<PAGE>
                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, 2001

                                       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:

NONE.


                                     Page 1
<PAGE>
The number of outstanding shares of each of the issuer's classes of capital or
common stock as of December 31, 2001

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>
INDEX

PART ONE

<TABLE>
<S>             <C>
Item 1.         Identity of Directors, Senior Management and Advisers  - Not applicable
Item 2.         Offer Statistics and Expected Timetable
Item 3.         Key Information  - Not applicable
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 - Not applicable
Item 14.        Material Modifications to the Rights of Security Holders and Use of
                Proceeds - Not applicable
Item 15.        [Reserved]
Item 16.        [Reserved]

PART THREE

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

SIGNATURES

EXHIBIT INDEX
</TABLE>


                                     Page 3
<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, 2001 is
derived from our Consolidated Financial Statements, which have been audited by
Luboshitz Kasierer, a member firm of Arthur Andersen, our independent auditors.
Effective as of June 1, 2002, Luboshitz Kasierer became 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 4
<PAGE>
STATEMENT OF OPERATIONS DATA

<TABLE>
<CAPTION>
                                                                   YEAR ENDED DECEMBER 31,
                                                  ----------------------------------------------------------------
                                                     1997          1998          1999          2000          2001
                                                  --------      --------      --------      --------      --------
                                                                (In thousands, except per share data)
<S>                                               <C>           <C>           <C>           <C>           <C>
Net sales                                         $ 15,683      $ 24,650      $ 26,615      $ 41,971      $ 28,413
Cost of sales                                        2,243         5,938         8,156        13,146        10,070
Inventory write off                                     --            --            --            --         1,441
Gross profit                                        13,440        18,712        18,459        28,825        16,902
Research and development expenses, net               5,519        11,192        13,157        11,270        11,039
Marketing and selling expenses, net                 13,449        18,509        27,171        26,372        24,716
General and administrative expenses                  3,196         5,204         6,592         7,769         7,200
Restructuring costs                                     --            --           827            --         2,073
Total operating expenses                            22,164        34,905        47,747        45,411        45,028
Operating (loss)                                    (8,724)      (16,193)      (29,288)      (16,586)      (28,126)
Other income (expenses), net                            --        (9,656)           --        57,744           941
Finance income, net                                  1,004         2,668           902         3,184         1,872
Income (loss) before income taxes                   (7,680)      (23,181)      (28,386)       44,342       (25,313)
Income tax (benefit)                                    --            --            --         9,013          (292)
Income (loss) from continuing operations            (7,680)      (23,181)      (28,386)       35,329       (25,021)
Loss from operations of discontinued segment            --            --            --        (6,493)       (4,403)
Loss on disposal of segment                             --            --            --            --        (2,359)
Net income (loss)                                   (7,680)      (23,181)      (28,386)       28,836       (31,783)
Basic net income (loss) per share from
continuing operations                                (0.89)        (2.08)        (2.47)         2.92         (2.06)
Diluted net income (loss) per share from
continuing operations                                (0.89)        (2.08)        (2.47)         2.67         (2.06)
Basic net income (loss) per share                    (0.89)        (2.08)        (2.47)         2.39         (2.62)
Diluted net income (loss) per share                  (0.89)        (2.08)        (2.47)         2.18         (2.62)
Weighted average number of shares outstanding        8,618        11,145        11,498        12,082        12,127
used in computation (basic)
Weighted average number of shares outstanding        8,618        11,145        11,498        13,252        12,127
used in computation (diluted)
</TABLE>


BALANCE SHEET DATA
<TABLE>
<CAPTION>
                                                   AS OF DECEMBER 31,
                                  1997        1998        1999        2000        2001
                                 -------     -------     -------     -------     -------
                                                     (In thousands)
<S>                              <C>         <C>         <C>         <C>         <C>
Working capital                  $16,093     $42,501     $35,975     $42,673     $17,117
Total assets                      24,757      59,945      89,271      92,967      51,561
Long-term Liabilities                726       1,224      21,778       6,449       7,577
Net assets                        19,711      50,871      58,990      62,370      31,229
Total shareholders' equity        19,711      50,871      58,990      62,370      31,229
Number of shares outstanding       8,627      11,413      11,771      12,127      12,127
</TABLE>


                                     Page 5
<PAGE>
3B.   CAPITALIZATION AND INDEBTEDNESS

Not applicable.

3C.   REASONS FOR THE OFFER AND USE OF PROCEEDS

Not applicable.

3D.   RISK FACTORS

PURCHASING OUR SHARES INVOLVES A HIGH DEGREE OF RISK. THE RISKS SET FORTH BELOW
SHOULD BE CAREFULLY REVIEWED BEFORE MAKING AN INVESTMENT DECISION IN OUR SHARES.
IN THE EVENT THAT ONE OR MORE OF THE RISKS SET FORTH BELOW OCCURS, OUR SHARE
PRICE COULD DECREASE AND YOU MAY LOSE ALL OR PART OF YOUR INVESTMENT.

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. The downturn in capital markets and reduction
of capital expenditures by telecom carriers 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 have a large order backlog. This makes the forecasting
of net sales inherently uncertain. This uncertainty is compounded because each
quarter's net sales are frequently from orders booked and shipped during the
last month of that quarter. Furthermore, a disproportionately large amount of
sales of the last month of each quarter are typically booked and shipped in the
latter half of the month. 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, the economic viability 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 telecom markets and in the Voice over Internet Protocol (VoIP) industry in
which we operate.

Our future results may also be affected by factors including our ability to
continue to develop, introduce and deliver enhanced and new products in a timely
manner, to offer new products at competitive 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 performance. The volatility in our operating results may
also result in significant


                                     Page 6
<PAGE>
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 and related sectors. It is also possible that our quarterly results
or 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 EXPECT TO CONTINUE
TO INCUR OPERATING LOSSES.

Since our incorporation in 1989, we have had limited sales and have incurred
significant operating losses. In 2001, we had an operating loss of $28.13
million and a net loss of $31.78 million. In 2000, we had an operating loss of
$16.59 million, although we reported net income of $28.84 million due to a sale
of a portion of our shares in ITXC Corp. In 1999 and 1998 we incurred net losses
of approximately $28.39 million and $23.18 million (including a one-time charge
in respect to acquired research and development of $9.7 million), respectively.
Our future prospects must be considered in light of the risks, expenses and
difficulties currently encountered by companies in the depressed telecom 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, timely introduce
advanced versions and enhancements of our products and successfully market and
support such advanced versions and enhancements.

We expect to continue to incur operating losses in 2002 and may incur operating
losses thereafter due to decreased sales revenues which are insufficient to
cover sales and marketing, product development, administrative and other
expenses. If revenue levels decrease, operating results will be adversely
affected because any corresponding reduction in expenses may not be
proportionate to the reduction in revenues. There can be no assurance that we
will achieve or sustain significant sales or profitability in the future.

ANY FURTHER REDUCTION IN CAPITAL SPENDING BY TELECOMMUNICATIONS COMPANIES WILL
ADVERSELY AFFECT OUR REVENUES AND OUR FUTURE GROWTH

The turbulent economic events of the last two years have evidenced a decrease in
economic growth in all sectors of the telecommunications industry. Along with
the downturn in capital markets, these events have precluded the establishment
of new carriers, who would have represented potential new customers for us. In
addition, many existing telecom providers, including some of our customers, have
sustained significant economic losses and 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 either canceling or
delaying capacity upgrades, network expansions and the implementation of new
technologies, resulting in longer sales cycles. The downturn in capital markets
and reduction of capital expenditures by telecom carriers have resulted in
decreased market demand for our products and longer sales and procurement
cycles,


                                     Page 7
<PAGE>
and have adversely affected our revenues. There can be no assurance there will
be no further deterioration in the telecom carrier sector, and that these events
will not continue to adversely affect our revenues and future growth.

IF OUR RELATIONSHIPS WITH OUR KEY PARTNERS ARE TERMINATED, OUR BUSINESS WILL BE
ADVERSELY AFFECTED.

Our relationship with ITXC provided for the purchase of approximately $7.1
million of our products and services by ITXC during 2001, constituting 25% of
our net sales in 2001. Our relationship with Deutsche Telekom AG provided for
the purchase of approximately $37.4 million of our products and services by
Deutsche Telekom between December 1997 and December 2001. During 2001, Deutsche
Telekom purchased $2.3 million of our products and services, constituting 8% of
our net sales in 2001. During 2000, Deutsche Telekom purchased $12.2 million of
our products and services, constituting 29% of our net sales in 2000.

If for any reason, our relationship with ITXC or Deutsche Telekom is terminated,
or if either of these key customers reduce purchases of our products, our
business, financial condition and results of operations would be materially
adversely affected. The impact of the termination or reduction of either or both
of these relationships would be intensified if we are unable to increase sales
to other customers in order to offset this termination or reduction.

WE WILL NOT ATTRACT AND RETAIN CUSTOMERS IF OUR SOLUTIONS DO NOT MEET MARKET AND
CUSTOMER REQUIREMENTS OR IF OUR PRODUCTS DO NOT ACHIEVE HOMOLOGATION
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 aggressive schedules. As the
variety and complexity of our product lines increase, the process of planning
production and inventory levels also becomes more difficult.

Short product life cycles place a premium on our ability to manage the
transition from current products to new products. Our results could be adversely
affected by factors such as development or manufacturing delays, variations in
product costs, and delays in


                                     Page 8
<PAGE>
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, telecom carriers outside the U.S. increasingly require that VoIP
products be designed to meet local homologation requirements to demonstrate
interoperability with existing networks of incumbent telecom carriers, each of
which may have different specifications. Failure to obtain such homologation
certification for our products may result in decreased revenues, significant
warranty, support and repair costs, divert the attention of our engineering
personnel, and cause significant customer relations problems.

IF VIABLE MARKETS FOR OUR PRODUCTS AND TECHNOLOGY FAIL TO DEVELOP AND GROW, OR
OUR PRODUCTS FAIL TO ACHIEVE MARKET ACCEPTANCE EVEN IF MARKETS DO DEVELOP AND
GROW, OUR BUSINESS WILL BE ADVERSELY AFFECTED.

The markets for our products are new, are rapidly evolving technologically, and
are characterized by competitors that have developed similar products and
services. 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. Broad market demand and acceptance of our
technology, products and solutions, and interoperability of our products with
other VoIP products are critical to our success and 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 IP networks and the
PSTN will become widespread or that our products and solutions will gain market
acceptance. The adaptation process of connecting IP networks and PSTNs can be
time consuming and costly to both us and our customers and the acceptance of the
product or system may depend, to a substantial extent, on the success of the
adaptation.

The market for our VoIP products and solutions is depressed and still evolving,
it is difficult to predict its future growth rate, if any, and the size of our
market. There can be no assurance that the market for our products and services
will develop or that our products and solutions will achieve market acceptance.
If the market fails to develop, develops more slowly than expected, or if our
products and solutions do not achieve market acceptance, our business, financial
condition or results of operations will be materially adversely affected. In
addition, the market acceptance of new products by our competitors or the
emergence of new industry standards could render our products technologically
obsolete and could result in the inability to sell our products in the
marketplace and result in inventory write-downs of hardware products and
components contained in our solutions.


                                     Page 9
<PAGE>
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.

If we do not increase our sales revenues, we may need to 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, from
strategic alliances or from the Office of the Chief Scientist of the State of
Israel (the "Chief Scientist"), 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. The recent downturn
in 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. 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.

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. In addition,
generally depressed economic conditions, and conditions relating to the
telecommunications industry in particular, pose serious risk factors that may
adversely affect our revenues and share price. Delisting procedures may be
instituted against us if our share price decreases below the NASDAQ limit, and
we may be delisted if our share price falls and remains below the limits
prescribed by NASDAQ.

In addition, global stock markets, including the NASDAQ, have been experiencing
and may continue to experience significant price and volume decreases which have
particularly affected the market prices of the stocks of high technology
companies and Israeli companies, including ourselves. Additional factors that
could cause the market price of our stock to 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 variations in actual or anticipated operating results, changes in
earnings estimates by analysts, 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 significantly affected and may continue to significantly affect the
market price of our ordinary shares. In the past, following decreases or
volatility in the market price of a company's securities, securities class
action litigation has often been instituted against


                                    Page 10
<PAGE>
such a company. Such litigation could result in substantial costs and 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. Almost all of our current and potential
competitors have greater name recognition, larger installed customer bases 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.

Various innovative voice, audio and other communications alternatives, which may
compete with our products are often introduced, and may be introduced in the
future. Such new communication alternatives may be based on traditional
telephone lines, the Internet or cable networks and may be combined with other
computing and broadcasting capabilities.

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 telephone
companies and other telecommunications infrastructure providers. Additional
competitors may include companies that currently provide computer software
products and services, such as telephone, media, publishing 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 and military conditions in Israel and in other countries in
which our business are located or in which our products are sold. 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


                                    Page 11
<PAGE>
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 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. In April 2002, Israel responded to Palestinian terrorist
attacks by undertaking military operations in Palestinian territory. 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 39 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.


