                     -F3-
<PAGE>



               VOCALTEC COMMUNICATIONS LTD. AND ITS SUBSIDIARIES

                     CONSOLIDATED STATEMENTS OF OPERATIONS
             In thousands of U.S. dollars (except per share data)

                                                                             Year ended December 31
                                                                       ----------------------------------------
                                                           Note            2002           2001           2000
                                                           ----            ----           ----           ----

Sales (*)                                                  (13)
  Products                                                                13,517         25,491         34,875
  Services                                                                 2,071          1,527          2,624
                                                                         -------        -------        -------
                                                                          15,588         27,018         37,499
                                                                         -------        -------        -------
Cost of sales                                              (14)
  Products                                                                 5,999          8,936         12,187
  Services                                                                   669            497            853
                                                                         -------        -------        -------
                                                                           6,668          9,433         13,040
  Inventory write-off                                      (16)              870          1,441              -
                                                                         -------        -------        -------
                                                                           7,538         10,874         13,040
                                                                         -------        -------        -------

       Gross profit                                                        8,050         16,144         24,459
                                                                         -------        -------        -------

Operating expenses
  Research and development, net                            (15)            6,138          7,842          8,290
  Marketing and selling                                                   16,401         23,692         23,018
  General and administrative                                               4,512          6,420          6,720
  Restructuring costs                                      (16)            2,703          1,753              -
                                                                         -------        -------        -------
       Total operating expenses                                           29,754         39,707         38,028
                                                                         -------        -------        -------
       Operating loss                                                    (21,704)       (23,563)       (13,569)

Other income, net                                          (17)           10,220            941         57,744
Financing income, net                                      (18)              409          1,872          3,184
                                                                         -------        -------        -------
       Income (loss) from continuing operations
         before income taxes (tax benefit)                               (11,075)       (20,750)        47,359


Tax benefit (income taxes)                                 (20)            5,294            292         (9,013)
                                                                         -------        -------        -------
       Income (loss) from continuing operations
         after income taxes (tax benefit)                                 (5,781)       (20,458)        38,346


Discontinued operations                                    (19)
  Loss from operations of discontinued segment                              (588)        (8,966)        (9,510)
  Loss on disposal of segment                                             (1,786)        (2,359)             -
                                                                         -------        -------        -------
       Net income (loss)                                                  (8,155)       (31,783)        28,836
                                                                          ======        =======         ======

Basic net earnings  (loss) per ordinary share
  Net earnings  (loss) from continuing operations                         (0.48)         (1.69)          3.17
  Loss from discontinued operations                                       (0.20)         (0.93)         (0.78)
                                                                         -------        -------        -------
  Net earnings  (loss)                                                    (0.68)         (2.62)          2.39
                                                                          ======        =======         ======
Diluted net earnings  (loss) per ordinary share
  Net earnings (loss) from continuing operations                          (0.48)         (1.69)          2.89
  Loss from discontinued operations                                       (0.20)         (0.93)         (0.71)
  Net earnings  (loss)                                                    (0.68)         (2.62)          2.18
                                                                          ======        =======         ======
Weighted average number of Ordinary shares used in
  computing net earnings (loss) per share amounts (in
   thousands)
    Basic                                                                 12,127         12,127         12,082
                                                                          ======        =======         ======
    Diluted                                                               12,127         12,127         13,252
                                                                          ======        =======         ======

(*)    Includes net sales to related parties in the amount of $4,969 (2001 - $9,367, 2000 - $18,333).

       The accompanying notes form an integral part of these consolidated financial statements.
</TABLE>


                                     -F4-
<PAGE>

<TABLE>
<CAPTION>

               VOCALTEC COMMUNICATIONS LTD. AND ITS SUBSIDIARIES

                 STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
               In thousands of U.S. dollars (except share data)



                                                                    Number      Share      Additional      Deferred
                                                                      of        capital     paid-in      compensation
                                                                    shares                  capital

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

<S>                                                                <C>                <C>      <C>               <C>
Balance as of January 1, 2000                                      11,771,302         35       94,627            (188)
Comprehensive income:
  Net income                                                                -          -            -               -
  Unrealized loss from available-for-sale marketable
    securities and reclassification adjustment (Note 21)                    -          -            -               -

  Total comprehensive income                                                -          -            -               -

Issuance of shares upon exercise of options                           355,756          1        2,388               -
Amortization of deferred compensation                                       -          -            -              91
                       --- ----                                    ----------         --       ------             ---
Balance as of December 31, 2000                                    12,127,058         36       97,015             (97)
Comprehensive loss:
  Net loss                                                                  -          -            -               -
  Unrealized gain from available-for-sale marketable
   securities net of reclassification adjustment (Note 21)                  -          -            -               -

  Total comprehensive loss                                                  -          -            -               -
Amortization of deferred compensation                                       -          -            -              59

Amortization of deferred compensation                                       -          -            -              59
                                                                   ----------         --       ------             ---
Balance as of December 31, 2001                                    12,127,058         36       97,015             (38)

Comprehensive Loss:
  Net loss                                                                  -          -            -               -
  Unrealized loss from available for sale marketable
    securities and reclassification adjustment (Note 21)                    -          -            -               -

  Total comprehensive loss

Amortization of deferred compensation                                       -          -            -              38
                                                                   ----------         --       ------             ---
Balance as of December 31, 2002                                    12,127,058         36       97,015               -
                                                                   ==========         ==       ======             ===


</TABLE>

Continued -

<TABLE>
<CAPTION>

                                                                 Accumulated       Accumulated          Total            Total
                                                                    other            deficit        comprehensive    shareholders'
                                                                comprehensive                          income           equity
                                                                   income                              (loss)
                                                                -------------      -----------      -------------    -------------

<S>                                                                 <C>               <C>                <C>                <C>
Balance as of January 1, 2000                                        34,471            (69,955)                           58,990
Comprehensive income:
  Net income                                                              -             28,836           28,836           28,836
  Unrealized loss from available-for-sale marketable
    securities and reclassification adjustment (Note 21)            (27,936)                 -          (27,936)         (27,936)
                                                                                                      ----------
  Total comprehensive income                                              -                  -              900
                                                                                                      ==========
Issuance of shares upon exercise of options                               -                  -                             2,389
Amortization of deferred compensation                                     -                  -                                91
                       --- ----                                       --------         -------                            ------
Balance as of December 31, 2000                                       6,535 (*)        (41,119)                           62,370
Comprehensive loss:
  Net loss                                                                -            (31,783)         (31,783)         (31,783)
  Unrealized gain from available-for-sale marketable
   securities net of reclassification adjustment (Note 21)              583                  -              583              583
                                                                                                       ----------
  Total comprehensive loss                                                -                  -          (31,200)
Amortization of deferred compensation                                     -                  -         ==========

Amortization of deferred compensation                                     -                  -                                59
                                                                      --------          -------                           ------
Balance as of December 31, 2001                                       7,118 (*)        (72,902)                           31,229

Comprehensive Loss:
  Net loss                                                                -             (8,155)          (8,155)          (8,155)
  Unrealized loss from available for sale marketable
    securities and reclassification adjustment (Note 21)             (7,118)                 -           (7,118)          (7,118)
                                                                                                       ----------
  Total comprehensive loss                                                                              (15,273)
                                                                                                       ==========
Amortization of deferred compensation                                     -                  -                                38
                                                                      --------          -------                           ------
Balance as of December 31, 2002                                           -            (81,057)                           15,994
                                                                      ========         ========                           ======



(*)    Net of taxes of $4,745 and $4,357, as of December 31, 2001 and 2000, respectively.

       The accompanying notes form an integral part of these consolidated financial statements.
</TABLE>


                                     -F5-
<PAGE>


<TABLE>
<CAPTION>

               VOCALTEC COMMUNICATIONS LTD. AND ITS SUBSIDIARIES

                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                         In thousands of U.S. dollars



                                                                                          Year ended December 31
                                                                                  ---------------------------------------
                                                                                     2002           2001           2000
                                                                                     ----           ----           ----
CASH FLOWS FROM OPERATING ACTIVITIES
<S>                                                                                 <C>           <C>             <C>
  Net income (loss)                                                                 (8,155)       (31,783)        28,836
  Adjustments required to reconcile net income (loss) to net cash used in
    operating activities -
       Depreciation                                                                  2,189          3,867          3,409
       Gain on sale of ITXC shares                                                 (10,313)          (941)       (60,744)
       Provision for decline in value of investments                                   256          1,296              -
       Impairment of equipment                                                         237              -              -
       Loss on disposal of segment                                                   1,576          1,758              -
       Amortization of deferred compensation                                            38             59             91
       Severance pay, net                                                              111            618             25
       Loss on sale of equipment                                                        67              -              -
       Other                                                                             -             30              -
      Changes in operating assets and liabilities:
       Decrease (increase) in trade receivables, net                                 4,662          2,966         (2,209)
       Decrease (increase) in other receivables                                        467          1,377           (811)
       Decrease (increase) in inventories                                             (478)         1,816         (3,822)
       Increase (decrease) in trade payables                                        (2,279)        (3,132)         5,613
       Increase (decrease) in accrued expenses and other
         liabilities                                                                (1,888)        (8,302)        10,032
       Increase in deferred revenues                                                 1,045             41              -
                                                                                   -------        -------        -------
         Net cash used in operating activities                                     (12,465)       (30,330)       (19,580)
                                                                                   -------        -------        -------