                                    Page 12
<PAGE>
Trade receivables as of December 31, 2001 amounted to approximately $5.4
million, net of allowances of approximately $7.2 million (mainly a reserve for
doubtful accounts and unrecognized revenues). Trade receivables as of May 31,
2002 amounted to approximately $5.7 million, net of allowances of approximately
$7.4 million. A portion of our receivables result from credit extended to
customers for purchases of our products. Some of these customers were proven to
be credit risks, and others may prove to be credit risks in the future. There
can be no assurance that any of our accounts receivable will be completely
collected. Any failure in the collection of 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, INCREASED WARRANTIES 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. In addition, our
customers are demanding longer product warranties that decrease our operating
margins. Further, an increasing number 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 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 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. Moreover,
the need to stock up on such components has increased our inventories and costs
of sales, and has negatively impacted our gross margins. We expect this trend to
continue in 2002 and beyond. 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 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


                                    Page 13
<PAGE>
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, 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,


                                    Page 14
<PAGE>
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.

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

Our marketing strategy includes sales through distributors and resellers, as
well as direct sales by our own sales force. Our marketing efforts would be
adversely affected by changes in our relationships with our distributors, value
added resellers and agents, or by other changes to their respective businesses.
There is no assurance that we will be successful in extending the duration of
our various agreements or in establishing similar relationships with other
entities if our current agreements are not extended. Although we believe that
our relationship with our distributors, value added resellers and agents is
generally good, the loss of our distributors or any event negatively affecting
their financial condition could have a material adverse effect on our business,
financial condition or results of operations

OUR EXPANSION INTO NEW INTERNATIONAL MARKETS EXPOSES US TO THE RISKS INHERENT IN
CONDUCTING BUSINESS IN INTERNATIONAL MARKETS.

A substantial portion of our sales are made directly or indirectly into
international markets, some of which are in developing countries. A key
component of our strategy is to continue to penetrate 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,
difficulties in collecting accounts receivable, 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


                                    Page 15
<PAGE>
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.

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

As of May 31, 2002 our principal shareholders, including our directors and
certain executive officers, beneficially owned more than 30% 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.

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) which may be eliminated or
ameliorated by a QEF Election (as defined in Item 10E) that is in effect for any
year in which we are a PFIC. Each U.S. Holder will be responsible for making
this QEF Election on such holder's tax return. Failure to make a QEF Election
may 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. U.S.
Holders should consult their United States tax advisors with respect to the
United States tax consequences of investing in our ordinary shares, and the
benefits of a QEF Election, as applied to their circumstances. Although we do
not believe that we have been a PFIC for any tax year through and including
2001, we may be deemed to be a PFIC by the tax authorities for tax year 2001 as
a result of our substantial holdings of cash, cash equivalents and securities
combined with a decline in our share price and we may be deemed to be a PFIC in
future years. 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


                                    Page 16
<PAGE>
Enterprise" status of certain existing facilities and approved programs from the
Government of Israel. In addition we benefit from participation by 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
investments in fixed assets. If we fail to meet such conditions in the future,
we could be required to refund tax benefits already received. 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 portions 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 1999, 2000 and 2001 the annual
rate of inflation was 1.3%, 0% and 1.4%, respectively, while the NIS was
devalued against the dollar by approximately -0.2%, -2.7% and 9.3%,
respectively. The rate of inflation for 2002 as of May 31, 2002 is was 4.9%, and
the NIS depreciated during 2002, until May 31, 2002, by approximately 1.3%.
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 or entities 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.

U.S. FEDERAL COMMUNICATIONS REGULATIONS


                                    Page 17
<PAGE>
To date, the Federal Communications Commission ("FCC") has not subjected IP
telephony providers nor VOIP solutions providers to the FCC regulations that
apply to long distance telecommunications carriers. At this time it is uncertain
whether or to what extent the FCC 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 FCC action
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
+972-9-970-9700. Our website is located at http://www.vocaltec.com. Our wholly
owned U.S. subsidiary, VocalTec Communications Inc., is located at One Executive
Drive, Suite 320, Fort Lee, NJ, USA 07024-3393.

Our capital expenditures for fiscal years 2001, 2000 and 1999 amounted to $1.8
million, $6.7 million and $3.2 million, respectively. These expenditures were
primarily for computer equipment in our Israel and worldwide offices.

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 remaining operations
with our U.S. wholly owned subsidiary, VocalTec Communications Inc. As a result,
we are using most of the computer equipment of TrulyGlobal in our research and
development operations. Such equipment has a net asset value of $1.6 million,
and we anticipate a reduction in our capital expenditure requirements resulting
from our use of this equipment.

Capital expenditures for another line of business, Surf&Call, 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 we will not incur any capital expenditures for Surf&Call
after such date.

During the second quarter of 2001, we decided to implement a number of
organizational changes due to substantial reduction in market demand, based on
an ongoing review of our operations. This initiative consisted of a number of
organizational changes, including a reduction in worldwide headcount of 140
employees, or approximately 40% of our workforce, and reduction in the office
facilities used for our activities.


                                    Page 18
<PAGE>
As of May 31, 2002, capital expenditures currently in progress consist of
approximately $0.43 million to be used in 2002 for research and development
activities.

4B.   BUSINESS OVERVIEW

We are a leading supplier of packet-based voice solutions for next generation
telecommunication networks suitable for the telecom and enterprise markets. Our
solutions incorporate carrier-class switching equipment and software that allow
voice to be delivered over packet-based networks, including the Internet. Our
solutions enable telecom 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 telecom carriers and service providers to increase their revenues
through the delivery of new and innovative web-based voice and data services
(such as voice virtual private networks) helping them to retain and expand their
customer base.

Our solutions are suitable for the telecom and enterprise markets and 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 publicly
switched telephone network ("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.

See Item 5 - Operating Review and Financial Prospects - for segmented financial
information.

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 (Internet
Protocol), 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


                                    Page 19
<PAGE>
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.

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. To accommodate this growth,
carriers have made major investments in packet-based networks. 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:

-     Carrier class equipment that complies with telecom carriers' quality
      standards.

-     Scalable solutions that support incremental growth from entry level
      deployments to massive global networks

-     Solutions compatible with the existing infrastructure, supporting the full
      range of traditional telephone signaling variants (SS7).

-     Multi-protocol solutions, supporting SIP, MGCP, Megaco and H.323.

-     Proven interoperability with VOIP equipment of other vendors for best of
      breed solutions

-     Distributed architecture for easy management and enhanced network
      efficiency

-     Simple and rapid installation, deployment and support


                                    Page 20
<PAGE>
THE VOCALTEC SOLUTION

We develop, market and sell a wide variety of carrier-grade, solutions based on
our award-winning softswitch architecture and VoIP products. Our solutions offer
high reliability, improved economics, interoperability, rapid deployment and an
open architecture and allow our customers to offer revenue-generating services.

We believe that our particular advantages are:

-     Strong SS7 capabilities, supporting over 50 national variants of this
      telephony signaling protocol.

-     Modular solutions for all sizes of networks.

-     Extensive next generation network experience.

-     Significant installed base with commercially deployed solutions in over
      100 countries.

-     Interoperability with many revenue-generating VoIP ports worldwide.

-     Multiple relationships with various solutions providers for the telecom
      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 VPN (Virtual Private Network). 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. This widely deployed solution is used by ITXC, one
of the world's largest international VoIP networks.


                                    Page 21
<PAGE>
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.

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.

VOCALTEC PRODUCTS

The solutions described above are based on a wide range of flexible and scalable
VocalTec products that meet the technical and interoperability requirements of
the world's leading communication companies.


VOCALTEC SOFTSWITCH ARCHITECTURE 3000

VSM3100(TM) Service Integration Module - This carrier-grade, scaleable module
provides centralized VoIP service aggregation and integration over packet
networks. The SM3100 performs call control, routing, addressing, security and
accounting for multiple, distributed gateways.

VSM3200(TM) MGC Module - Performs call control and signaling routing for PSTN
and SS7 voice traffic. The VSM3200 frees the media gateway to serve as a pure
voice transport device. By working opposite multiple media gateways
simultaneously, the VSM3200 maximizes a network's performance,
cost-effectiveness and scalability.

VSM3300(TM) SIP Module - This module integrates SIP endpoints and applications
into today's H.323-based VoIP networks. The VSM3300 provides seamless,
standards-based interoperability between media gateways, H.323 gateways and SIP
networks. The


                                    Page 22
<PAGE>
VSM3300 mediates between SIP endpoints and VocalTec's advanced VSM3100 Service
Integration Module.

VNM3900(TM) Network Manager - This centralized tool allows network
administrators to manage and monitor the VSA 3000 modules (VSM3100, VSM3200,
VSM3300), VocalTec gateways, and third party H.323 gateways. The VNM3900
combines remote configuration and extensive provisioning capabilities with a
web-based interface.

VNM3910(TM) Customer Network Manager - This web application enables hosted Voice
VPN customers to perform administration and subscriber provisioning activities
for multi-level VPNs. The VNM3910 allows customers to configure closed user
groups, subscriber features and assignment, and other attributes. Self
management via the web maximizes customers' accessibility, while reducing the
service provider's management costs.

VNM3920(TM) Traffic Manager - Based on near-real time monitoring and analysis of
enriched call detail record (CDR) information, VNM3920 proactively identifies
potential problems before they affect service levels. Statistical reports and
graphs facilitate traffic analysis for optimized network planning and marketing
decisions. VNM3920 reduces operational costs by ensuring maximum utilization of
network equipment.

VNM3930(TM) Billing Mediator - The VNM3930 collects and stores CDRs in a central
repository. This module formats and exports CDR files to billing and other
systems, and provides analytical tools for field-level investigations of
individual CDRs. VNM3930 increases revenues by consolidating CDRs in a single
database and preventing the loss of billable CDRs.


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-


                                    Page 23
<PAGE>
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 Interactive Voice Response (IVR) to 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 small capacity VoIP DSP processor boards, ECI
Telecom Ltd. for the supply of large capacity VoIP DSP processor boards, and
Intel for the supply of signaling boards and components.

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 expanded our direct sales channels and currently have a direct global sales
organization with sales and support based in Israel, the United States, Japan,
Germany, China, Hong Kong, Singapore, Italy, Spain, France and Sweden. 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 and have recently
increased due to the depressed telecommunications markets and generally weak
market demand for 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.

INDUSTRY STANDARDS

We recognize that standards are important for interoperability and for providing
the


                                    Page 24
<PAGE>
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 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 continue to participate as members in such consortia.

We actively support all the most 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. 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. For the telecommunications market, we have entered into
several agreements that provide a percentage charge of the cost of the system
purchased for technical support. 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 enables us to design
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, Avaya/Lucent Technologies Inc., Siemens, Nortel
Networks Corporation, Nuera Communications, Comworks Technologies, Sonus
Networks Inc. and Clarent Corporation.

We believe that in such a rapidly changing market, key competitive factors
include a broad base of users, strategic alliances, key reference customers,
interoperability, integration of products with vendors of complementary hardware
and software products


                                    Page 25
<PAGE>
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 places
of incorporation are:

-     VocalTec Communications Inc. (USA)
-     VocalTec Communications Japan KK, (Japan)
-     VocalTec Communications Deutschland GmbH (Germany)
-     VocalTec Communications Hong Kong Limited (Hong Kong)
-     VocalTec Communications International B.V. (Netherlands)
-     VocalTec Communications Italy S.r.l. (Italy)
-     VocalTec Communications Singapore Pte Ltd. (Singapore)
-     VocalTec Communications France SAS (France)
-     VocalTec Communications Spain S.L. (Spain)
-     VocalTec Communications Sweden AB (Sweden)
-     VocalTec Communications Australia Pty Ltd. (Australia)

 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 49,600 square feet pursuant to a lease expiring in July 2002. We
possess an option to extend the lease on similar terms. We currently pay total
yearly rental and management fees of approximately $0.95 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 38,000 square feet are currently being used by our
company. We are subleasing approximately 2,500 square feet to Surf&Call
Solutions Ltd., and are attempting to sublease additional unused space in our
premises. We are currently re-negotiating renewal of our lease and the return of
a portion of our unused space.

We maintain car leases, and our total liability for early termination of the
leases is up to an aggregate of approximately $300,000.

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


                                    Page 26
<PAGE>
Our subsidiary in the United States rents approximately 16,500 square feet in
Fort Lee, New Jersey under a lease expiring in July 2003. The annual rent for
these facilities is approximately $354,000. Approximately 10,000 square feet are
being used by our U.S. subsidiary, and we are currently attempting to sublease
additional unused footage in these premises and are simultaneously negotiating
with our landlord to lease smaller premises.

We lease a Network Operating Center in New York, New York, which rents
approximately 150 square feet. The annual rent for these facilities is $180,000.
The rental fees are fully paid until October 2002, at which time the lease
expires. We do not intend to renew this lease.

Our subsidiary in Japan leases approximately 2,200 square feet in Tokyo under a
lease expiring in July 2002 and will be automatically renewed. The annual rent
for the facility is approximately $100,000.

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.

Our representative office in China leases approximately 2,200 square feet in
Beijing under a lease expiring in July 2002. The annual rent for the facility is
approximately $44,500. We are currently in the process of renewing this lease.