CASH FLOWS FROM INVESTING ACTIVITIES
  Increase (decrease) in bank deposits                                               3,000         28,673        (30,943)
  Sales (purchase) of held to maturity securities                                   (2,224)        (5,496)         1,000
  Proceeds from sale of investment in  ITXC                                         13,106          1,049         61,217
  Investment in companies                                                                -           (718)          (828)
  Purchase of equipment                                                               (815)        (1,797)        (6,680)
  Proceeds from sale of equipment                                                      104              6              -
  Loan issued to Surf & Call                                                          (550)             -              -
  Long-term bank deposits                                                                -          1,000         (1,000)
                                                                                   -------        -------        -------
         Net cash provided by investing activities                                  12,621         22,717         22,766
                                                                                   -------        -------        -------

CASH FLOWS FROM FINANCING ACTIVITIES
  Repayment of long-term bank loans                                                      -              -        (20,017)
  Proceeds from options exercised                                                        -              -          2,389
                                                                                   -------        -------        -------
         Net cash used in financing activities                                           -              -        (17,628)
                                                                                   -------        -------        -------

INCREASE (DECREASE) IN CASH AND THE CASH EQUIVALENTS                                   156         (7,613)       (14,442)
CASH AND CASH EQUIVALENTS AT THE BEGINNING OF THE YEAR                               9,860         17,473         31,915
                                                                                   -------        -------        -------
CASH AND CASH EQUIVALENTS AT THE END OF THE YEAR                                    10,016          9,860         17,473
                                                                                   =======        =======        =======


SUPPLEMENTAL CASH FLOWS INFORMATION:
  Cash paid during the year for income taxes                                           372             45          6,381
                                                                                   =======        =======       ========


       The accompanying notes form an integral part of these consolidated financial statements.
</TABLE>


                                     -F6-
<PAGE>


               VOCALTEC COMMUNICATIONS LTD. AND ITS SUBSIDIARIES

                NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
                         In thousands of U.S. dollars


Note 1   -    GENERAL

              VocalTec Communications Ltd. and its subsidiaries (the
              "Company"), is a leading telecom equipment provider offering
              packet voice solutions for carriers and service providers,
              credited with innovating and providing packetized telephony
              solutions since 1995.

              During 2002, the Company disposed of its Surf & Call segment and
              recorded a loss on disposal of segment of $1.8 million (see Note
              19). In addition, in 2002, the Company approved a cost reduction
              plan and recorded restructuring costs of $2.7 million (see Note
              16). During 2002, 61% of the Company's revenues were derived
              from major customers (see Note 13).

Note 2   -    SIGNIFICANT ACCOUNTING POLICIES

              The consolidated financial statements have been prepared in
              conformity with generally accepted accounting principles in the
              United States. ("U.S." GAAP)

              A.     USE OF ESTIMATES

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

              B.     FINANCIAL STATEMENTS IN U.S. DOLLARS

                     The accompanying financial statements have been prepared
                     in U.S. dollars, as the currency of the primary economic
                     environment in which the operations of the Company are
                     conducted is the U.S. dollar. Most of the Company's sales
                     are made outside Israel and all are made in U.S. dollars.
                     A majority of the costs and expenses are incurred outside
                     Israel in non-Israeli currencies, primarily in U.S.
                     dollars. Thus, the functional and reporting currency of
                     the Company is the U.S. dollar.


                                     -F7-
<PAGE>


            NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Cont.)
                         In thousands of U.S. dollars


Note 2   -    SIGNIFICANT ACCOUNTING POLICIES (Cont.)

              B.     FINANCIAL STATEMENTS IN U.S. DOLLARS (Cont.)

                     Transactions and balances originally denominated in U.S.
                     dollars are presented at their original amounts.
                     Transactions and balances in other currencies are
                     remeasured into U.S. dollars in accordance with
                     principles set forth in Statement No. 52 of the Financial
                     Accounting Standards Board of the United States ("FASB").
                     Accordingly, items have been remeasured as follows:

                     Monetary items - at the current exchange rate at the
                     balance sheet date.

                     Nonmonetary items - at historical exchange rates.

                     Income and expense items - at exchange rates current as
                     of the date of recognition of those items (excluding
                     depreciation and other items relating to nonmonetary
                     items).

                     Exchange gains and losses from the remeasurement
                     mentioned above are reflected in the statement of
                     operations as financial income or expenses, as
                     appropriate.

                     The representative rate of exchange between the New
                     Israeli Shekel (NIS) and the U.S. dollar at December 31,
                     2002 was U.S. $1.00 - NIS 4.737 (2001 and 2000 - NIS
                     4.416 and NIS 4.041, respectively).

              C. PRINCIPLES OF CONSOLIDATION

                     The consolidated financial statements include the
                     accounts of the Company and its wholly-owned
                     subsidiaries. The Company's subsidiaries are VocalTec
                     Communications Inc. (U.S.A.), VocalTec Communications
                     Japan K.K. (Japan), VocalTec Communications GmbH
                     (Germany), VocalTec Communications Bejing China (China),
                     VocalTec Communications Hong-Kong (Hong-Kong) and
                     VocalTec Communication International B.V. (Netherlands).
                     VocalTec Communications Inc. is a marketing and selling
                     company and all the other subsidiaries are support
                     companies for marketing and selling activities of the
                     parent company. All intercompany balances and
                     transactions, have been eliminated under consolidation.


                                     -F8-
<PAGE>

            NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Cont.)
                         In thousands of U.S. dollars


Note 2   -    SIGNIFICANT ACCOUNTING POLICIES (Cont.)

              D. CASH EQUIVALENTS

                     Cash equivalents are short-term, highly liquid
                     investments that are readily convertible to cash with
                     original maturities of three months or less.

              E. INVESTMENTS

                     Short term:

                     The short-term investments include short-term bank
                     deposits and commercial paper.

                     Short-term bank deposits are deposited with original
                     maturities of more than three months but less than a
                     year. The short-term deposits are recorded at cost. The
                     accrued interest is presented in other receivables.

                     Marketable securities:

                     Commercial paper have been categorized as held to
                     maturity securities in accordance with Statement of
                     Financial Accounting Standards No. 115, "Accounting for
                     Certain Investments in Debt and Equity Securities" ("SFAS
                     No. 115") as the Company has the positive intent and
                     ability to hold these securities until maturity.
                     Accordingly, these investments are stated at cost
                     (including accrued interest).


                     The non-restricted portion of an investment in equity
                     securities of a publicly-traded company which was
                     available-for-sale is recorded at fair market value in
                     accordance with SFAS No. 115. Unrealized gains and
                     losses, net of taxes were included in accumulated other
                     comprehensive income, a separate component of
                     shareholders equity. Realized gains and losses on sales
                     of such investments are included in the statements of
                     operations.



                                     -F9-
<PAGE>

            NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Cont.)
                         In thousands of U.S. dollars


Note 2   -    SIGNIFICANT ACCOUNTING POLICIES (Cont.)

              E. INVESTMENTS (Cont.)

                     Other:

                     Investments in private companies and in securities that
                     are restricted for more than one year in the above
                     mentioned publicly traded company are stated at cost less
                     write-down for any decline in value which is other than
                     temporary, if applicable. Management recorded an
                     impairment in its investments in private companies,
                     measured by the amount the carrying value exceeded its
                     fair value. The write-down for the decline in the value
                     of these investments was $256, $1,296 and $0 for the
                     years ended December 31, 2002, 2001 and 2000,
                     respectively.

              F. INVENTORIES

                     Inventories are stated at the lower of cost or market
                     value. Inventory write-offs are provided to cover risks
                     arising from slow-moving items, technological
                     obsolescence, excess inventories, and discontinued
                     products. Inventory cost (components) is determined by
                     the average-cost method. Finished goods is determined
                     based on components and direct manufacturing and assembly
                     costs.

              G. ALLOWANCE FOR DOUBTFUL ACCOUNTS

                     Allowance for doubtful accounts is computed on both a
                     specific and general basis. The specific allowance is
                     determined based upon the Company's review of all
                     specific accounts, whereby collectibility is doubtful.
                     Expense (income) in respect of the allowance for doubtful
                     accounts was $(517), $698 and $187 as of December 31,
                     2002, 2001 and 2000, respectively.

              H. FAIR VALUE OF FINANCIAL INSTRUMENTS

                     The carrying amount of cash and cash equivalents,
                     short-term investments, trade receivables, other
                     receivables, severance funds, trade payables and other
                     liabilities are equivalent to, or approximate their fair
                     value due to the short-term maturity of these
                     instruments.