Our subsidiary in Hong Kong leases approximately 1,900 square feet under a lease
expiring in June 2002. The annual rent for the facility is approximately
$85,000. We are currently negotiating with our landlord to lease smaller
premises.

We lease additional office space in Singapore, Italy, Spain, France, Sweden, and
Miami.


ITEM 5.     OPERATING AND FINANCIAL REVIEW AND PROSPECTS

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. These statements involve substantial risks and uncertainties. In
some cases you can identify these statements by forward-looking words such as
"anticipate," "believe," "could," "estimate," "expect," "intend," "may,"
"should," "will," and "would" or similar words. You should read statements that
contain these words carefully because they discuss future expectations, contain
projections of future results of operations or of financial position or state
other forward-looking information. The important factors listed in the section
captioned "Risk Factors," as well as any cautionary language in this report,
provide examples of risks, uncertainties and events that may cause our actual
results to differ materially from the expectations described in these
forward-looking statements. You should be aware that the occurrence of the
events described in these risk factors and elsewhere in this report, including
in the section captioned "Critical Accounting Policies," could have a material
adverse effect on the business, results of operations and


                                    Page 27
<PAGE>
financial position of VocalTec.

Any forward-looking statements in this report are not guarantees of future
performances, and actual results, developments and business decisions may differ
from those envisaged by such forward-looking statements, possibly materially.
VocalTec disclaims any duty to update any forward-looking statements, all of
which are expressly qualified by the statements in this section.

OVERVIEW

Recent turbulent economic conditions worldwide have affected the
telecommunications industry in particular. As a result, spending in the telecom
industry has decreased substantially in 2001. Accordingly, sales of VoIP
products to telecom service providers have decreased and continue being
generally unpredictable, as fluctuation in demand for voice infrastructure
products is dependent on the service providers expansion of their networks.

The major product changes during the past three years was the introduction of
our award-winning softswitch technology and our gateway 2000 and gateway 480
products. In addition, during 2000 we stopped selling our Internet Phone
products, as these sales accounted for a small percentage of our net sales in
1999 and 1998. 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 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, and trends within our company, 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

The critical accounting policies listed below, in our opinion, materially affect
our estimates, assumptions and judgments in compiling our Consolidated Financial
Statements.

Revenue Recognition: We recognize revenue when (1) we and a creditworthy
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. This policy ensures that we report
revenues in accordance with generally accepted accounting principles in the U.S.
Factors that could materially


                                    Page 28
<PAGE>
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.

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 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 profit and loss
statements. We include both past actual expenses and accruals for expected
expenses, along with the impairment of the value of fixed assets belonging to
these segments after the balance sheet date. Exit costs relating to continuing
operations are presented as "restructuring costs" within the operational
expenses. These exit costs include severance and notice payments to employees
and other contractual obligations.

Conservative Accounting Practices: 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

The following discussion of our financial condition and results of operations
should be read in conjunction with our 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."

NET SALES

Net sales consist of sales of VoIP turnkey solutions, products and related
support and maintenance services. We posted net sales in 2001 of $28.4 million,
32% lower than net sales in 2000 in the amount of $42 million. Revenues for 2001
were 7% higher than revenues in 1999, which were in the amount of $26.6 million.
The decrease in net sales in 2001 was primarily attributable to weakened market
demand, financial difficulties of telecom carriers and service providers, as
well as excess PSTN capacity, longer sales cycles and turbulent global economic
conditions, all of which affected the telecom


                                    Page 29
<PAGE>
industry and resulted in decreased capital expenditures by telecom customers.
The increase in net sales in 2000 was primarily attributable to increased
capital expenditures by our customer base, our increased sales and marketing
efforts, including an increased number of sales offices, a larger, more focused,
sales force and a growing acceptance of packet-based telephony.

Sales of our turnkey solutions (consisting of software, hardware and services)
to the service provider market comprised the most significant portion of sales
in 2001. These sales resulted from increased market demand in previous years for
turnkey solutions rather than sales of product units. These turn-key solutions
accounted for approximately 75% of our net sales in 2001, compared with 54% in
2000, and 57% in 1999. Other revenues were generated by licenses, projects and
support.

During 2000 we stopped selling Internet Phone, as a result of our increased
focus on turnkey solutions and carrier markets. Sales of Internet Phone
accounted for 5% of our net sales in 1999.

In 2000 and 2001 revenues from consulting for customization services were
negligible, down from 35% of our total revenues in 1999. This decrease is
attributable to the changed composition of sales due to increased sales of
turnkey projects with less customization requirements, and the reduction in
demand for customization services by Deutsche Telekom. As our customers have
less customization requirements, we expect that future revenues from consulting
services will continue to be negligible and that we will sell more turnkey
products and projects and less consulting services.

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. In each of 2000 and 1999,
we experienced an increase in net sales through distribution channels serving
the carrier or corporate markets. These channels represented a higher percentage
of net sales in 2000 compared with 1999 due to our increased focus and marketing
efforts in such channels. In 2001 our net sales through distribution channels
decreased from 2000, in generally the same proportion as the decrease in overall
sales.

The direct sales operations to telecommunications service providers was
initiated in 1997, primarily due to a strategic business cooperation agreement
with Deutsche Telekom.

Sales to Deutsche Telekom in 2001 decreased to 8% of net sales, compared with
29% of net sales in 2000, and 49% of net sales in 1999. Sales to ITXC Corp.
accounted for 25% of revenues during 2001, compared with 15% in 2000. Sales to
ECI accounted for 4% of revenues in 2001 compared with 11% in 2000. The increase
in percentage of net sales to ITXC is a result of the decrease in sales to
Deutsche Telekom in 2001. If for any reason, our relationship with ITXC or
Deutsche Telekom is terminated, or if either of these key customers reduce
purchases of our products, our business, financial condition and results of
operations will be materially adversely affected.


                                    Page 30
<PAGE>
Geographic revenues as a percentage of overall revenues changed as follows:

-     Sales in the Americas increased to 33% of total revenues in 2001, compared
      with 20% in 2000 and 13% in 1999.
-     Sales in Europe decreased to 38% of total revenues in 2001, compared with
      43% in 2000 and 63% in 1999.
-     Sales in Asia Pacific increased slightly to 23% of total revenues in 2001,
      compared with 19% in 2000 and 21% in 1999.
-     Sales in Israel decreased to 4% of total revenues in 2001, compared with
      11% in 2000 and 2% in 1999.

The difference in 2001 percentages in geographic revenue distribution from
previous years is mainly a result of the decrease in sales to Deutsche Telekom
in Europe in 2001.

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

COST OF SALES

Cost of sales including an inventory write-off in the amount of $1.4 million was
$11.5 million or 41% of net sales in 2001, compared with $13.1 million or 31% of
net sales in 2000 and $8.2 million, or 31% of net sales, in 1999. Cost of sales
excluding the inventory write-off was $10.1 million, or 35% of net sales. Cost
of sales primarily include the cost of hardware that we must purchase to provide
as part of our turnkey solutions, third party billing software, reserves for
price reductions of products in inventory, cost of operations for rendering
maintenance services to customers, royalties payments to third parties, warranty
reserves, and other inventory write-offs.

In 1999, 2000 and 2001, cost of sales increased in absolute numbers and as a
percentage of sales due to increased sales of turnkey solutions containing both
software and hardware components, as opposed to sales of purely software
products. We expect that cost of sales may increase in the future due to
customers' preference for full turnkey solutions containing both software and
hardware products, increasingly competitive prices, customer requirements for
longer warranty periods, and increased inventory-related costs.

In 2001, gross margins including an inventory write-off for obsolete stock, was
59%, and excluding the inventory write-off were 65%, 69% and 69% in the years
2001, 2000 and 1999, respectively. The decrease in 2001 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.

We believe that the gross margin on product sales may decrease in future periods
due to increased competition which may cause us to reduce prices of certain of
our products,


                                    Page 31
<PAGE>
increased amounts paid for licensed technology to be incorporated in future
products and increased costs associated with providing longer customer warranty
periods, 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
$11 million, or 39% of net sales in 2001, compared with $11.3 million, or 27% of
net sales in 2000, and $13.2 million, or 49% of net sales in 1999. Although the
actual amount spent on research and development costs decreased, 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 necessary 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% - 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.

In 2001, total research and development grants from the Chief Scientist were
$2.5 million, all of which related to royalty bearing programs. Total cash
grants received from the Chief Scientist in 2001 (for years 2000 and 2001) were
$2.5 million. As of December 31, 2001 grant receivables were $0.3 million.

In 2001, we paid royalties to the Chief Scientist in an aggregate amount of
approximately $1.1 million. We currently have an additional $0.4 million in
accrued obligations to pay for royalties previously incurred under royalty
bearing programs of the Chief Scientist.

In 2000, total research and development grants from the Chief Scientist were
$2.1 million


                                    Page 32
<PAGE>
of which $0.2 million were royalty-free and resulted from the MAGNET program
(see "Research and Development Consortia" below). Total cash grants received
from the Chief Scientist in 2000 were $4.4 million, of which $2.5 million
related to royalty bearing programs and $2.0 million related to the MAGNET
program. On December 31, 2000, grants receivables were $0.3 million.

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 1999, total research and development grants from the Chief Scientist were
$2.0 million, of which $1.3 million related to royalty bearing programs and $0.8
million resulted from the MAGNET program. Total cash grants received from the
Chief Scientist in 1999 were $1.4 million, of which $0.7 million related to
royalty bearing programs and $0.6 million resulted from the MAGNET program. On
December 31, 1999, grant receivables were $1.2 million.

In 1999, we paid royalties to the Chief Scientist in an aggregate amount of
approximately $44,000, with an additional $0.2 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. Under this program we were allocated 720,000 Euros for the two and a
half year duration of the project, all of which forms part of a non
royalty-bearing program. In 2001, total research and development grants from the
Fifth Framework Programme were 188,000 Euros. Total cash received in 2001 from
this program were 63,000 Euros. In 2000, total research and development grants
from the Fifth Framework Programme were 340,000 Euros. Total cash received in
2000 from this program 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 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.


                                    Page 33
<PAGE>
We are a member in 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, net.

Marketing and selling expenses, net were $24.7 million, or 87% of net sales, in
2001 compared with $26.4 million, or 63% of net sales in 2000 and $27.2 million,
or 102% of net sales, in 1999. Marketing and selling expenses include salaries
and benefits, sales commissions, travel expenses and related facilities costs
for our sales, marketing, customer support and distribution personnel as well as
royalties to third parties. Marketing and selling expenses also include the
costs of programs aimed at increasing revenue, such as advertising, trade shows
and other market development programs.

The decrease in marketing and selling expenses in absolute terms in 2001 was the
result of the reduction in sales and marketing staff. 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
could not be reduced in the same proportion our revenues decreased, without
harming future revenue opportunities.

The decrease from 1999 in marketing and selling expenses in absolute terms in
2000 was the result of the separation of sales and marketing expenses of
TrulyGlobal, now presented in our financial statements in the discontinued
operations line. This amount was offset partially by the establishment and
expansion of the marketing, sales and customer support operations relating to
the carrier and service providers markets in our offices in Singapore,
Australia, Italy, France, and Hong Kong. A large number of sales and support
personnel were redeployed worldwide, in order to be based in the territories
that they serve.

In 1999, the relatively high levels of marketing and selling expenses was a
result of the establishment of sales and marketing activities in Germany and
China, expansion of the marketing, sales and customer support operations
relating to the carrier and service providers markets of our U.S. subsidiary,
VocalTec Communications Inc., as well as increased bad debts expenses.

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/production, human
resources, legal, information services, and administrative personnel. General
and administrative expenses also include


                                    Page 34
<PAGE>
expenses associated with computer equipment and software used in the
administration operations. General and administrative expenses were $7.2 million
or 25% of net sales in 2001, compared with $7.8 million, or 19% of net sales in
2000 and $6.6 million, or 25% of net sales, in 1999. If we find it necessary to
add any systems, processes and people necessary to support overall increases in
the scope of our operations, general and administrative expenses will increase
in absolute terms.

Restructuring costs.

During the second quarter of 2001, we decided to implement a number of
organizational changes due to substantial reduction in market demand, based on
an ongoing review of our operations. This initiative consisted of a number of
organizational changes, including a reduction in worldwide headcount of 140
employees, or approximately 40% of our workforce and reduction in the office
facilities used for our activities. As most of the affected employees were
entitled to a notice period, severance payments and other benefits, we recorded
$1.6 million for these items. Payments for vacant office space for the remainder
of the lease periods were estimated at $0.4 million while another $0.1 million
was paid for other expenses, such as coverage of obligations. The total cost
associated with these charges was $2.1 million, paid mostly in cash. Of this
amount, we paid a total of $1.9 million as of December 31, 2001, and a total of
$2.0 million as of May 31, 2002. We expect that these restructuring costs along
with discontinued operations will result in lower operating expenses during
2002.

In May 1999, we made a decision to intensify our strategic market focus. This
initiative consisted of a number of organizational changes, including a
reduction in worldwide headcount of approximately 40 people and the liquidation
of VocalTec Communications UK Ltd., our U.K. subsidiary, which had focused on
research and development and product management for collaboration software
products for corporate intranets. Total costs associated with those changes were
$0.8 million.