                                     -F10-
<PAGE>

            NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Cont.)
                         In thousands of U.S. dollars


Note 2   -    SIGNIFICANT ACCOUNTING POLICIES (Cont.)

              I. EQUIPMENT, NET

                     Equipment is stated at cost less accumulated
                     depreciation. Depreciation is calculated by the
                     straight-line method over the estimated useful lives of
                     the assets at the following annual rates:

<TABLE>
<CAPTION>
                                                                      %
                                                        -----------------------------
<S>                                                               <C>
                    Computers and related equipment               25 - 33
                    Office furniture and equipment                 7 - 25
                    Leasehold improvements                Over the term of the lease
                                                         or the life of the asset, by
                                                                the shorter of
</TABLE>

                     The Company's long-lived assets are reviewed for
                     impairment in accordance with Statement of Financial
                     Accounting Standards No. 144 "Accounting for the
                     Impairment or Disposal of Long-Lived Assets" whenever
                     events or changes in circumstances indicate that the
                     carrying amount of an asset may not be recoverable.
                     Recoverability of assets to be held and used is measured
                     by a comparison of the carrying amount of an asset to the
                     future undiscounted cash flows expected to be generated
                     by the assets. If such assets are considered to be
                     impaired, the impairment to be recognized is measured by
                     the amount by which the carrying amount of the assets
                     exceeds their fair value. See Note 16 for impairment of
                     equipment recorded as restructuring costs.

              J. REVENUE RECOGNITION

                     The Company generates revenues mainly from licensing the
                     rights to use its software products and from providing
                     maintenance and support services for the software sold.
                     The Company's products are sold to end users and to
                     resellers, both of whom are considered end-users for the
                     purpose of revenue recognition.

                                     -F11-
<PAGE>

            NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Cont.)
                         In thousands of U.S. dollars


Note 2   -        SIGNIFICANT ACCOUNTING POLICIES (Cont.)

              J. REVENUE RECOGNITION (Cont.)

                     The Company accounts for sale of its software products in
                     accordance with Statement of Position 97-2, "Software
                     Revenue Recognition," as amended ("SOP No. 97-2").
                     Revenue earned on software arrangements involving
                     multiple elements is allocated to each element based on
                     the relative fair value of the elements. Fair value is
                     determined based on vendor specific objective evidence
                     (VSOE) of the fair value of the elements. The VSOE of the
                     fair value of the elements is determined based on the
                     price charged for the undelivered element when sold
                     separately.

                     Revenues from sale of software products are recognized
                     when persuasive evidence of an arrangement exists,
                     delivery of the product has occurred, the fee is fixed or
                     determinable, and collectibility is probable and no
                     further obligation exists.

                     In contracts for which an acceptance provision is
                     required by the customer, the Company defers revenue (and
                     the related costs) until receiving the acceptance
                     confirmation. The Company does not grant a right of
                     return to its customers.

                     Revenues from maintenance and support services included
                     in multiple element arrangements are deferred and
                     recognized on a straight-line basis over the term of the
                     maintenance and support agreement.

                     Revenues from products not delivered upon customers'
                     request due to scheduling of systems integration and/or
                     lack of storage space at the customers' facilities during
                     the integration are recognized when the criteria of Staff
                     Accounting Bulletin No. 101 "Income Recognition" ("SAB
                     No. 101") for bill-and-hold transactions are met.


                                     -F12-
<PAGE>

            NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Cont.)
                         In thousands of U.S. dollars


Note 2   -        SIGNIFICANT ACCOUNTING POLICIES (Cont.)

              J. REVENUE RECOGNITION (Cont.)

                     Revenues from software licenses and joint development
                     projects that require significant customization,
                     integration and installation are recognized in accordance
                     with Statement of Position 81-1 "Accounting for
                     Performance of Construction - Type and Certain Production
                     - Type Contracts" ("SOP 81-1"), using contract accounting
                     on a percentage of completion method, based on the
                     relationship of actual costs incurred to total costs
                     estimated to be incurred over the duration of the
                     contract and in accordance with the "Input Method".
                     Provisions for estimated losses on uncompleted contracts
                     are made in the period in which such losses are first
                     determined, in the amount of the estimated loss on the
                     entire contract. No such estimated losses were identified
                     in the reported periods.

                     Revenues are recognized on a cash basis, when management
                     has doubt regarding collectibility. Amounts received
                     where revenue recognition criteria have not been fully
                     met, and thus the revenue is not yet earned, are
                     reflected as deferred revenue.

              K. RESEARCH AND DEVELOPMENT COSTS, NET

                     Research and development costs, net of participations by
                     the Government of Israel through the Ministry of Industry
                     and Trade, Office of the Chief Scientist, are charged to
                     the statement of operations as incurred. Statement of
                     Financial Accounting Standard No. 86 "Accounting for the
                     Costs of Computer Software to be Sold, Leased or
                     Otherwise Marketed", ("SFAS No. 86"), requires
                     capitalization of certain software development costs
                     subsequent to the establishment of technological
                     feasibility.

                     Based on the Company's product development process,
                     technological feasibility is established upon completion
                     of a working model. Costs incurred by the Company between
                     completion of the working models and the point at which
                     the products are ready for general release have been
                     insignificant. Therefore, all research and development
                     costs have been expensed.

                     Royalty-bearing grants from the Government of Israel for
                     funding approved research and development projects are
                     recognized at the time the Company is entitled to such
                     grants, on the basis of the costs incurred and included
                     as a deduction of research and development costs.


                                     -F13-
<PAGE>

            NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Cont.)
                         In thousands of U.S. dollars


Note 2   -        SIGNIFICANT ACCOUNTING POLICIES (Cont.)

              L. INCOME TAXES

                     The Company accounts for income taxes in accordance with
                     Statement of Financial Accounting Standard No. 109,
                     "Accounting for Income Taxes" ("SFAS No. 109"). SFAS No.
                     109 prescribes the use of the liability method whereby
                     deferred tax asset and liability account balances are
                     determined based on differences between financial
                     reporting and tax bases of assets and liabilities and are
                     measured using the enacted tax rates and laws that will
                     be in effect when the differences are expected to
                     reverse. The Company provides a valuation allowance, if
                     necessary, to reduce deferred tax assets to their
                     estimated realizable value.

              M. SHARE-BASED COMPENSATION

                     The Company has elected to follow Accounting Principles
                     Board Opinion No. 25, ("APB No. 25") "Accounting for
                     Stock Issued to Employees" and the FASB Interpretation
                     No. 44, "Accounting for Certain Transactions Involving
                     Stock Compensation" in accounting for its employee stock
                     option plans. According to APB No. 25, compensation
                     expense is measured under the intrinsic value method,
                     whereby compensation expense is equal to the excess, if
                     any of the quoted market price of the share at the date
                     of grant of the award over the exercise price.
                     Compensation expense is recorded over the vesting period
                     on a straight line basis. The Company provides the
                     disclosures required by Statement of Financial Accounting
                     Standard No. 123 "Accounting for Stock-Based
                     Compensation" ("SFAS No. 123") and SFAS No. 148"
                     "Accounting for Stock - Based Compensation - Transition
                     and disclosure".

                                     -F14-
<PAGE>

            NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Cont.)
                         In thousands of U.S. dollars


Note 2   -        SIGNIFICANT ACCOUNTING POLICIES (Cont.)

              M. SHARE-BASED COMPENSATION (Cont.)

                     If compensation cost had been determined under the
                     alternative fair value accounting method provided under
                     SFAS No. 123, the Company's stock-based employee
                     compensation cost, net income (loss) and basic and
                     diluted net earnings (loss) per share would have changed
                     to the following pro forma amounts:

<TABLE>
<CAPTION>

                                                                 For the year ended December 31
                                                           ------------------------------------------
                                                             2002            2001            2000
                                                             ----            ----            ----
<S>                                                          <C>           <C>              <C>
             Net income (loss)
               As reported                                  (8,155)       (31,783)          28,836
             Add: Share-based employee
               compensation expense included in
                reported net income (loss):
                 As reported                                     -              -               47
             Deduct: Total share-based
               compensation expense determined
               under fair value method for all
               awards                                        1,339          2,299            4,062

               Pro forma  net income (loss)                 (9,494)       (34,082)          24,774

             Earnings (loss) per share:
               Basic - as reported from
                  continuing operations                      (0.48)         (1.69)            3.17
               Basic - pro forma from
                  continuing operations                      (0.58)         (1.88)            2.83
               Basic - as reported from
                   discontinued operations                   (0.20)         (0.93)           (0.78)
               Basic - pro forma from
                   discontinued operations                   (0.20)         (0.93)           (0.78)

               Diluted - as reported from
                 continuing operations                       (0.48)         (1.69)            2.89
               Diluted - pro forma from
                 continuing operations                       (0.58)         (1.88)            2.59
               Diluted - as reported
             from discontinued
             operations                                      (0.20)         (0.93)           (0.71)
               Diluted - pro forma from
             discontinued operations                         (0.20)         (0.93)           (0.71)
             Basic net earnings (loss) per
               share:
                   As reported                               (0.68)         (2.62)            2.39
                 Pro forma                                   (0.78)         (2.81)            2.05
             Diluted net earnings (loss) per share:
                 As reported                                 (0.68)         (2.62)            2.18
                 Pro forma                                   (0.780         (2.81)            1.88

</TABLE>
                                     -F15-
<PAGE>

            NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Cont.)
                         In thousands of U.S. dollars


Note 2   -        SIGNIFICANT ACCOUNTING POLICIES (Cont.)

              M. SHARE-BASED COMPENSATION (Cont.)

                     Under SFAS No. 123 the fair value of each option grant is
                     estimated on the date of grant using the Black-Scholes
                     option-pricing model with the following weighted-average
                     assumptions used for grants in 2002, 2001 and 2000: (1)
                     expected life of the option of 2.2 years (2001 - 2.2,
                     2000 - 2.1); (2) dividend yield of 0% (2001, 2000 -
                     same); (3) expected volatility of 130% (2001 - 68%, 2000
                     -159%), (4) risk-free interest rate of 1.75% (2001 -
                     1.75%, 2000 -5%). Compensation expense is recorded over
                     the vesting period.

                     The Company applies SFAS No. 123 and Emerging Issues Task
                     Force "Accounting for Equity Instruments that are Issued
                     to Other than Employees for Acquiring, or in Conjunction
                     with Selling, Goods or Services" ("EITF 96-18") with
                     respect to options issued to non-employees.

              N. SEVERANCE PAY

                     The Company's liability for severance pay is calculated
                     pursuant to Israeli severance pay law based on the most
                     recent salary of the employees multiplied by the number
                     of years of employment, as of the balance sheet date.
                     Employees are entitled to one month's salary for each
                     year of employment or a portion thereof. The Company's
                     liability for all of its employees, is fully provided by
                     monthly deposits with insurance policies and by an
                     accrual. The value of these policies is recorded as an
                     asset in the Company's balance sheet.

                     The deposited funds include profits accumulated up to the
                     balance sheet date. The deposited funds may be withdrawn
                     only upon the fulfillment of the obligation pursuant to
                     Israeli severance pay law or labor agreements. The value
                     of the deposited funds are based on the cash surrendered
                     value of these funds and include immaterial profits.

                     Severance expense for the years ended December 31, 2002,
                     2001 and 2000 amounted to approximately $1,758, $1,338
                     and $213, respectively.


                                     -F16-
<PAGE>

            NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Cont.)
                         In thousands of U.S. dollars


Note 2   -        SIGNIFICANT ACCOUNTING POLICIES (Cont.)

              O. CONCENTRATION OF CREDIT RISKS

                     Financial instruments that potentially subject the
                     Company and its subsidiaries to concentrations of credit
                     risk consist principally of cash and cash equivalents,
                     short-term investments and trade receivables.

                     Cash and cash equivalents are invested in U.S. dollars
                     with major banks in the United States and in Israel.
                     Management believes that the financial institutions that
                     hold the Company and its subsidiaries investments are
                     financially sound and, accordingly, minimal credit risk
                     exists with respect to these investments. Such cash and
                     cash equivalents in the United States may be in excess of
                     insured limits and are not insured in other
                     jurisdictions.

                     The Company's investment in commercial paper is held in
                     high quality securities and financially sound
                     institutions.

                     The Company and its subsidiaries' trade receivables, are
                     generally derived from sales of products and services
                     rendered to large and solid organizations located
                     primarily in Europe, North America, and the Far East. The
                     Company and its subsidiaries perform ongoing credit
                     evaluations of its customers and has not experienced any
                     material losses. For new customers, the Company may
                     require a letter of credit or upfront cash payments. An
                     allowance for doubtful accounts is determined with
                     respect to those amounts that the Company has determined
                     to be doubtful of collection and a general allowance is
                     provided to cover additional exposures.

              P. NET EARNINGS (LOSS) PER SHARE

                     The Company computes net earnings (loss) per share in
                     accordance with SFAS No. 128, "Earnings per Share". Under
                     the provisions of SFAS No. 128, basic net earnings (loss)
                     per share ("Basic EPS") is computed by dividing net
                     earnings (loss) by the weighted average number of
                     ordinary shares outstanding during the year. Diluted net
                     earnings (loss) per share ("Diluted EPS") is computed by
                     dividing net earnings (loss) by the weighted average
                     number of shares outstanding during the year and dilutive
                     share equivalents then outstanding.


                                     -F17-
<PAGE>

            NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Cont.)
                         In thousands of U.S. dollars


Note 2   -        SIGNIFICANT ACCOUNTING POLICIES (Cont.)

              P. NET EARNINGS (LOSS) PER SHARE (Cont.)

                     In the years ended December 31, 2002 and 2001, all
                     outstanding stock options have been excluded from the
                     calculation of the diluted net loss per ordinary share
                     since such securities were anti-dilutive. The total
                     weighted average number of shares related to the
                     outstanding options excluded from the calculations of
                     diluted net earnings (loss) per ordinary share were
                     2,214,873, 2,069,114 and 645,914 for the years ended
                     December 31, 2002, 2001 and 2000, respectively.

                     The following table sets forth the computation of basic
                     and diluted net earnings (loss) per share:

                     1. Numerator

<TABLE>
<CAPTION>

                                                                      Year ended December 31,
                                                            ------------------------------------------
                                                                 2002           2001            2000
                                                                 ----           ----            ----
<S>                                                           <C>             <C>            <C>
                           Net income (loss) to
                             shareholders of
                             ordinary shares                $     (8,155)  $    (31,783)  $     28,836
                                                            =============  =============  ============
                     2.     Denominator

                                                                      Year ended December 31,
                                                            -------------------------------------------
                                                                2002            2001           2000
                                                                ----            ----           ----
                    Weighted average number of
                      shares for basic net earnings
                      (loss) per share                            12,127         12,127          12,082
                                                            -------------  -------------  -------------
                    Effect of dilutive securities:
                      Employee stock options                           -              -           1,170

                    Denominator for diluted net
                      earnings (loss) per share -
                      adjusted weighted average
                      shares and exercise of
                      options                                     12,127         12,127          13,252
                                                            =============  =============  =============
</TABLE>

                                     -F18-
<PAGE>

            NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Cont.)
                         In thousands of U.S. dollars


Note 2   -        SIGNIFICANT ACCOUNTING POLICIES (Cont.)

              Q. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

                     In June 2002, the FASB issued SFAS No. 146, "Accounting
                     for Costs Associated with Exit or Disposal Activities,"
                     which addresses the recognition, measurement, and
                     reporting of costs associated with exit and disposal
                     activities, including restructuring activities. SFAS No.
                     146 requires that costs associated with exit or disposal
                     activities be recognized when they are incurred rather
                     than at the date of a commitment to an exit or disposal
                     plan. SFAS No. 146 also requires liabilities incurred in
                     respect of such costs to be measured at fair value. SFAS
                     No. 146 is effective for all exit or disposal activities
                     initiated after December 31, 2002. The Company does not
                     expect the adoption of SFAS No. 146 to have a material
                     impact on the Company's results of operations or
                     financial position.


Note 3   -    CASH AND CASH EQUIVALENTS

                                                           December 31
                                                     --------------------------
                                                       2002              2001
                                                       ----              ----
             Cash in banks                             5,004             4,159
             Bank deposits                             5,012(*)          5,701
                                                      ---------          ------
                                                      10,016             9,860
                                                      =========          ======
              (*)    Bearing an annual average interest rate of 2.0% (1.9% as
                     of December 31, 2001).


Note 4   -    SHORT-TERM INVESTMENTS

                                                           December 31
                                                     --------------------------
                                                        2002             2001
                                                        ----             ----
             Bank deposits                                 -             3,000
             Commercial paper (**)                     7,720(*)          5,496
                                                      ---------          ------
                                                       7,720             8,496
                                                      =========          ======

              (*)    Bearing an annual average interest rate of 2.2% (3.2% as
                     of December 31, 2001).

              (**)   Market  value of the  commercial  paper is $7,738 at
                     December 31, 2002 ($5,501 at December 31, 2001).