OTHER INCOME (EXPENSE), NET

Net gain on sale of ITXC shares. In 2001, we sold 180,000 shares of ITXC Corp,
and realized net proceeds of approximately $1.05 million after taxes. During
2002, as of May 31, 2002, we sold 220,000 shares of ITXC, and realized net
proceeds of approximately $1.3 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, and other expenses of approximately $3 million.
We intend to gradually reduce our holdings in ITXC by selling a portion of our
shares each quarter subject to restrictions imposed, if any, under Rule 144 of
the Securities Act of 1933.

FINANCING  INCOME, NET

Financing income, net was $1.9 million, or 7% of net sales in 2001, compared
with $3.2 million, or 8% in 2000, and $0.9 million, or 3% in 1999. The decrease
in finance income in 2001 was as a result of lower cash balances and lower
interest rates on deposits. The


                                    Page 35
<PAGE>
increase in finance 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

Tax benefits in the U.S. in 2001 amounted to $0.6 million, and we paid income
tax of $0.3 million for our various subsidiaries, leaving us with a net tax
benefit of $0.3 million in 2001. Capital gains taxes in 2000 were $9 million,
and income (before income taxes) was $44.3 million. These taxes were for the
gain on sale of ITXC shares, after deduction of net operating loss carryforwards
for tax purposes. Our effective corporate tax rate in 2000 was 20.4% resulting
from the one-time capital gains from our sale of ITXC shares. Due to reported
losses, our effective tax rate was 0% in 1999 and 2001.

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. If our losses in the United States continue during 2002, we may be
entitled to a tax refund for 2002.

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 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, 2001, we had net operating loss carryforwards in Israel of
approximately $54 million for tax purposes, and net operating loss carry
forwards in the U.S. of approximately $5.8 million. These net operating loss 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.

TRULYGLOBAL 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. As a result, the remaining operations, employees
and customer base of TrulyGlobal were integrated into VocalTec's operations.
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


                                    Page 36
<PAGE>
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 US
GAAP.

NET INCOME (LOSS)

Net loss in 2001 was $31.8 million or 112% of net sales, or $2.62 per share.
This includes a charge for restructuring costs of $2.1 million, or $0.17 per
share, a charge for discontinued operations of $6.8 million or $0.56 per share,
a gain from our sale of ITXC shares of $0.94 million or $0.08 per share, a tax
benefit of $0.29 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 $35.3 million or 84% of net
sales, or $2.92 per share. Net income in 2000 was $28.84 million or 69% of net
sales, or $2.39 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
or 32% of net sales.

Net loss in 1999 was $28.39 million, or 107% of net sales, or $2.47 per share.
This includes a charge for restructuring costs of $0.83 million, or $0.07 per
share. The net loss excluding the restructuring charge was $27.56 million, or
$2.40 per share, or 104% of net sales. The net losses in 2001 were primarily
attributable to the weakness in sales due to decreased capital expenditures by
telecommunications carriers. In 2000 (excluding the income from the sale of
shares) and 1999 the net losses were primarily due to accelerated sales,
marketing and research and development activities.

Our net revenues for the first quarter of 2002 were $3.3 million, and our net
loss was $3.85 million, after tax refund benefits in the amount of $3.79 million
as detailed in the Tax Refunds and Tax Benefits section above, and $0.33 million
capital gain. This decrease in revenues in the first quarter from previous
quarters resulted from the delayed processing of orders by the T-Systems
division of the Deutsche Telekom Group, which orders arrived after the end of
the first quarter. We anticipate our net loss to continue throughout in 2002.

SEGMENT REPORTING

In the second quarter of 2000 we began operating three business units: our core
unit VocalTec, TrulyGlobal, and Surf&Call. In 2001, our core business unit,
VocalTec, posted net sales of $27 million with an operating loss of $23.6
million.

In 2001, the Surf&Call business unit (Surf&Call Network Services) posted net
sales of $1.4 million and an operating loss of $4.6 million. 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


                                    Page 37
<PAGE>
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, and may be entitled in the future to royalties on sales
made by the new 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 will serve as
resellers of each other's products on favorable terms and conditions. The 2001
profit and loss statements does not yet reflect the carve-out. As of 2002,
Surf&Call will be presented as discontinued operations, including the $0.55
million convertible loan write-off and the write-off in the amount of $0.76
million for the transferred equipment. The Surf&Call carve-out will affect
various items in the Profit and Loss Statement for 2001, although the net loss
for 2001 will remain unchanged.

In June 2001, the third business unit, TrulyGlobal Inc. ceased operations after
being unsuccessful in obtaining external financing, and the remaining operations
and personnel were subsequently merged into VocalTec Communications, Inc.
TrulyGlobal's operating results appear in the financial statements as
discontinued operations, in accordance with U.S. GAAP. In addition, this
affected various items in the Profit and Loss Statement for 2000.

Our financial statements are reported in dollars and the vast majority of our
sales are made in 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 2001, the rate of inflation in Israel was 1.4%. The rate of
depreciation of the NIS in relation to the dollar was 9.3%. The depreciation of
the NIS in relation to the dollar led to a lower dollar cost of operations in
Israel.

LIQUIDITY AND CAPITAL RESOURCES

We believe that our revenues, cash, cash equivalents, and our shares in ITXC
provide us with the ability to timely generate adequate amounts of cash to meet
our ongoing cash requirements. During the past three years, we covered our cash
flow requirements using operating revenues, proceeds of the sale of a portion of
our holdings of ITXC shares, grants from the Chief Scientist and other cash
reserves.

On December 31, 2001, we had approximately $18.4 million in cash, cash
equivalents and short-term deposits, comprised of $9.9 million in cash and cash
equivalents and $8.5 million in short-term investments, compared to a total of
$49.2 million, comprised of


                                    Page 38
<PAGE>
$17.5 million in cash and cash equivalents and $31.7 million in short-term
investments (deposits for periods of longer than three months and shorter than
one year) in 2000. Some of our short-term investments consist of commercial
papers currently rated A2/P2. VocalTec generally holds 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, 2001, we had working capital of approximately $17.1 million
compared with working capital of $42.7 million on December 31, 2000. The
decrease in working capital during 2001 resulted primarily from our company's
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 in 2001 decreased and were insufficient to cover
operating expenses.

Net cash used in operating activities was $30.33 million, $19.58 million and
$20.63 million for the years ending December 31, 2001, 2000 and 1999,
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 $0.05 million
in 2001 and $6.38 million in 2000.

Net cash provided by investment activities was $22.72 million, $22.77 million
and $25.56 million for the years ending December 31, 2001, 2000 and 1999,
respectively. Net cash provide by investment activities generally consists of
short-term investments which matured during the relevant year. In 2000, net cash
provided by investments included proceeds from the sale of ITXC shares. In 2001
and in 1999, net cash from short-term investments amounted to $23.18 million and
$29.64 million, respectively. In 2000, cash deposited as short-term investments
was $29.94 million. Proceeds from the sale of ITXC shares were $1.0 million in
2001 and $61.2 million in year 2000. In years 2001, 2000 and 1999 our
investments in the shares of other companies amounted to $0.7 million, $0.8
million, and $1.0 million, respectively, while cash used for purchase of
equipment was $1.8, million, $6.7 million, and $3.2 million, respectively.

In 2000, cash flows used for financing activities amounted to $17.6 million. In
1999, net cash derived from financing activities was $22.0 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.

We anticipate that operating expenses will exceed revenues, net of cost of sales
in 2002 and possibly beyond. Throughout 2001 we undertook a series of cost
reduction measures and may 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 as well as
proceeds from future sales of ITXC stock 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


                                    Page 39
<PAGE>
industry, our sales decreasing as a result of evolving industry standards and
rapid technological changes that could result in our products being no longer in
demand, or our failure to retain our customers, we may need to reduce our
operating expenses or use more of our cash reserves and/or sell a portion of our
ITXC shares 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, utilize more of our cash reserves and/or sell a portion of
our shares in ITXC. If such measures are insufficient, we may attempt to
establish lines of credit or sell additional equity securities or debt
securities. The recent downturn in 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.

On October 1, 1999, ITXC consummated its initial public offering. In March 2000,
we sold shares of ITXC common stock in a secondary offering conducted by ITXC.
We realized net proceeds, after taxes, of approximately $50 million from the
sale. In 2001, we sold 180,000 shares of ITXC Corp, and realized net proceeds of
approximately $1.05 million after taxes. During 2002, as of May 31, 2002, we
sold 220,000 shares of ITXC Corp., and realized net proceeds of approximately
$1.3 million. We continue to hold 4,388,165 shares, or approximately 9.5% of
ITXC's outstanding common stock. For information relating to the valuation of
our investment in ITXC and the presentation of this investment on our balance
sheet, see "Item 11 - Quantitative and Qualitative Disclosures About Market
Risks".

Our holdings in ITXC are presented in the balance sheet as of December 31, 2001
as follows: the portion of 1.8 million shares "available-for-sale" during 2002
is stated at fair market value which was $7.19 per share, representing a total
of $13.0 million and the restricted portion of the shares (2.8 million shares)
is presented at cost of $1.7 million. The fair market value of this portion of
the ITXC investment, as of December 31, 2001, was approximately $20 million.

Proceeds from sales of ITXC shares are subject to capital gains tax in the
U.S., as these shares are held by our U.S. subsidiary.

In 2001 and to date, we have not incurred any debt.

Capital expenditures in 2001 were approximately $1.8 million compared with $6.7
million in 2000 and $3.2 million in 1999. 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 do not anticipate a
significant investment in capital expenditure in 2002, as we will continue to
use the computer equipment of TrulyGlobal in our research and development
operations. Such equipment has a net asset value of $1.6 million, and we
anticipate a reduction in our capital expenditures resulting from our use of
this equipment. See Item 4A for further details.


                                    Page 40
<PAGE>
In May 2002, we finalized the carve-out of our Surf&Call operations into a
separate entity. The carve-out does not materially affect our current cash and
cash equivalent balances, but is expected to reduce our operating expenses by
approximately $0.6 million per quarter.

The cost of our solutions increased during 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, and our total liability for early termination of
the leases is in the amount of up to $300,000.

INVENTORY AND RECEIVABLES

Inventories at the end of 2001 were $3.61 million compared with $5.42 million at
the end of 2000 and $1.60 million at the end of 1999. The decrease in 2001
compared with 2000 was due to lower inventory levels and an accrual for
inventory write-off of $1.4 million. The increase in 2000 compared with 1999
resulted from increased hardware for the product developed jointly with ECI
Telecom as well as a larger quantity of evaluations units at customer sites, and
outsourcing of components integration for some products.

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 decreased to approximately
$5.4 million at the end of 2001, compared to approximately $8.4 million at the
end of 2000 and approximately $6.2 million at the end of 1999. 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
unrecognized sales and bad debts is adequate due to the short history and lack
of collection experience we have with these types of providers.

Other receivables decreased to $2.5 million at the end of 2001 compared with
$3.9 million at the end of 2000, and $3.1 million at the end of 1999. The
decrease in 2001 was due to lowered 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 Scientist
receivables.


                                    Page 41
<PAGE>
RECENT ACCOUNTING PRONOUNCEMENTS

The Financial Accounting Standards Board issued Statement No. 141, Business
Combinations and Statement No. 142, Goodwill and Other Intangible Assets in June
2001. These standards are effective for fiscal years beginning after December
15, 2001. Under these standards, goodwill and intangible assets deemed to have
indefinite lives will be subject to annual impairment tests rather than be
amortized over certain periods, while other intangible assets will continue to
be amortized accordingly. We believe that there will be no material impact on
our consolidated results of operations and financial statements from these
standards.

The Financial Accounting Standards Board issued in August 2001 Statement No.
144, Accounting for the Impairment and Disposal of Long-Lived Assets. This
standard became effective on January 1, 2002, and provides guidance on the
disposal of long-lived assets to be abandoned or sold. We believe that there
will be no material impact on our consolidated results of operations and
financial statements from these standards.

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. Several
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 which 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, 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 which 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 2001, we invested $8.8 million
($6.4 million without Surf&Call) in our research and development efforts for
salaried personnel, compared with $8.4 million in 2000 and $10.3 million in
1999.


                                    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 carriers who would have represented potential new customers for
us. In addition, existing telecom 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
reduction of capital expenditures by telecom carriers have resulted in decreased
market demand for our products, and have adversely affected our revenues.

During 2001, we undertook cost reduction measures that resulted in a
restructuring charge in the second quarter of approximately $1.84 million, and
in the fourth quarter of approximately $0.23 million. Among the restructuring
measures, there was a reduction of approximately 40% of the total workforce, and
a salary reduction of an average of above 12%, among other measures.

In 2001, our wholly-owned subsidiary, TrulyGlobal, Inc., ceased operations after
having been unsuccessful in obtaining external financing, and its remaining
operations and personnel were merged into VocalTec Communications, Inc. A number
of TrulyGlobal engineers were integrated into our core development group, and
the assets and technology of TrulyGlobal was integrated into the VocalTec
technology. The merger enabled us to retain the operations, assets and
technology of TrulyGlobal, as well as some key members of the TrulyGlobal team.

In 2001, the Surf&Call business unit (Surf&Call Network Services) posted net
sales of $1.4 million and an operating loss of $4.6 million. 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


                                    Page 44
<PAGE>
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, and may be entitled in the future to royalties on sales
made by the new 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 will serve as
resellers of each other's products on favorable terms and conditions. The 2001
profit and loss statements does not yet reflect the carve-out. As of 2002,
Surf&Call will be presented as discontinued operations, including the $0.55
million convertible loan write-off and the write-off in the amount of $0.76
million for the transferred equipment. The Surf&Call carve-out will affect
various items in the Profit and Loss Statement for 2001, although the net loss
for 2001 will remain unchanged.

The turbulent economic events commencing in 2000 have resulted in a substantial
decrease in our share price and market capitalization. Accordingly, the value of
the stock options granted to our employees was adversely affected. Since we
believe that there is great significance in maintaining the equity incentive of
our employees, we are continuously exploring new ways to provide such incentives
in today's uncertainty of the financial markets. As part of this policy, we
implemented a stock exchange option program. Under this program, each employee
was entitled to cancel all or any portion of the employee's outstanding
unexercised stock options that were issued under our various stock option plans
for new options equal to 80% of the canceled options. The exercise price for the
new options is equal to the fair market value at the time of the new grant.


ITEM 6.     DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES

6A.     DIRECTORS AND SENIOR MANAGEMENT

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

<TABLE>
<CAPTION>
    NAME                     POSITION
    ----                     --------
<S>                          <C>
    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
</TABLE>


                                    Page 45
<PAGE>
<TABLE>
<CAPTION>
    NAME                     POSITION
    ----                     --------
<S>                          <C>
    Rina Shainski            Director
    Hugo Goldman             Chief Financial Officer
    Ira Palti                Chief Operating Officer
</TABLE>

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.

RINA SHAINSKI has served as director since July 2000.  Ms. Shainski has been a
partner in Carmel Ventures Fund since April 2000. From September 1997 to March
2000, Ms. Shainski served as Vice President, Business Development at Clal
Industries and Investments Ltd., one of Israel largest investment and holding
companies.  From 1989 to 1996, Ms. Shainski served in a number of executive
positions in Tecnomatix Technologies Ltd., including Vice President Business
Development and Director of Research and Development.  In addition Ms. Shainski
currently serves as a director of several companies, including Fundtech
Corporation.  Ms. Shainski qualifies as an External Director according to the
Companies Law.

LIOR HARAMATY is a co-founder of our company and has served as director since
1989. Mr. Haramaty served as Senior Vice President of Commercial Development
from December 1999, Vice President of Professional Services from May 1999, Vice
President of Technical Marketing from November 1995 and Director of Technical
Marketing from 1993, to mid 2000. Prior to 1993, Mr. Haramaty was responsible
for VocalTec's research and development and operations groups.

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 currently holds the position of 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


                                    Page 46
<PAGE>
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 Companies Law.

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.

IRA PALTI serves as our Chief Operating Officer and has served as Vice President
of Research and Development from February 1999 to November 1999. From 1997 to
1999, Mr. Palti served as the Chief Executive Officer of Automedia Ltd. From
1995 to 1997, Mr. Palti served as the Vice President of Research and Development
at Netmanage Corp. From 1984 to 1994, Mr. Palti held various management and
software development positions at Rosh/ServiceSoft Corp.

6B.     COMPENSATION OF DIRECTORS AND EXECUTIVE OFFICERS

The aggregate compensation paid to all our directors and officers as a group
during the fiscal year 2001 was approximately $1.74 million in salaries,
directors' fees, and bonuses, and 330,000 options. 30,000 of these options were
granted on January 8, 2001 at an exercise price of $3.95, 150,000 of these
options were granted on April 27, 2001 at an exercise price of $3.75, and
150,000 of these options were granted on April 27, 2001 at an exercise price of
$3.56. Options expire ten years after the date of the grant. Employees,
including those Executive Officers that are also employees, were given the
opportunity to participate in an Options Exchange Program, implemented by the
Company in August 2001. See Item 6E of this report - Share Ownership.

The aggregate total amounts set aside or accrued by the Company or its
subsidiaries to provide for severance payments is approximately $0.54 million.

6C.     BOARD PRACTICES

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 and Rina Shainski, their
respective terms as directors expire in July 2003 and may be renewed for one
additional three-year term; (b) Ami Tal's term as director expires at the 2002
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


                                    Page 47
<PAGE>
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 providing for benefits upon termination of employment. 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 member of
senior management member.

Our audit committee is comprised of Douglas Dunn, Yoav Chelouche and Rina
Shainski. 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. The following are
examples of functions within the authority of the Audit Committee:

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

-     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.

-     To assist our Board of Directors in performing its duties to oversee our
      accounting and financial policies, internal controls, and financial
      reporting practices.

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

6D.     EMPLOYEES

At December 31, 2001, we employed 256 full time employees, including 191
employees in the core business unit, 22 employees in the Surf&Call Solutions
unit, and 43 employees in shared services and administration. Of these employees
99 were employed in research and development (compared with 142 in 2000 and 94
in 1999), 110 were employed in sales and marketing (compared with 152 in 2000
and 89 in 1999) and 47 were employed in general and administrative (compared
with 86 in 2000 and 70 in 1999). Of these employees, 187 were based in our
facilities in Israel, 31 in the United States, 27 in Asia Pacific and 11 in
Europe. As of May 31, 2002 we employed a total of 235 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 as otherwise
applicable under Israeli law. During 2001, we eliminated 140 positions as part


                                    Page 48
<PAGE>
of our restructuring plans.

6E.     SHARE OWNERSHIP

As of May 31, 2002 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 Trading International, as well as 7,500
shares and 340,000 options held by Elon Ganor and 10,000 shares and 138,000
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) 2001 Master Stock Option Plan.


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. The exercise price per share is usually 100% of the
fair market value of the shares on the date of grant, as determined by the
closing price reported by the Nasdaq National Market on the date of grant for
incentive stock options, or 95% of the fair market value of the shares on the
date of grant, as determined by the closing price reported by the Nasdaq
National Market on the date of grant for nonqualified 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.


                                    Page 49
<PAGE>
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 31, 2002, 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)     1,267,550          10.5%
c/o L.C.I.T. S.A Dufourstrasse 131
P.O.B. 219 Zurich 8034, Switzerland

Officers and directors as a group (2)       1,480,675          12.2%
(8  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 (i) 220,000 options for ordinary shares held by Dr. Ganor that
      are exercisable within 60 days of the date stated above and (ii) 90,000
      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) 523,125 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. Does not
      include 559,475 ordinary shares for which options granted to officers and
      directors of our company are outstanding but are not currently
      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.


                                    Page 50
<PAGE>
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 $10.0 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
2001 under this credit line was in the amount of $9.7 million. To date,
approximately $4 million of the credit line has been used.

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

-     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.

-     In November 2001, we merged the operations of our wholly-owned
      subsidiary, TrulyGlobal Inc. into VocalTec Communications Inc.

-     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, and may be entitled in the future to royalties on
      sales made by the new 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 will serve as resellers of each other's products on
      favorable terms and conditions. The 2001 profit and loss statements do not
      yet reflect the carve-out. As of 2002, Surf&Call will be presented as
      discontinued operations, including the $0.55 million convertible loan


                                    Page 51
<PAGE>
      write-off and the write-off in the amount of $0.76 million for the
      transferred equipment. The Surf&Call carve-out will affect various items
      in the Profit and Loss Statement for 2001, although the net loss for 2001
      will remain unchanged.

-     We have been generating sales of our products to ITXC Corp. During
      calendar year 2001, such sales amounted to 25% of our gross revenues,
      compared with 15% in 2000.

In addition, we entered into an employment agreement with Dr. Elon Ganor in
October 2001, providing for the continued employment of Dr. Ganor as Chief
Executive Officer. The employment agreement continues indefinitely until notice
of termination is given by either party.

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 $27.4 million, or 96% of net sales in 2001, compared with
$37.4 million, or 89% of net sales, in 2000, and $26.2 million, or 98% of net
sales, in 1999.

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 financial condition.

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, infringed several of Multi-Tech's patents. In October 2001, we
settled the suit on terms and conditions with no material effect on the
operations of VocalTec.

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


                                    Page 52
<PAGE>
dividends in the foreseeable future.

8B.     SIGNIFICANT CHANGES

Except as disclosed elsewhere in this report, there have been no other
significant changes since December 31, 2001.


ITEM 9.     THE OFFER AND LISTING

9A.     OFFER AND LISTING DETAILS

Through June 24, 2002 for the periods indicated, the high and low reported
trading prices of our ordinary shares as reported by Nasdaq were as follows:


<TABLE>
<CAPTION>
                                HIGH       LOW
                                ----       ---
<S>                            <C>         <C>
1997                           33.25       5.250
1998                           24.625      5.56
1999                           19.75       8.031
2000                           53.25       3.5
2001                            8.125      0.600

2000
First quarter                  53.25       14.94
Second quarter                 29.25       12.5
Third quarter                  26.5         9.5
Fourth quarter                 10.75        3.5

2001
First quarter                   8.13        3.00
Second quarter                  4.00        1.86
Third quarter                   2.15        0.60
Fourth quarter                  3.68        1.01

LAST SIXTH MONTHS
December                        3.68        2.34
January                         3.02        2.05
February                        2.31        1.63
March                           1.95        1.5
April                           1.82        1.05
May                             1.42        1.11
June (through June 24, 2002)    1.267       0.91
</TABLE>

As of May 31, 2002, 12,127,058 of our ordinary shares were issued and
outstanding. At such date, the last reported sale price of the ordinary shares
was $1.26 per share, and the


                                    Page 53
<PAGE>
ordinary shares were held by 120 record holders. Of those 120 record holders, 95
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 May 31, 2002 we believe approximately 48% 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".

9D.     SELLING SHAREHOLDERS

Not applicable.

9E.     DILUTION

Not applicable.


9F.     EXPENSES OF THE ISSUE

Not applicable.


ITEM 10.    ADDITIONAL INFORMATION

10A.    SHARE CAPITAL

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


                                    Page 54
<PAGE>
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 2002, (b) another class to hold office until our
annual meeting of shareholders to be held in 2003 and (c) a third class to hold
office until our annual meeting of shareholders to be held in 2004.

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 which 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.


                                    Page 55
<PAGE>
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:

      -     Any amendment to the articles of association;

      -     An increase in the company's authorized capital;

      -     A merger; or

      -     Approval of some of the acts and transactions which 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.

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


                                    Page 56
<PAGE>
(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 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.


                                    Page 57
<PAGE>
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 which 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 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.


                                    Page 58
<PAGE>
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
2002, 2003 and 2004. At each shareholder meeting, the successors of each class
of directors whose terms expire are elected to hold officer 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) holder 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 voting on such matter at a General Meeting.

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, who must also be residents of Israel. 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:

      -     an employment relationship;

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

      -     control; and

      -     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.

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.


                                    Page 59
<PAGE>
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 National Market 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
any person who is a current or former employee of a company or of any of its
affiliates, as well as any immediate family member of an executive officer of a
company or of any of its affiliates. At least three of our current directors
meet the independence standard of the Nasdaq rules.

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:

      -     the chairman of the board of directors;

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

      -     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.

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, Rina
Shainski, and Douglas Dunn, and, we believe, is independent under Nasdaq rules.


                                    Page 60
<PAGE>
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 which 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. 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 which 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


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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 which
would provide coverage for any monetary liability incurred as a result of any of
the following:

      -     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;

      -     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;

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

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

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:

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

      -     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

      -     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


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

      -     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

      -     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:

      -     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

      -     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

Material contracts not in the ordinary course of business consist of the
employment agreement between our company and Elon Ganor, our CEO.

10D. EXCHANGE CONTROLS

While the State of Israel has, in the past, maintained extensive controls on
foreign currency, these regulations were, in large part, lifted in 1998. 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.


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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 which 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 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.


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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 an FIC, which is at
least 25% owned by non-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 there under 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


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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.

From time to time, the Government of Israel has discussed reducing the benefits
available to companies under the Investment Law. 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.
However, grants made available to our company by the Israeli Government are not
included in the amount of the R&D expenses.


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Under the law for the Encouragement of Industrial Research and Development, 1984
(the "Research Law"), research and development programs which 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 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.

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.


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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.

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


                                    Page 68
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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

Israeli law generally imposes a capital gains tax on the sale of securities and
any other capital asset. The basic tax rate applicable to corporations is
currently 36% in 1997 and thereafter. From 1994, the maximum tax rate for
individuals was fixed at 50%. These rates are subject to the provisions of any
applicable bilateral double taxation treaty. The treaty concerning double
taxation between the United States and Israel (the "Treaty") is discussed below.

Under existing regulations, as long as our ordinary shares are quoted on Nasdaq
(or listed on a stock exchange recognized by the Israeli Ministry of Finance)
and we continue to qualify as an Industrial Company under the Industry Law,
capital gains on the sale of the ordinary shares by individuals, will generally
be exempt from Israeli capital gains tax. There can be no assurance that we will
maintain such listing or qualification. Notwithstanding the foregoing, dealers
in securities in Israel are taxed at regular tax rates applicable to business
income. The foregoing exemption does not apply to companies subject to the
Inflationary Adjustments Law.