                                     -F19-
<PAGE>

            NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Cont.)
                         In thousands of U.S. dollars


Note 5   -    TRADE RECEIVABLES, NET

                                                            December 31
                                                      ------------------------
                                                       2002              2001
                                                       ----              ----
             Trade Receivables                         1,653             7,483
             Less:  Allowance for doubtful accounts      909             2,077
                                                     ---------          ------
                                                         744             5,406
                                                     =========          ======


Note 6   -    OTHER RECEIVABLES

                                                              December 31
                                                     --------------------------
                                                         2002             2001
                                                         ----             ----
             Prepaid expenses                             563              664
             Government participation receivables         264              285
             Government institute receivable              328              346
             Deposits with leasing companies              452              587
             Other                                        428              620
                                                      ---------          ------
                                                        2,035            2,502
                                                      =========          ======


Note 7   -    INVENTORIES

                                                              December 31
                                                       ------------------------
                                                        2002             2001
                                                        ----             ----
             Components                                  1,596            2,388
             Finished goods (*)                          2,490            1,220
                                                      ---------          ------
                                                         4,086            3,608
                                                      =========         =======

              (*)    $2,211 and $569 as of December 31, 2002 and 2001,
                     respectively were delivered to customers' sites and were
                     not recognized as cost of sales since revenue recognition
                     criteria for the related sales have not been met. The
                     Company has title to the inventories at balance sheet
                     date.

              (**)   Regarding inventory write-off - see Note 16.


                                     -F20-
<PAGE>

            NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Cont.)
                         In thousands of U.S. dollars


Note 8   -    INVESTMENTS IN COMPANIES

                                                              December 31
                                                       ------------------------
                                                         2002             2001
                                                         ----             ----
             Investment in ITXC shares                     -             14,656
             Other investment                              -                256


              The Company, through its wholly owned U.S. subsidiary, had an
              investment in ITXC Inc. ("ITXC"). ITXC completed its initial
              public offering ("IPO") in October 1999 on the NASDAQ in the
              U.S. In March 2000, ITXC completed a secondary offering on the
              NASDAQ, in which the Company sold 779,743 shares of ITXC in
              consideration for $61,217 and recorded a gain of $60,744. In
              November 2001, the Company sold 180,000 shares of ITXC in
              consideration for $1,049 and recorded a gain of $941. During
              2002, the Company sold its remaining shares of ITXC (4,608,165
              shares) in consideration for $13,106 and recorded a gain of
              $10,313 (see Note 21).

              The Company's investment in ITXC was subject to Rule 144 under
              the Securities Act of 1933 which restricts the number of shares
              of ITXC that the Company could sell during specified future
              periods. As of December 31, 2001, the portion of the Company's
              investment in ITXC which was not restricted was classified as
              "available-for-sale" and stated at fair market value. The
              remaining shares were presented at cost.

              The investment in ITXC is presented in the balance sheet as
              follows:


                                                                December 31
                                                           ---------------------
                                                           2002            2001
                                                           ----            ----
             At fair market value (*)                        -           12,955
             At cost (fair market value at
               December 31, 2001 - $20,177)                  -            1,701
                                                      ---------          ------
                                                             -           14,656
                                                      =========          ======
             (*)  Includes unrealized gains                  -           11,864
                                                      =========          ======


                                     -F21-
<PAGE>

            NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Cont.)
                         In thousands of U.S. dollars


Note 9   -    EQUIPMENT, NET


                                                                December 31
                                                         -----------------------
                                                           2002           2001
                                                           ----           ----
             Computers and related equipment              12,162         13,120
             Office furniture, equipment and
               leasehold improvements                      2,563          2,611
                                                       ---------        -------
                                                          14,725         15,731
             Less - accumulated depreciation              12,250         10,711
                                                       ---------        -------
             Depreciated cost                              2,475          5,020
                                                       =========        =======


              The majority of the equipment is located in Israel.

              For the years ended December 31, 2002, 2001 and 2000,
              depreciation expense was approximately $2,189, $3,867 and
              $3,409, respectively.

              Regarding impairment of equipment - see Note 16.


Note 10   -   ACCRUED EXPENSES AND OTHER LIABILITIES

                                                                December 31
                                                         ----------------------
                                                           2002           2001
                                                           ----           ----
             Accrued expenses                                956          1,186
             Accrued restructuring expenses                1,090            225
             Employees and payroll accruals                1,459          2,003
             Accrued vacation pay                            782          1,206
             Income taxes                                    890          2,046
             Other                                           819            955
                                                       ---------        -------
                                                           5,996          7,621
                                                       =========        =======


                                     -F22-
<PAGE>

            NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Cont.)
                         In thousands of U.S. dollars


Note 11  -    COMMITMENTS AND CONTINGENCIES

              A.     In connection with its research and development
                     activities through December 31, 2002, the Company
                     received and accrued participation payments from the
                     Office of the Chief Scientist of the Ministry of Industry
                     and Trade in Israel ("OCS") in the total amount of
                     approximately $8.1 million. In return for the Government
                     of Israel's participation, the Company is committed to
                     pay royalties at a rate of 3% - 3.5% of sales of the
                     developed product, up to 100% of the amount of grants
                     received linked to the U.S. dollar (for grants received
                     under programs approved subsequent to January 1, 1999,
                     100% plus interest at LIBOR). The obligation to pay these
                     royalties is contingent on actual sales of the products
                     and in the absence of such sales no payment is required.

                     The Company's total commitment for royalties payable to
                     the OCS with respect to future sales, based on Government
                     of Israel participationsreceived or accrued, net of
                     royalties paid or accrued, totaled approximately $5.6
                     million as of December 31, 2002.

                     Royalties accrued as of December 31, 2002, 2001 and 2000
                     were $163, $360 and $710, respectively.

                     The Company has no future commitments for royalties in
                     respect of other participations received.

              B.     Certain allegations, mainly for patent infringement and
                     breach of contract have been made against the Company or
                     its U.S. subsidiary. These allegations have not resulted
                     in any action brought against the Company.

              C.     The Company's facilities in Israel and in the United
                     States are rented under operating leases with periods
                     ending January 2005 for facilities in Israel and July
                     2003 for facilities in the United States (some with
                     renewal options). Rent expense amounted to $964, $1,390
                     and $1,446 for the years ended December 31, 2002, 2001
                     and 2000, respectively. Annual minimum rental commitments
                     under non-cancelable leases at balance sheet date are
                     approximately as follows as of December 31,:

                    2003                                              695
                    2004                                              664
                    2005                                               79
                                                                  ---------
                                                                    1,438
                                                                  =========



                                     -F23-
<PAGE>

            NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Cont.)
        In thousands of U.S. dollars (except share and per share data)


Note 12  -    SHARE CAPITAL

              A. General

                     Ordinary shares confer upon their holders the right to
                     receive notice to participate and vote in general
                     meetings of the Company and the right to receive
                     dividends if declared.

              B.     Stock Options

                     Through December 31, 2002, the Company has granted
                     options to purchase Ordinary Shares to key employees,
                     officers, directors and consultants of the Company as an
                     incentive to attract and retain qualified persons.

                     In 1998, 1999, 2000 and 2001, the Company adopted stock
                     option and incentive plans (the "Option Plans") which
                     provide for the grant by the Company of options to
                     purchase up to an aggregate of 1,000,000, 1,000,000,
                     1,000,000 and 1,000,000 Ordinary Shares, respectively, to
                     officers, directors, key employees, or consultants of the
                     Company or any of its subsidiaries. The plans will expire
                     ten years after their adoption unless terminated earlier
                     by the Board of Directors. The exercise price of stock
                     options issued under the Option Plans will be no less
                     than 95% of the fair market value of the Ordinary Shares
                     as of the date of grant. As of December 31, 2002
                     1,406,717, share options are still available for future
                     grant under the plans described above. Options which are
                     cancelled before expiration date become available for
                     future grants. Options generally vest over a period of
                     four years from the date of the grant.



                                     -F24-
<PAGE>
            NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Cont.)
        In thousands of U.S. dollars (except share and per share data)



Note 12  -    SHARE CAPITAL

              B. Stock Options (Cont.)

                     In July 2001, the Company initiated a voluntary stock
                     option exchange program for its employees. Under the
                     program, employees of the Company and its subsidiaries
                     who have been granted options under the Company's stock
                     option plans, were given the opportunity to cancel
                     outstanding stock options previously granted to them in
                     exchange for an amount of new options equal to 80% of the
                     options cancelled, to be granted at a future date not
                     less than six months and one day from the cancellation of
                     the options pursuant to the terms of the Company's stock
                     option plans 922,387 options were cancelled under this
                     program.

                     In February 2002, as part of the option exchange program,
                     891,310 new options were granted to employees. The
                     exercise price of these new options approximated the fair
                     market value of the Company's ordinary shares as reported
                     by NASDAQ on the date of grant. The vesting period is
                     over 2.5 years.



                                     -F25-
<PAGE>
            NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Cont.)
        In thousands of U.S. dollars (except share and per share data)



Note 12  -    SHARE CAPITAL (Cont.)