Individuals who are non-residents of Israel are subject to a graduated income
tax on income 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. 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.

U.S. 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 U.S. 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


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not address the U.S. federal income tax consequences of purchasing, holding or
disposing of ordinary shares to shareholders who own (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 taxpayers whose
functional currency is not the dollar. The following discussion also does not
address any aspect of state, local or non-U.S. tax laws. Further, this summary
generally considers only a U.S. Holder (as defined below) that will own ordinary
shares as capital assets (generally, assets held for investment) and does not
consider the tax treatment of persons who will hold ordinary shares through a
partnership or other pass-through entity. Each prospective investor is advised
to consult such person's own tax advisor with respect to the specific U.S.
federal, state and local tax consequences to such person of purchasing, holding
or disposing of ordinary shares.

TAXATION OF U.S. HOLDERS

For purposes of this discussion, a "U.S. Holder" is any holder of ordinary
shares who is: (i) a citizen or resident of the United States: (ii) a
corporation partnership or limited liability company 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 U.S. federal income
tax purposes regardless of source; or (iv) a trust, generally if a U.S. court is
able to exercise primary supervision over its administration and one or more
U.S. fiduciaries have the authority to control all of its substantial decisions.

Distributions. While it is not anticipated that we will pay dividends in the
foreseeable future, the gross amount of any distribution from our company
received by a U.S. Holder which is treated as a dividend for U.S. federal income
tax purposes (before reduction for any Israeli tax withheld at source), will be
included in such U.S. Holder's gross income, will be subject to tax at the rates
applicable to ordinary income and will not qualify for the dividends received
deductions applicable in certain cases to U.S. corporations. To the extent that
such distribution exceeds our earnings and profits and provided that we are not
a PFIC as to such U.S. Holder, such distribution will be treated as a
non-taxable return of capital to the extent of the U.S. Holder's adjusted basis
in the ordinary shares and thereafter as taxable capital gain. For U.S. federal
income tax purposes, the amount of any dividend paid in NIS by our company 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 U.S.
source ordinary income or loss.

Credit for Israeli Taxes Withheld. Any dividends paid by our company to a U.S.
Holder with respect to the ordinary shares generally will be treated for U.S.
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 the ordinary shares generally


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will be eligible for credit against the U.S. Holder's U.S. 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 U.S. federal income taxes otherwise
payable with respect to such classes of income. Subject to the particular
circumstances of a U.S. Holder, dividends distributed by our company with
respect to ordinary shares generally will be classified as "passive income."

Alternatively, a U.S. Holder may elect to claim a U.S. tax deduction for 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. In addition, a non-corporate U.S. holder
may not 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 ordinary shares will be U.S.- source income or loss
for purposes of the U.S. federal foreign tax credit limitation. However, a U.S.
Holder who is also a U.S. Treaty Resident and who sells the ordinary shares in
Israel may elect to treat gain from the sale or other disposition of ordinary
shares as foreign-source income for purposes of the U.S. 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 ordinary
shares as a foreign-source for purposes of such tax credit limitation. U.S.
Holders should consult their own tax advisors regarding the application of the
U.S. federal foreign tax credit limitation to gain or loss recognized on the
disposition of 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 ordinary
shares.

PASSIVE FOREIGN INVESTMENT COMPANY STATUS

Generally a foreign 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 (U.S. or foreign) in which such corporation
is considered to own 25% or more of the ordinary shares 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 fair
market value of the assets of any company in which such corporation is
considered to own 25% or more of the ordinary shares 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 2001. 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 Internal
Revenue Service that address these questions, there is uncertainty with respect
to the appropriate method for implementing the asset test.


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Based upon an independent valuation of our assets, we believe that we were not a
PFIC during 2001. Based in part on advice from our professional advisors, we
believe that the total asset value method for such purpose is an appropriate
method, and under such method we were not a PFIC in 2001.

However, the U.S. Internal Revenue Service may disagree with this conclusion,
asserting that were characterized as a PFIC during 2001 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.

In view of this uncertainty and the complexity of the issues regarding our
treatment as a PFIC for 2001 and possibly for subsequent years, US holders are
urged to consult their own tax advisors for guidance. For those U.S. Holders
whose tax advisors believe that we were a PFIC for 2001 or for any subsequent
years and notify us in writing of their request for the information required to
effectuate the QEF Election described below, we will make such information
available to them.

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 neither a "QEF election" or
a "mark-to-market election" (as described below):

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

-     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;

-     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;

-     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, ordinary shares; and

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


                                    Page 72
<PAGE>
shares in the corporation at any time during a year when the corporation was a
PFIC and who made neither a QEF election nor mark-to-market election (as
discussed below) with respect to such shares with their tax return that included
the last day of the corporation's first taxable year as 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 are deemed to be a PFIC for 2001, if a U.S. Holder makes a
valid QEF election with respect to ordinary shares:

-     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) net
      ordinary earnings as ordinary income and (ii) net capital gain as
      long-term capital gain, in each case computed under U.S. 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;

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

-     the U.S. Holder would not be required under these rules 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 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 warrants or rights 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.

Under certain circumstances, a U.S. Holder may also obtain treatment similar to
that afforded a shareholder who has made a timely QEF election by making an
election in a year subsequent to the first year during the U.S. Holder's holding
period that we are classified as a PFIC to treat such holder's interest as
subject to a deemed sale and recognizing gain, but not loss, on such deemed sale
in accordance with the general PFIC rules, including the interest charge
provisions, described above and thereafter treating such interest in VocalTec 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, an amount equal to the
difference between the shareholder'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


                                    Page 73
<PAGE>
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 would not be subject
to deemed ratable allocations of gain, the interest charge, and the denial of
basis step-up at death described above. Subject to the ordinary shares ever
ceasing to be marketable, a mark-to-market election is irrevocable without
obtaining the consent of the IRS and would continue to apply even in years that
we are no longer a PFIC.

U.S. HOLDERS OF ORDINARY SHARES ARE URGED TO CONSULT THEIR TAX ADVISORS ABOUT
PFIC RULES, INCLUDING THE ADVISABILITY, PROCEDURE AND TIMING OF MAKING A QEF
ELECTION, IN CONNECTION WITH THEIR HOLDING OF ORDINARY SHARES, INCLUDING
WARRANTS OR RIGHTS TO ACQUIRE ORDINARY SHARES.

TAXATION OF NON-U.S. HOLDERS

Subject to the discussion below with respect to the U.S. backup withholding tax,
a non-U.S. Holder (i.e., any person other than a U.S. Holder) generally will not
be subject to U.S. federal income tax on dividends from our company, 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
U.S. trade or business, or 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, U.S. tax information reporting and
"backup withholding" of U.S. federal income tax at a 31% on dividends on, and
the proceeds of dispositions of, ordinary shares may apply to both U.S. and
non-U.S. Holders. Backup withholding will not apply, however, to a Holder who
furnishes a 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 U.S. backup
withholding rules will be allowed as a refund or credit against the U.S.
Holder's or non-U.S. Holder's U.S. federal income tax liability, provided the
required information is furnished to the IRS.

10F. DIVIDENDS AND PAYING AGENTS

Not applicable.

10G. STATEMENT BY EXPERTS


                                    Page 74
<PAGE>
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.


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:


                                    Page 75
<PAGE>
                     FAIR MARKET VALUE ON DECEMBER 31, 2001
                      (IN THOUSANDS, EXCEPT INTEREST RATES)

<TABLE>
<CAPTION>
                                                 DEC 31, 2001    FY 2002
                                                 ------------    -------
<S>                                              <C>             <C>
                  Total Portfolio                     18,356       18,356
                  Average Interest Rate                2.76%        2.76%
                  Average Duration (Month)              1.00         1.00
                  Cash Equivalents (up to three
                  months maturity)                    16,385
                  Average Interest Rate                2.74%
                  Short Term Investments
                  (three-twelve months maturity)       1,970
                  Average Interest Rate                2.96%
</TABLE>



ITXC HOLDINGS

Our holdings in ITXC are presented in the balance sheet as of December 31, 2001
as follows: the portion of 1.8 million shares "available-for-sale" during 2002
is stated at fair market value which was $7.19 per share, representing a total
of $13.0 million and the restricted portion of the shares (2.8 million shares)
is presented at cost of $1.7 million. The fair market value of this portion of
the ITXC investment, as of December 31, 2001, was approximately $20 million. See
Item 5 for a detailed description of our shareholdings in ITXC Corp.


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.    RESERVED


ITEM 16.    RESERVED


                                    Page 77
<PAGE>
                                   PART THREE


ITEM 17.    FINANCIAL STATEMENTS

Not applicable.


ITEM 18.    FINANCIAL STATEMENTS


            CONSOLIDATED FINANCIAL STATEMENTS AS OF DECEMBER 31, 2001




                                    CONTENTS


<TABLE>
<CAPTION>
                                                                    PAGE
                                                                    ----

<S>                                                                <C>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS                              2

CONSOLIDATED FINANCIAL STATEMENTS

  Consolidated Balance Sheets                                       3 - 4

  Consolidated Statements of Operations                               5

  Consolidated Statements of Shareholders' Equity and
    Comprehensive Income                                              6

  Consolidated Statements of Cash Flows                               7

  Notes to the Consolidated Financial Statements                   8 - 28
</TABLE>


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 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. Herzliya lease, dated July 20, 1998, previously
            filed


                                    Page 78
<PAGE>
            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)   Lease Agreement Fort Lee Executive Park, by and between VocalTec
            Communications Inc. and Executive Park LLC., dated June 18, 1998,
            previously filed with the SEC on June 30, 2001 as Exhibit 4.1(f) to
            the Company's Annual Report on Form 20-F for the year ended December
            31, 2000, which is incorporated herein by reference.

8.    List of Subsidiaries.


                                   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.

Name:   Elon Ganor
        ------------------------

Title:  Chairman of the Board of
        Directors and CEO
        ------------------------


VOCALTEC COMMUNICATIONS LTD.

   June 27, 2002


                                    Page 79
<PAGE>
                          VOCALTEC COMMUNICATIONS LTD.


                        CONSOLIDATED FINANCIAL STATEMENTS
                             AS OF DECEMBER 31, 2001
<PAGE>
                          VOCALTEC COMMUNICATIONS LTD.


            CONSOLIDATED FINANCIAL STATEMENTS AS OF DECEMBER 31, 2001


                                    CONTENTS


<TABLE>
<CAPTION>
                                                                       PAGE
                                                                       ----

<S>                                                                  <C>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS                                 2

CONSOLIDATED FINANCIAL STATEMENTS

  Consolidated Balance Sheets                                          3 - 4

  Consolidated Statements of Operations                                  5

  Consolidated Statements of Shareholders' Equity and
    Comprehensive Income                                                 6

  Consolidated Statements of Cash Flows                                  7

  Notes to the Consolidated Financial Statements                      8 - 28
</TABLE>


                                   # # # # # #
<PAGE>
                    REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS



To the Shareholders of
VocalTec Communications Ltd.:


We have audited the accompanying consolidated balance sheets of VocalTec
Communications Ltd. (an Israeli Corporation) and subsidiaries (the Company) as
of December 31, 2000 and 2001, and the related consolidated statements of
operations, shareholders' equity and comprehensive income and cash flows for
each of the three years in the period ended December 31, 2001. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.

We conducted our audits in accordance with auditing standards generally accepted
in the United States and in Israel, including those prescribed under the
Auditors' Regulations (Auditor's Mode of Performance), 1973. 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 VocalTec
Communications Ltd. and subsidiaries as of December 31, 2000 and 2001, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 2001, in conformity with accounting principles
generally accepted in the United States.




                                                      LUBOSHITZ KASIERER
                                                        Arthur Andersen

Tel-Aviv, Israel
January 22, 2002


                                      -2-
<PAGE>
                          VOCALTEC COMMUNICATIONS LTD.

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


<TABLE>
<CAPTION>
                                                                                              DECEMBER 31
                                                                                        ---------------------
                                                                       NOTE             2000             2001
                                                                       ----             ----             ----
<S>                                                                    <C>             <C>               <C>
CURRENT ASSETS
  Cash and cash equivalents                                            (3)             17,473            9,860
  Short-term investments                                               (4)             31,673            8,496
  Trade receivables, net                                               (5)              8,372            5,406
  Other receivables                                                    (6)              3,879            2,502
  Inventories                                                                           5,424            3,608
                                                                                       ------           ------
  Total current assets                                                                 66,821           29,872
                                                                                       ------           ------

INVESTMENTS AND LONG-TERM DEPOSITS
  Investments in companies                                             (7)             14,620           14,912
  Bank deposits                                                                         1,000                -
  Deposits with insurance companies                                   (10)              1,636            1,757
                                                                                       ------           ------
                                                                                       17,256           16,669
                                                                                       ------           ------

EQUIPMENT, NET                                                         (8)              8,890            5,020
                                                                                       ------           ------


                                                                                       92,967           51,561
                                                                                       ======           ======
</TABLE>


                                      -3-
<PAGE>
<TABLE>
<CAPTION>
                                                                        DECEMBER 31
                                                                        -----------
                                                         NOTE        2000         2001
                                                         ----        ----         ----
<S>                                                      <C>       <C>          <C>
CURRENT LIABILITIES
  Accounts payable and accrued expenses                    (9)      24,148       12,755
                                                                   -------      -------

LONG-TERM LIABILITIES
  Deferred income taxes                                   (20)       4,356        4,745
  Accrued severance pay                                   (10)       2,093        2,832
                                                                   -------      -------
                                                                     6,449        7,577
                                                                   -------      -------

  Total liabilities                                                 30,597       20,332
                                                                   -------      -------

COMMITMENTS AND CONTINGENCIES                             (11)

SHAREHOLDERS' EQUITY
    Share capital                                         (12)
      Ordinary shares of NIS 0.01 par value:
       Authorized - 30,000,000 shares;
       Issued and outstanding - 12,127,058 shares                       36           36
       as of December 31, 2000 and 2001
    Additional paid-in capital                                      97,015       97,015
    Deferred share-based compensation                                  (97)         (38)
    Accumulated other comprehensive income                (21)       6,535        7,118
    Accumulated deficit                                            (41,119)     (72,902)
                                                                   -------      -------
  Total shareholders' equity                                        62,370       31,229
                                                                   -------      -------

                                                                    92,967       51,561
                                                                   =======      =======
</TABLE>




-------------------------------------                   ------------------------
             ELON A. GANOR                                   HUGO GOLDMAN
 Chief Executive Officer and Chairman                   Chief Financial Officer
             of the Board

Date of approval:
January 22, 2002

       THE ACCOMPANYING NOTES FORM AN INTEGRAL PART OF THESE CONSOLIDATED
                             FINANCIAL STATEMENTS.


                                      -4-
<PAGE>
                          VOCALTEC COMMUNICATIONS LTD.

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


<TABLE>
<CAPTION>
                                                                                     YEAR ENDED DECEMBER 31
                                                                               ------------------------------------
                                                                NOTE           1999            2000            2001
                                                                ----           ----            ----            ----

<S>                                                             <C>            <C>             <C>             <C>
Net sales                                                       (13)           26,615          41,971          28,413
                                                                              -------          ------         -------
Cost of sales
  Cost of goods sold                                            (14)            8,156          13,146          10,070
  Inventory write-off                                                               -               -           1,441
                                                                              -------          ------         -------
                                                                                8,156          13,146          11,511
                                                                              -------          ------         -------

       Gross profit                                                            18,459          28,825          16,902
                                                                              -------          ------         -------

Operating expenses:
  Research and development, net                                 (15)           13,157          11,270          11,039
  Marketing and selling, net                                    (16)           27,171          26,372          24,716
  General and administrative                                                    6,592           7,769           7,200
  Restructuring costs                                           (17)              827               -           2,073
                                                                              -------          ------         -------
       Total operating expenses                                                47,747          45,411          45,028
                                                                              -------          ------         -------

       Operating loss                                                         (29,288)        (16,586)        (28,126)

Other income, net                                                                   -          57,744             941
Financing income, net                                           (18)              902           3,184           1,872
                                                                              -------          ------         -------
       Income (loss) from continuing operations
         before income taxes                                                  (28,386)         44,342         (25,313)

Income taxes (tax benefit)                                      (20)                -           9,013            (292)
                                                                              -------          ------         -------
  Income (loss) from continuing operations                                    (28,386)         35,329         (25,021)

Discontinued operations:                                        (19)
  Loss from operations of discontinued segment                                      -          (6,493)         (4,403)
  Loss on disposal of segment                                                       -               -          (2,359)
                                                                              -------          ------         -------
      Net income (loss)                                                       (28,386)         28,836         (31,783)
                                                                              =======          ======         =======

Net basic income (loss) per ordinary share:
  Net income (loss) from continuing operations                                 (2.47)           2.92           (2.06)
  Loss from discontinued operations                                                 -          (0.53)          (0.56)
                                                                              -------          ------         -------
  Net income (loss)                                                            (2.47)           2.39           (2.62)
                                                                              =======          ======         =======

Net diluted income (loss) per ordinary share:
  Net income (loss) from continuing operations                                 (2.47)           2.67           (2.06)
  Loss from discontinued operations                                             -              (0.49)          (0.56)
                                                                              -------          ------         -------
  Net income (loss)                                                            (2.47)           2.18           (2.62)
                                                                              =======          ======         =======

Weighted average number of ordinary shares used
  in computing per share amounts (in thousands):
    Basic                                                                      11,498          12,082          12,127
                                                                              =======          ======         =======
    Diluted                                                                    11,498          13,252          12,127
                                                                              =======          ======         =======
</TABLE>


       THE ACCOMPANYING NOTES FORM AN INTEGRAL PART OF THESE CONSOLIDATED
                             FINANCIAL STATEMENTS.


                                      -5-
<PAGE>
                          VOCALTEC COMMUNICATIONS LTD.

                    CONSOLIDATED STATEMENTS OF SHAREHOLDERS'
                         EQUITY AND COMPREHENSIVE INCOME
                In thousands of U.S. dollars (except share data)



<TABLE>
<CAPTION>
                                          NUMBER    SHARE    ADDITIONAL    DEFERRED     ACCUMULATED
                                            OF      CAPITAL   PAID-IN    COMPENSATION      OTHER
                                          SHARES              CAPITAL                  COMPREHENSIVE
                                                                                          INCOME
                                        ----------  ------   ----------  ------------  -------------
<S>                                     <C>         <C>      <C>         <C>           <C>
Balance as of January 1, 1999           11,413,420      35     92,696          (291)          --
Comprehensive Income:
  Net loss                                      --      --         --            --           --
  Unrealized gain from available-for-
    sale securities                             --      --         --            --       34,471

  Total comprehensive income                    --      --         --            --           --

Shares issued                              357,882      --      1,999            --           --
Deferred compensation                           --      --        177          (177)          --
Amortization of deferred compensation           --      --       (245)          280           --
                                        ----------      --     ------           ---       ------

Balance as of December 31, 1999         11,771,302      35     94,627          (188)      34,471
Comprehensive income:
  Net income                                    --      --         --            --           --
  Unrealized loss from available-for-
    sale securities net of
    reclassification adjustment                 --      --         --            --      (27,936)

  Total comprehensive income                    --      --         --            --           --

Shares issued                              355,756       1      2,388            --           --
Amortization of deferred compensation           --      --         --            91           --
                                        ----------      --     ------           ---       ------
Balance as of December 31, 2000         12,127,058      36     97,015           (97)       6,535
Comprehensive Income:
  Net loss                                      --      --         --            --           --
  Unrealized gain from available-for-
    sale securities net of
    reclassification adjustment
    (see disclosure)                            --      --         --            --          583

  Total comprehensive loss                      --      --         --            --           --

Amortization of deferred compensation           --      --         --            59           --
                                        ----------      --     ------           ---       ------
Balance as of December 31, 2001         12,127,058      36     97,015           (38)       7,118
                                        ==========      ==     ======           ===        =====
</TABLE>

<TABLE>
<CAPTION>
                                          ACCUMULATED      TOTAL        TOTAL
                                            DEFICIT    COMPREHENSIVE
                                                          INCOME

                                          -----------  -------------    -----
<S>                                       <C>          <C>             <C>
Balance as of January 1, 1999               (41,569)                    50,871
Comprehensive Income:
  Net loss                                  (28,386)     (28,386)      (28,386)
  Unrealized gain from available-for-
    sale securities                              --       34,471        34,471
                                                         --------
  Total comprehensive income                     --        6,085
                                                         ========
Shares issued                                    --                      1,999
Deferred compensation                            --                         --
Amortization of deferred compensation            --                         35
                                             ------                     ------

Balance as of December 31, 1999             (69,955)                    58,990
Comprehensive income:
  Net income                                 28,836       28,836        28,836
  Unrealized loss from available-for-
    sale securities net of
    reclassification adjustment                  --      (27,936)      (27,936)
                                                         --------
  Total comprehensive income                     --          900
                                                         ========
Shares issued                                    --                      2,389
Amortization of deferred compensation            --                         91
                                             ------                     ------
Balance as of December 31, 2000             (41,119)                    62,370
Comprehensive Income:
  Net loss                                  (31,783)     (31,783)      (31,783)
  Unrealized gain from available-for-
    sale securities net of
    reclassification adjustment
    (see disclosure)                             --          583           583
                                                         --------
  Total comprehensive loss                       --      (31,200)
                                                         ========
Amortization of deferred compensation            --                         59
                                             ------                     ------
Balance as of December 31, 2001             (72,902)                    31,229
                                            =======                     ======
</TABLE>


       THE ACCOMPANYING NOTES FORM AN INTEGRAL PART OF THESE CONSOLIDATED
                             FINANCIAL STATEMENTS.



                                      -6-
<PAGE>
                          VOCALTEC COMMUNICATIONS LTD.

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

<TABLE>
<CAPTION>
                                                                                    YEAR ENDED DECEMBER 31
                                                                               ---------------------------------
                                                                                 1999         2000         2001
                                                                               -------      -------      -------
<S>                                                                            <C>           <C>         <C>
CASH FLOWS FROM OPERATING ACTIVITIES
  Net income (loss)                                                            (28,386)      28,836      (31,783)
  Adjustments to reconcile net income (loss) to net cash used in operating
    activities -
      Expenses not affecting operating cash flows:
       Decline in value of investments                                              --           --        1,290
       Loss on disposal of segment                                                  --           --        1,758
       Amortization of deferred compensation                                        35           91           59
       Severance pay, net                                                          303           25          618
       Depreciation                                                              3,584        3,409        3,867
       Gain on sale of ITXC shares                                                  --      (60,744)        (941)
       Other                                                                        24           --           36
      Changes in operating assets and liabilities:
       Decrease (increase) in trade receivables, net                             2,849       (2,209)       2,966
       Decrease (increase) in other receivables                                    254         (811)       1,377
       Decrease (increase) in inventories                                           51       (3,822)       1,816
       Increase (decrease) in accounts payable and accrued expenses                653       15,645      (11,393)
                                                                               -------      -------      -------
         Net cash used in operating activities                                 (20,633)     (19,580)     (30,330)
                                                                               -------      -------      -------

CASH FLOWS FROM INVESTING ACTIVITIES
  Short-term investments, net                                                   29,644      (29,943)      23,177
  Proceeds from sale of investment in  ITXC                                         --       61,217        1,049
  Investment in companies                                                       (1,000)        (828)        (718)
  Purchase of equipment                                                         (3,228)      (6,680)      (1,797)
  Proceeds from sale of equipment                                                  143           --            6
  Long-term bank deposits                                                           --       (1,000)       1,000
                                                                               -------      -------      -------
         Net cash provided by (used in) investing activities                    25,559       22,766       22,717
                                                                               -------      -------      -------

CASH FLOWS FROM FINANCING ACTIVITIES
  Long-term bank loans received from (repaid to) banks                          20,000      (20,017)          --
  Proceeds from options exercised                                                1,999        2,389           --
                                                                               -------      -------      -------
         Net cash provided by financing activities                              21,999      (17,628)          --
                                                                               -------      -------      -------

INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS                                26,925      (14,442)      (7,613)
CASH AND CASH EQUIVALENTS AT  BEGINNING OF YEAR                                  4,990       31,915       17,473
                                                                               -------      -------      -------
CASH AND CASH EQUIVALENTS AT END OF YEAR                                        31,915       17,473        9,860
                                                                               =======      =======      =======

NON-CASH ACTIVITY

  Unrealized gain (loss) from available-for-sale securities, net                34,471      (27,936)         583
                                                                               =======      =======      =======

SUPPLEMENTAL CASH FLOWS INFORMATION:
  Cash paid for income taxes                                                        --        6,381           45
                                                                               =======      =======      =======
</TABLE>

       THE ACCOMPANYING NOTES FORM AN INTEGRAL PART OF THESE CONSOLIDATED
                             FINANCIAL STATEMENTS.


                                      -7-
<PAGE>
                          VOCALTEC COMMUNICATIONS LTD.

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




NOTE 1   -    GENERAL

              A.     The Company, an Israeli corporation, is a leading supplier
                     of Internet Telephony solutions, credited with launching
                     the VOIP (Voice Over Internet Protocol) industry in 1995.
                     The core business of the company is providing turnkey IP
                     (Internet Protocol) telephony solutions to service
                     providers.

              B.     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 in non-Israeli currencies (mainly
                     the U.S. dollar). A majority of the costs and expenses are
                     incurred outside Israel in non-Israeli currencies,
                     primarily in U.S. dollars. Thus, the functional currency of
                     the Company is the U.S. dollar.

                     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 (which are immaterial for each reported period) are
                     reflected in the statement of operations. The
                     representative rate of exchange at December 31, 2001 was
                     U.S. $1.00 - 4.416 New Israeli Shekel (NIS) (2000 and 1999
                     - NIS 4.041 and NIS 4.153, respectively).


                                      -8-
<PAGE>
                          VOCALTEC COMMUNICATIONS LTD.