              Transactions related to the above mentioned options during each
              of the three years in the period ended December 31, 2002 are
              summarized as follows:

<TABLE>
<CAPTION>

                                                           Number of         Weighted         Weighted
                                                            shares           average        average fair
                                                                             exercise         value of
                                                                              price            options
                                                                            per share          granted
                                                           ----------       ---------       ------------

<S>                              <C>                          <C>            <C>                <C>
             Outstanding January 1, 2000                      2,879,943      $      8.89

               Granted                                          975,400      $     12.32            $9.31
               Exercised                                       (355,756)     $      6.72
               Forfeited                                       (430,444)     $      9.36
                                                           -------------

             Outstanding December 31, 2000                    3,069,143      $     10.19

               Granted                                          795,650      $      4.37            $1.83

               Forfeited                                     (1,821,216)     $     10.67
                                                           -------------

             Outstanding December 31, 2001                    2,043,577      $      7.01

               Granted                                        1,610,880      $      1.61            $1.13

               Forfeited                                     (1,061,174)     $      5.82
                                                           -------------

             Outstanding December 31, 2002                    2,593,283      $      4.08
                                                           =============
</TABLE>

              The number of exercisable options as of December 31, 2001 and
              2000 were 1,131,720 and 987,364, respectively, with a weighted
              average exercise price of $7.32 and $8.16, respectively.


                                     -F26-
<PAGE>
            NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Cont.)
        In thousands of U.S. dollars (except share and per share data)


Note 12 -     SHARE CAPITAL (Cont.)

              The following table summarizes information about options
              outstanding and exercisable at December 31, 2002:
<TABLE>
<CAPTION>

                                                    Options outstanding                            Options exercisable
                              -----------------------------------------------------------  ---------------------------------
                               Number outstanding     Weighted-average        Weighted            Number           Weighted
    Range of exercise           at December 31,          remaining            average        outstanding at        average
           prices                    2002               contractual      exercise prices        December 31,        exercise
                                                           life                                    2002             prices
             $                                            (years)                $                                     $
    -----------------          ------------------     ----------------   ---------------     ---------------       ---------
<S>  <C>                          <C>                    <C>                <C>               <C>                <C>
     0.57-0.60                       340,000                9.80               0.58              90,000             0.58
     1.11-1.17                        23,000                9.37               1.13                   -             -
     1.50-1.58                        80,122                8.58               1.53              56,237             1.53
     1.82-1.92                       902,506                9.11               1.85             314,487             1.85
     3.56-3.75                       304,113                8.31               3.66              88,798             3.63
     3.95-4.88                       329,125                3.80               4.01             291,750             4.01
     5.95-6.65                        16,000                4.38               6.65              13,962             6.65
     6.76-7.12                        23,623                6.57               6.92              18,303             6.93
     7.13-7.50                       210,250                5.50               7.49             210,250             7.49
     7.69-8.63                        61,502                7.76               8.19              39,239             8.19
     8.96-9.43                        80,999                6.64               9.06              70,525             9.06
     10.45-11.00                       8,750                6.33              10.67               7,875            10.63
     11.50-11.83(*)                   48,000                6.71              11.69              41,000            11.71
     12.83-14.00                     100,293                6.97              13.31              80,525            13.31
     15.20-16.15                      40,000                7.01              16.00              27,500            16.00
     17.25                            25,000                7.70              17.25              14,058            17.25
                                   2,593,283                                   4.08           1,364,509             5.34
</TABLE>


       Compensation expense recorded for the years ended December 31, 2002,
       2001 and 2000 was $0, $0 and $47, respectively.

       (*)    Includes 28,000 options granted to consultants in 1999 for whom
              compensation in the amount of $177 was calculated based on the
              fair value of the options using the Black-Scholes option-pricing
              model. The compensation cost charged to operations for the year
              ended December 31, 2002 amounted to $38 (2001 - $59, 2000 -
              $44).


                                     -F27-
<PAGE>

            NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Cont.)
                         In thousands of U.S. dollars


Note 13  -    GEOGRAPHIC AND MAJOR CUSTOMERS INFORMATION

              The Company manages its business on a basis of one reportable
              segment (see Note 19 for discontinued operations of previously
              reported Surf & Call segment). The Company follows Statement of
              Financial Accounting Standards No. 131, "Disclosure about
              Segment of an Enterprise and Related Information".

<TABLE>
<CAPTION>

                                                                           Year ended December 31
                                                                   ----------------------------------------
                                                                     2002           2001           2000
                                                                     ----           ----           ----
<S>                                                              <C>              <C>             <C>
             Sales classified by geographic
             areas based on end- customer
             location:
                 Europe                                              7,446           9,342         13,680
                 North America (principally
                   United States)                                    1,612           9,471          8,194
                 Far East                                            6,049           6,661          8,058
                 Israel                                                103           1,026          4,611
                 Other                                                 378             518          2,956
                                                                    ------          ------         ------
                                                                    15,588          27,018         37,499
                                                                    ======          ======         ======

             Sales to a single customer
               exceeding 10%:
                                                                       %                %              %
                                                                     ----             ----           ----
                 Customer A (**)                                        24             (*)             33
                 Customer B                                             23               -              -
                 Customer C (**)                                       (*)              26             16
                 Customer D                                            (*)             (*)             12

             (*) Less than 10%
             (**)   Related parties (Customer A - shareholder; Customer C - investee until March 2002)

</TABLE>

<TABLE>
<CAPTION>

Note 14  -    COST OF SALES
                                                                             Year ended December 31
                                                                     --------------------------------------
                                                                       2002           2001           2000
                                                                       ----           ----           ----
<S>                                                                 <C>            <C>             <C>
             Cost of sales include royalties to
               the Government of Israel                                 444            834            716
                                                                     ======         ======          ======
</TABLE>


                                     -F28-
<PAGE>
            NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Cont.)
                         In thousands of U.S. dollars


<TABLE>
<CAPTION>

Note 15  -    RESEARCH AND DEVELOPMENT, NET

                                                                         Year ended December 31
                                                                   --------------------------------------
                                                                     2002           2001           2000
                                                                     ----           ----           ----
<S>                                                                  <C>           <C>            <C>
             Research and development expenses                       7,985         10,458         10,491
             Less - participations by the
               Government of Israel:
             Royalty bearing participation                           1,701          2,457          2,009
             Other participation                                       146            159            192
                                                                     -----          -----          -----
                                                                     6,138          7,842          8,290
                                                                     =====          =====          =====
</TABLE>


Note 16   -   RESTRUCTURING COSTS

              In April 2001 and June 2001, the Board of Directors approved
              cost reduction plans. The cost reduction plans accounted for in
              accordance with SAB 100, "Restructuring and Impairment Charges"
              and EITF Issue 94-3, "Liability Recognition for Certain Employee
              Termination Benefits and Other Costs to Exit an Activity
              (including certain Costs in a Restructuring") provided for the
              termination of one hundred and twenty nine employees from the
              following departments: 46 from research and development; 58 from
              marketing, sales and customer service; and 25 from
              administration. In respect of the above plans, the Company
              recorded restructuring costs of $3,514 ($320 of the
              restructuring costs were reclassified to discontinued operations
              as the costs relate to Surf & Call segment which was
              discontinued in 2002 - see Note 19). This charge includes an
              inventory write off in the amount of $1,441 (included in cost of
              sales). Components of the restructuring charge for the year
              ended December 31, 2001, were as follows:


<TABLE>
<CAPTION>

                                                                                      Restructuring
                                                                                         charge
                                                                                      -------------
<S>                                                                                        <C>
             Employee terminations                                                         1,472
             Other exit costs (mainly facility costs)                                        601
                                                                                      -------------
                                                                                           2,073
             Less - costs reclassified to discontinued operations                            320
                                                                                      -------------
                                                                                           1,753
                                                                                      =============
</TABLE>

              As of December 31, 2002, no accrued liability remains with
              respect to the 2001 restructuring charge.

                                     -F29-
<PAGE>
            NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Cont.)
                         In thousands of U.S. dollars


Note 16   -   RESTRUCTURING COSTS (Cont.)

              In September 2002, the Board of Directors approved a cost
              reduction plan. As a result of the cost reduction plan, 68
              employees were terminated from the following departments: 24
              from research and development; 28 from marketing, sales and
              customer service; and 16 from administration. The Company
              recorded restructuring costs of $3,277 as follows:
<TABLE>
<CAPTION>

                                                                                       Year ended
                                                                                      December 31,
                                                                                          2002
                                                                                      -------------
<S>                                                                                       <C>
             Restructuring charge                                                         2,703
             Write-off of inventory (included in cost of sales)                             574
                                                                                      -------------
                                                                                          3,277
                                                                                      =============
</TABLE>

              Components of the restructuring charge for the year ended
              December 31, 2002, amounts paid during the period and the
              remaining accrued liability as of December 31, 2002, are as
              follows:
<TABLE>
<CAPTION>

                                                      Restructuring                        Accrued
                                                         charge           Payments        liability
                                                      -------------       --------        ---------
<S>                                                        <C>               <C>               <C>
             Employee terminations                         1,302             1,157             145
             Other exit costs (mainly   facility
             costs of $820)                                1,164               219             945
                                                      -------------       --------        ---------
                                                           2,466             1,376           1,090
                                                      =============       ========        =========
             Write down of equipment
               (non-cash)                                    237
                                                      -------------
                                                           2,703
                                                      =============
</TABLE>


Note 17   -   OTHER INCOME, NET
<TABLE>
<CAPTION>

                                                                     Year ended December 31
                                                                -------------------------------------
                                                                  2002           2001          2000
                                                                  ----           ----          ----
<S>                                                              <C>               <C>         <C>
             Gain on sale of ITXC shares                         10,313            941         60,744
             Provision for decline in value of
               investments in                                      (256)        (1,296)             -
               private companies (see Note 2E)
             Legal proceedings and other                            163          1,296         (3,000)
                                                                --------       -------        --------
                                                                 10,220            941         57,744
                                                                ========       =======        ========
</TABLE>


                                     -F30-
<PAGE>
            NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Cont.)
                         In thousands of U.S. dollars



Note 18   -   FINANCING INCOME, NET
<TABLE>
<CAPTION>

                                                                      Year ended December 31
                                                                  ------------------------------------
                                                                   2002          2001           2000
                                                                   ----          ----           ----
<S>                                                             <C>            <C>             <C>
             Financing income (expenses):
               Interest on cash equivalents and
                 short-term investments                             440          1,462          3,456
               Foreign currency translation
                 adjustments                                        (31)           410           (272)
                                                                --------       -------        --------
                                                                    409          1,872          3,184
                                                                ========       =======        ========
</TABLE>


Note 19  -    DISCONTINUED OPERATIONS
<TABLE>
<CAPTION>

                                                                       Year ended December 31
                                                                 -------------------------------------
                                                                  2002           2001           2000
                                                                  ----           ----           ----
<S>                                                               <C>          <C>            <C>
             Loss from operations of
               discontinued segment:
                 Surf & Call                                       (588)        (4,563)        (3,017)
                 TrulyGlobal                                          -         (4,403)        (6,493)
                                                                --------       --------       --------
                                                                   (588)        (8,966)        (9,510)
                                                                ========       ========       ========
             Loss on disposal of segment:
               Surf & Call                                       (1,786)             -              -
               TrulyGlobal                                            -         (2,359)             -
                                                                --------       --------       --------
                                                                 (1,786)        (2,359)             -
                                                                ========       ========       ========

</TABLE>

              A.     In November, 2001, the operations of TrulyGlobal Inc.
                     ("TrulyGlobal"), a separate operating segment and wholly
                     owned subsidiary of the Company were merged into the
                     operations of Vocalec Communications Inc., another wholly
                     owned subsidiary of the Company. Upon disposal, the
                     Company incurred shutdown costs of approximately $0.6
                     million for termination and other expenses, plus an
                     approximately $1.8 million write-off of net equipment. No
                     significant assets or liabilities of TrulyGlobal exist in
                     the Company. The Company accounted for this transaction
                     in accordance with Accounting Principles Board 30,
                     "Reporting the Results of Operations - Reporting the
                     Effects of Disposal of a Segment of a Business, and
                     Extraordinary, Unusual and Infrequently Occurring Events
                     and Transactions".

                     There were no revenues from the TrulyGlobal segment for
                     the years ended December 31, 2002, 2001 and 2000,
                     respectively.

                                     -F31-
<PAGE>
            NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Cont.)
                         In thousands of U.S. dollars


Note 19  -    DISCONTINUED OPERATIONS (Cont.)

              B.     In March 2002, the Company's management approved the
                     carve out of the Surf & Call segment into a separate
                     entity. For this purpose a new company was established
                     and in May 2002 an agreement was signed between the
                     Company and the newly established company. The Company
                     transferred certain of its employees to the new company.
                     Under the terms of the agreements, the Company
                     contributed technology and equipment to the new company
                     through a loan and unsecured promissory note in the
                     amount of $1.3 million and received voting rights in the
                     new company of 19.9%. The new company may utilize the
                     Company's software products at a market value of $1
                     million without charge for a period of three years ($73
                     thousand was utilized as of December 31, 2002). In
                     addition, the Company will receive for no additional
                     consideration a warrant to purchase preferred shares that
                     will present 30% of the share capital of the new company.
                     In the event that the Company will have voting securities
                     above 19.9%, these voting securities will be
                     automatically converted to shares with no voting rights.
                     No investment balance exists in the new company at
                     December 31, 2002.

                     The Company accounted for this transaction in accordance
                     with Statement of Financial Accounting Standard No. 144,
                     "Accounting for the Impairment and Disposal of Long-Lived
                     Assets". Accordingly, the Surf & Call segment was
                     presented as discontinued operations since the operating
                     and cash flows of the segment have been eliminated from
                     the ongoing operations of the entity as a result of the
                     carve out and the Company will not have any significant
                     continuing involvement in the operations of the segment
                     after the carve out.

                     Loss on disposal of Surf & Call includes shutdown costs
                     of approximately $0.4 million for termination and other
                     expenses, plus an amount of approximately $1.3 million as
                     a write-off of the loans the Company provided to the new
                     company upon establishment. The loans were written off
                     due to management's estimation of uncollectibility.

                     As a result of the disposal of the Surf & Call segment,
                     the results of operations of the above segment were
                     reported as discontinued operations in the statements of
                     operations in all reported periods. The results of
                     operations in prior periods have been reclassified.

                     No significant assets or liabilities of Surf & Call exist
                     as of December 31, 2002.

                     Revenues from the Surf & Call segment amounted to $0,
                     $1,395 and $4,472 for the years ended December 31, 2002,
                     2001 and 2000, respectively.

                                     -F32-
<PAGE>
            NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Cont.)
                         In thousands of U.S. dollars


Note 20  -    TAXES ON INCOME

              A.     Measurement of taxable income under the Income Tax Law
                     (Inflationary Adjustments), 1985,

                     Results for tax purposes are measured and reflected in
                     real terms in accordance with the change in the Israeli
                     Consumer Price Index ("CPI"). As explained in Note 2B,
                     the consolidated financial statements are presented in
                     U.S. dollars. The differences between the change in the
                     Israeli CPI and in the NIS/U.S. dollar exchange rate
                     causes a difference between taxable income or loss and
                     the income or loss before taxes reflected in the
                     consolidated financial statements. In accordance with
                     paragraph 9(f) of Statement of Financial Accounting
                     Standard No. 109 "Accounting for Income Taxes" ("SFAS No.
                     109"), the Company has not provided deferred income taxes
                     on this difference between the reporting currency and the
                     tax bases of assets and liabilities.

              B.     Tax benefits under Israel's Law for the Encouragement of
                     Industry (Taxation), 1969

                     The Company is an "industrial company", as defined by the
                     Law for the Encouragement of Industry (Taxes), 1969, and
                     as such, is entitled to certain tax benefits, mainly
                     amortization of costs relating to know-how and patents
                     over eight years, the right to claim public issuance
                     expenses, and accelerated depreciation.

              C.     Tax benefits under the Law for the Encouragement of Capital
                     Investments, 1959

                     The Company's investment in equipment in the amount of
                     approximately $1,065 has received "Approved Enterprise"
                     status through the "Alternative Benefits" program, and,
                     as such, is eligible for various benefits. The Company
                     currently has two "Approved Enterprise" programs. These
                     benefits include accelerated depreciation of fixed assets
                     used in the investment program, as well as a full tax
                     exemption on undistributed income for a period of two
                     years and reduced tax rates for an additional period of
                     up to eight years (depending on the percentage of foreign
                     share ownership in the Company), commencing with the date
                     on which taxable income is first earned. Income derived
                     by the Company from its approved enterprise, is to be
                     exempt from tax for two years and will be liable to
                     reduced rate of 25% for an additional period of up to 8
                     years. The 25% rate may be reduced further, depending on
                     the rate of foreign share ownership in the Company. Since
                     the Company has had no taxable income since inception,
                     the benefits period has not yet commenced.

                                     -F33-
<PAGE>
            NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Cont.)
                         In thousands of U.S. dollars


Note 20  -    TAXES ON INCOME (Cont.)

              C.  (Cont.)

                     The period of tax benefits, detailed above, is subject to
                     a limit of 12 years from the commencement of production,
                     or 14 years from the approval date, whichever earlier.
                     The entitlement to the above benefits is conditional upon
                     the Company's fulfilling the conditions stipulated by the
                     above law, regulations published thereunder and the
                     instruments of approval for the specific investments in
                     "Approved Enterprises". In the event of failure to comply
                     with these conditions, the benefits may be canceled and
                     the Company may be required to refund the amount of the
                     benefits, in whole or in part, including interest. As of
                     December 31, 2002, management believes that the Company
                     is meeting all of the aforementioned conditions.

                     The tax-exempt income attributable to the "Approved
                     Enterprise" can be distributed to shareholders without
                     subjecting the Company to taxes only upon the complete
                     liquidation of the Company. If these retained tax-exempt
                     profits are distributed in a manner other than in the
                     complete liquidation of the Company they would be taxed
                     at the corporate tax rate applicable to such profits as
                     if the Company had not elected the alternative system of
                     benefits, currently 25% for an "Approved Enterprise". As
                     of December 31, 2002, the accumulated deficit of the
                     Company does not include tax-exempt profits earned by the
                     Company's "Approved Enterprise".

                     Income from sources other than the "Approved Enterprise"
                     during the benefit period will be subject to tax at the
                     regular corporate tax rate of 36%.

              D.     Final tax assessments for the years up to 1999 have been
                     received and agreed upon with the Israeli tax
                     authorities.

              E.     On January 1, 2003, a comprehensive tax reform took
                     effect in Israel. Pursuant to the reform, resident
                     companies are subject to Israeli tax on income accrued or
                     derived in Israel or abroad. In addition, the concept of
                     "controlled foreign corporation" was introduced,
                     according to which an Israeli company may become subject
                     to Israeli taxes on certain income of a non-Israeli
                     subsidiary if the subsidiary's primary source of income
                     is passive income (such as interest, dividends,
                     royalties, rental income or capital gains). The tax
                     reform also substantially changed the system of taxation
                     of capital gains.


                                     -F34-
<PAGE>
            NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Cont.)
                         In thousands of U.S. dollars


Note 20  -    TAXES ON INCOME (Cont.)

              F.     VocalTec Ltd. has net operating loss carryforwards for
                     tax purposes of approximately $72 million as of December
                     31, 2002 which may be carried forward indefinitely.
                     VocalTec Communications Inc., which is subject to U.S.
                     income taxes, has a loss for tax purposes of
                     approximately $0.1 million as of December 31, 2002
                     (including TrulyGlobal Inc's losses for tax purposes,
                     which merged during 2001 with VocalTec Inc.) Under
                     certain conditions this loss can be carried against
                     previous tax payments of VocalTec Communications Inc., or
                     can be carried forward until the year 2022. A valuation
                     allowance of the entire deferred tax asset in respect of
                     the carryforward losses was recorded due to the
                     uncertainty of the future tax realization. Management
                     currently believes that since the Company has a history
                     of losses it is more likely than not that the deferred
                     tax regarding the loss carryforwards will not be realized
                     in the foreseeable future.

              G.     Taxes on income (tax benefit) is comprised as follows:

<TABLE>
<CAPTION>

                                                                       Year ended December 31,
                                                                ---------------------------------------
                                                                  2002             2001          2000
                                                                  ----             ----          -----
<S>                                                              <C>               <C>          <C>
                    Foreign:
                      Current taxes                                   670            294         7,432
                      State taxes                                     391              -         1,581
                      Taxes in respect of prior years           (*)(6,355)          (586)            -
                                                                ----------          ----        -------
                                                                   (5,294)          (292)        9,013
                                                                ==========          ====        =======
</TABLE>

                     (*)    $3.8 million relates to a tax refund received in
                            2002 due to carry back of losses from 2001 against
                            income from prior years. In addition, since the
                            Company realized its entire investment in ITXC in
                            2002 (see Note 8), it reassessed its tax liability
                            due to the change in circumstances and as a result
                            decreased its tax liability by approximately $2.5
                            million.


                                     -F35-
<PAGE>
            NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Cont.)
                         In thousands of U.S. dollars


Note 20-      TAXES ON INCOME (Cont.)

              H. Deferred taxes on income:

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

<TABLE>
<CAPTION>

                                                                                 December 31,
                                                                        ------------------------------
                                                                             2002            2001
                                                                             ----            ----
<S>                                                                  <C>                 <C>
                    Deferred tax asset
                      Reserves and allowances                           $       1,400   $       2,000
                      Net operating loss carryforwards                         26,100          21,600
                                                                              -------         -------
                                                                               27,500          23,600
                    Net deferred tax asset before valuation
                      allowance                                                27,500          23,600
                                                                              -------         -------
                    Valuation allowance                                       (27,500)        (23,600)
                                                                              -------         -------

                    Net deferred tax asset                                          -               -
                                                                              =======         =======
                    Deferred tax liability
                      Unrealized gain from available-for-
                        sale of ITXC shares                                 $       -        $  4,745
                                                                              =======         =======
</TABLE>


                     During 2002, the Company decreased the valuation
                     allowance by $2.1 million due to the income derived from
                     Vocaltec Communications Inc. and increased the allowance
                     by $6 million due to additional losses incurred and
                     changes in reserves and allowances. Management currently
                     believes that since the Company has a history of losses
                     it is more likely than not that the deferred tax asset
                     will not be utilized in the foreseeable future.

                                     -F36-
<PAGE>
            NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Cont.)
                         In thousands of U.S. dollars


Note 20-      TAXES ON INCOME (Cont.)

              I.     A reconciliation between the theoretical tax expense,
                     assuming all income is taxed at the statutory tax rate
                     applicable to income of the Company, and the actual tax
                     expense as reported in the statements of operations, is
                     as follows:

<TABLE>
<CAPTION>

                                                                   For the year ended December 31
                                                           --------------------------------------------
                                                                 2002           2001          2000
                                                                 ----           ----          ----
<S>                                                         <C>               <C>          <C>
                    Income (loss) from continuing
                    operations before taxes, as
                      reported in the consolidated
                      statements of operations               $   (11,075)   $   (20,750)  $    47,359
                                                              ===========    ===========   ===========

                    Statutory tax rate                                36%            36%           36%
                                                              ===========    ===========   ===========
                    Theoretical tax expenses on
                      the above amount at the
                      Israeli statutory tax rate             $    (3,987)   $    (7,470)  $    17,049
                    State taxes                                      391              -         1,581
                    Tax adjustment in respect of
                      different tax rate for foreign
                      subsidiary                                    (228)           167         2,111
                    Deferred taxes on losses and
                      other temporary differences
                      for which valuation                          5,961          6,691         4,697
                      allowance was provided
                    Tax benefit in respect of
                      utilization of losses for which
                      valuation allowance
                      was provided                                (2,052)             -       (13,680)
                    Taxes in respect of prior years               (6,355)          (586)            -
                    Differences in basis of
                      measurement for financial
                      reporting and tax return
                      purposes                                        80            800        (1,256)
                    Nondeductible expenses,
                      exempt income and others                       896            106        (1,489)
                                                              -----------    -----------   -----------
                    Actual tax expense (benefit)             $    (5,294)   $      (292)  $     9,013
                                                              ===========    ===========   ===========
</TABLE>

                                     -F37-
<PAGE>
            NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Cont.)
                         In thousands of U.S. dollars



Note 20 -     TAXES ON INCOME (Cont.)

              J.     Income (loss) from continuing operations before income
                     taxes (tax benefit) is comprised as follows:
<TABLE>
<CAPTION>

                                                  For the year ended December 31
                                              ---------------------------------------
                                                2002           2001           2000
                                                ----           ----           ----
<S>                                            <C>           <C>             <C>
                    Israel                     (15,697)      (17,492)        (10,148)
                    Foreign                      4,622        (3,258)         57,507
                                              ---------      --------        --------
                                               (11,075)      (20,750)         47,359
                                              =========      ========        ========

</TABLE>


Note 21-      OTHER COMPREHENSIVE INCOME (LOSS)
<TABLE>
<CAPTION>

                                                                   For the year ended December 31
                                                                --------------------------------------
                                                                 2002           2001           2000
                                                                 ----           ----           ----
<S>                                                            <C>            <C>             <C>
              Unrealized gain (loss) on available-
               for-sale securities during the
               period, net of taxes in the amount
               of $(620), $765 and $7,432 in 2002,
               2001 and 2000, respectively                       (930)          1,147          25,376
              Less - reclassification adjustment for
               gain included in net income, net of
               taxes in the amount of $4,125, $377
               and $7,432 in 2002, 2001 and 2000,
               respectively                                    (6,188)           (564)        (53,312)
                                                              --------         ------         --------
              Net unrealized gain (loss) on
               available-for-sale securities                   (7,118)            583         (27,936)
                                                              ========         ======         ========
</TABLE>







                                     -F38-

<PAGE>
                                # # # # # # # #


   SCHEDULE II


<TABLE>
<CAPTION>
                                              Balance at      Charged to                     Charged to
                                              beginning of       P&L        Changes         Comprehensive   Balance at
                                               period          statement    Written off        income       End of period

<S>                                             <C>              <C>         <C>                  <C>           <C>
          Year Ended December 31, 2000
          Allowance for sales returns           5,308            3,440         -                  -             8,748
          Allowance for doubtful accounts       1,335              187       -400                 -             1,122

          Year Ended December 31, 2001
          Allowance for sales returns           8,748           -3,672         -                  -             5,076
          Allowance for doubtful accounts       1,122              698        257                 -             2,077

          Year Ended December 31, 2002
          Allowance for sales returns           5,076            3,733                            -             8,809
          Allowance for doubtful accounts       2,077             -517       -651                 -               909
</TABLE>