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


NOTE 2   -    SIGNIFICANT ACCOUNTING POLICIES

              The financial statements have been prepared in conformity with
              accounting principles generally accepted in the United States. The
              significant accounting policies followed in the preparation of the
              financial statements, applied on a consistent basis, are as
              follows:

              A.     PRINCIPLES OF CONSOLIDATION

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

              B.     CASH AND CASH EQUIVALENTS

                     For the purpose of the statements of cash flows, all highly
                     liquid investments are considered cash equivalents if the
                     investments mature within three months from the date of
                     acquisition.

              C.     INVENTORIES

                     Inventories, consisting principally of components, are
                     stated at the lower of cost or market. Inventory cost is
                     determined by the average - cost method.

              D.     ALLOWANCE FOR DOUBTFUL ACCOUNTS

                     Allowance for doubtful accounts is computed for specific
                     accounts the collectibility of which is doubtful and based
                     upon the Company's experience.


                                      -9-
<PAGE>
                          VOCALTEC COMMUNICATIONS LTD.

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


NOTE 2   -    ACCOUNTING POLICIES (CONT.)

              E.     FAIR VALUE OF FINANCIAL INSTRUMENTS

                     The carrying amount of cash and cash equivalents, trade
                     receivables, other receivables, credit from banks and
                     others, liabilities to suppliers and others are equivalent
                     to, or approximate their fair value due to the short-term
                     maturity of these instruments.

              F.     INVESTMENT IN COMPANIES

                     The non-restricted portion of an investment in a
                     publicly-traded company which is available-for-sale is
                     recorded at fair market value in accordance with Statement
                     of Financial Accounting Standards ("SFAS") No. 115
                     "Accounting for Certain Investments in Debt and Equity
                     Securities". The difference between the fair market value
                     and cost (unrealized gain) is included as a separate
                     component of comprehensive income.

                     Investments in private companies and the restricted portion
                     of the investment in the above mentioned publicly traded
                     company are stated at cost less write-down for any declines
                     in value which is other than temporary, if applicable.

              G.     EQUIPMENT

                     Equipment is stated at cost. Depreciation is computed by
                     the straight-line method over the estimated useful life of
                     the assets.

              H.     RESEARCH AND DEVELOPMENT COSTS

                     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
                     operations as incurred. Software development costs are
                     considered for capitalization when technological
                     feasibility is established in accordance with SFAS 86,
                     "Accounting for the Costs of Computer Software to be Sold,
                     Leased or Otherwise Marketed." Costs incurred subsequent to
                     achievement of technological feasibility in the process of
                     software production have not been material. Therefore, the
                     Company has not capitalized any of its research and
                     development expenses and does not anticipate that its
                     development process will differ materially in the future.


                                      -10-
<PAGE>
                          VOCALTEC COMMUNICATIONS LTD.

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


NOTE 2   -    ACCOUNTING POLICIES (CONT.)

              I.     INCOME TAXES

                     The Company accounts for income taxes under the liability
                     method of accounting. Under the liability method, deferred
                     taxes are determined based on the differences between the
                     financial statement and tax bases of assets and liabilities
                     at enacted tax rates in effect in the year in which the
                     differences are expected to reverse. Valuation allowances
                     are established, when necessary, to reduce deferred tax
                     assets to amounts expected to be realized.

              J.     REVENUE RECOGNITION

                     Revenues from products are generally recognized upon
                     delivery, provided there is persuasive evidence of an
                     agreement, the fee is fixed or determinable and collection
                     of the related receivable is probable. Amounts received
                     where revenue recognition criteria have not been fully met,
                     and thus the revenue is not yet earned, are reflected as
                     deferred revenue. Amounts billed where revenue recognition
                     criteria have not been fully met, and thus revenue is not
                     yet earned, are reflected as allowance for unrecognized
                     income and netted with the related trade receivables.

                     Revenue from maintenance contracts is recognized ratably
                     over the term of the maintenance contract. Revenues related
                     to services are recognized as the services are rendered.

              K.     SHARE-BASED COMPENSATION

                     The Company has adopted the disclosure provisions of SFAS
                     No. 123, "Accounting for Stock-Based Compensation," and the
                     accounting rules set forth in Accounting Principles Board
                     ("APB") Opinion 25, "Accounting for Stock Issued to
                     Employees" including the FASB issued interpretation No. 44,
                     "Accounting for Certain Transactions Involving Stock
                     Compensation an interpretation of APB 25." The Company has
                     provided the necessary pro forma disclosures as if the fair
                     value method had been applied (See Note 12).


                                      -11-
<PAGE>
                          VOCALTEC COMMUNICATIONS LTD.

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


NOTE 2   -    ACCOUNTING POLICIES (CONT.)

              L.     NET INCOME (LOSS) PER SHARE

                     The Company computes net income (loss) per share in
                     accordance with SFAS No. 128, "Earnings per Share". Under
                     the provisions of SFAS No. 128, basic net income (loss) per
                     share ("Basic EPS") is computed by dividing net income
                     (loss) by the weighted average number of ordinary shares
                     outstanding. Diluted net income (loss) per share ("Diluted
                     EPS") is computed by dividing net income (loss) by the
                     weighted average number of shares and dilutive share
                     equivalents then outstanding. The total number of shares
                     related to the outstanding options excluded from the
                     calculations of diluted net loss per share were 2,879,943
                     and 2,069,114 for the years ended December 31, 1999 and
                     2001, respectively. A reconciliation between the numerator
                     and denominator of Basic EPS and Diluted EPS for the year
                     ended December 31, 2000, follows:


<TABLE>
<S>                                                                                    <C>
                    Net Income                                                              28,836
                    Basic:
                      Weighted average shares used in computing
                        basic net income per share                                      12,081,598
                                                                                        ==========

                    Basic net income per share                                                2.39
                                                                                        ==========

                    Diluted:
                      Shares used above                                                 12,081,598
                      Adjustment to reflect weighted effect of diluted
                        shares due to share options                                      1,170,279
                                                                                        ----------
                                                                                        13,251,877
                                                                                        ==========

                    Diluted net income per share                                              2.18
                                                                                        ==========
</TABLE>

              M.     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 reported amounts of assets and liabilities and
                     disclosure of contingent assets and liabilities at the date
                     of the financial statements and the reported amounts of
                     revenues and expenses during the reporting period. Actual
                     results could differ from those estimates.


                                      -12-
<PAGE>
                          VOCALTEC COMMUNICATIONS LTD.

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


NOTE 2   -    ACCOUNTING POLICIES (CONT.)

              N.     RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

                     In July 2001, the Financial Accounting Standards Board
                     issued Statements of Financial Accounting Standards No.
                     141, Business Combinations ("SFAS 141") and No. 142,
                     Goodwill and Other Intangible Assets ("SFAS 142"). SFAS 141
                     requires all business combinations initiated after June 30,
                     2001, to be accounted for using the purchase method. Under
                     SFAS 142, goodwill and intangible assets with indefinite
                     lives are no longer amortized but are reviewed annually (or
                     more frequently if impairment indicators arise) for
                     impairment. All other intangible assets will continue to be
                     amortized over their estimated useful lives. The
                     amortization provisions of SFAS 142 apply to goodwill and
                     intangible assets acquired after June 30, 2001. With
                     respect to goodwill and intangible assets acquired prior to
                     July 1, 2001, the Company is required to adopt SFAS 142
                     effective January 1, 2002. The adoption of SFAS No. 142
                     will not have a material effect on the Company's
                     consolidated financial statements.

                     In August 2001, the Financial Accounting Standards Board
                     issued Statement of Financial Accounting Standards No. 144,
                     Accounting for the Impairment or Disposal of Long-Lived
                     Assets ("SFAS 144"). Although SFAS 144 supersedes FASB
                     Statement No. 121, it retains the requirements of SFAS 121
                     regarding recognition of impairment loss for long-lived
                     assets to be held and used (based on undiscounted cash
                     flows) and resolves certain implementation issues. Also,
                     the accounting model used in SFAS 121 for long-lived assets
                     to be disposed of by sale (lower of carrying amount or fair
                     value less cost to sell) is broadened by SFAS 144 to
                     include discontinued operations and supersedes APB Opinion
                     No. 30. Therefore, discontinued operations will no longer
                     be measured on a net realizable value basis and future
                     operating losses will no longer be recognized before they
                     occur. SFAS 144 also broadens the presentation of
                     discontinued operations to include a component of an entity
                     (rather than a segment of a business). The provisions of
                     SFAS 144 are effective for financial statements issued for
                     fiscal years beginning after December 15, 2001, and interim
                     periods within those years. The Company believes that the
                     adoption of SFAS 144 will not have a material impact on the
                     Company's consolidated financial statements.


                                      -13-
<PAGE>
                          VOCALTEC COMMUNICATIONS LTD.

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


NOTE 2   -    ACCOUNTING POLICIES (CONT.)

              O.  DERIVATIVE FINANCIAL INSTRUMENTS

                     Effective January 1, 2001, the Company adopted Statement of
                     Financial Accounting Standards ("SFAS") No. 133 "Accounting
                     for Derivative Instruments and Hedging Activities". The
                     Company's derivative financial instruments consist of
                     foreign currency forward exchange and option contracts.
                     These contracts are utilized by the Company, from time to
                     time, to manage risk exposure to movements in foreign
                     exchange rates. None of these contracts have been
                     designated as hedging instruments. These contracts are
                     recognized as assets or liabilities on the balance sheet at
                     their fair value, which is the estimated amount at which
                     they could be settled based on market prices or dealer
                     quotes, where available, or based on pricing models.
                     Changes in fair value are recognized currently in earnings.
                     The adoption of SFAS No. 133 had no material impact on
                     reported earning for the year ended December 31, 2001.


NOTE 3   -    CASH AND CASH EQUIVALENTS

<TABLE>
<CAPTION>
                                                                DECEMBER 31
                                                                -----------
                                                             2000          2001
                                                             ----          ----

<S>                                                         <C>            <C>
             Cash in banks                                   4,532         4,159
             Bank deposits                                  12,941         5,701 (*)
                                                            ------         -----
                                                            17,473         9,860
                                                            ======         =====
</TABLE>

              (*) Mainly bearing annual interest of 1.9% to 5.3%.


NOTE 4   -    SHORT-TERM INVESTMENTS

<TABLE>
<CAPTION>
                                                                   DECEMBER 31
                                                                2000          2001
                                                                ----          ----

<S>                                                            <C>            <C>
             Bank deposits                                     31,673         3,000 (*)
             Commercial papers                                     --         5,496
                                                               ------         -----
                                                               31,673         8,496
                                                               ======         =====
</TABLE>

              (*) Mainly bearing annual interest of 2.4% to 7.0%.


                                      -14-
<PAGE>
                          VOCALTEC COMMUNICATIONS LTD.

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


NOTE 5   -    TRADE RECEIVABLES, NET

<TABLE>
<CAPTION>
                                                      DECEMBER 31
                                                      -----------
                                                    2000       2001
                                                   ------     ------

<S>                                                <C>        <C>
             Trade Receivables                     18,242     12,559
             Less -
               Allowance for doubtful accounts      1,122      2,077
               Unrecognized revenue                 8,748      5,076
                                                   ------     ------
                                                    8,372      5,406
                                                   ======     ======
</TABLE>


NOTE 6   -    OTHER RECEIVABLES

<TABLE>
<CAPTION>
                                                           DECEMBER 31
                                                           -----------
                                                          2000      2001
                                                         -----     -----

<S>                                                      <C>         <C>
             Prepaid expenses                            1,169       664
             Government participation receivables          590       285
             Accrued interest                              950       184
             Government institute receivable               473       346
             Other                                         697     1,023
                                                         -----     -----
                                                         3,879     2,502
                                                         =====     =====
</TABLE>


                                      -15-
<PAGE>
                          VOCALTEC COMMUNICATIONS LTD.

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


NOTE 7   -    INVESTMENTS IN COMPANIES

<TABLE>
<CAPTION>
                                                                  DECEMBER 31
                                                                  -----------
                                                             2000             2001
                                                             ----             ----

<S>                                                         <C>              <C>
             ITXC                                           13,792           14,656
             Other                                             828              256
                                                            ------           ------
                                                            14,620           14,912
                                                            ======           ======
</TABLE>

              The Company, through its wholly owned U.S. subsidiary, has 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 the net amount
              of $61,217 and recorded a net gain of $60,744 (see Note 18). In
              November 2001, the Company sold 180,000 shares of ITXC in the
              amount of $1,049 and recorded a gain of $941 (see Note 18). The
              Company's remaining investment in ITXC is subject to Rule 144
              under the Securities Act of 1933 which restricts the number of
              shares of ITXC that the Company may sell during specified future
              periods. As of December 31, 2000 and 2001, the portion of the
              Company's investment in ITXC which is not restricted is classified
              as "available-for-sale" and stated at fair market value. The
              remaining shares are presented at cost. Income tax expenses are
              deducted from the unrealized gain on available-for-sale
              securities. The investment in ITXC is presented in the balance
              sheet as follows:

<TABLE>
<CAPTION>
                                                                                      DECEMBER 31
                                                                                      -----------
                                                                                2000             2001
                                                                                ----             ----

<S>                                                                            <C>              <C>
             At fair market value (*)                                          11,933           12,955
             At cost (fair market value at
               December 31, 2001 - $20,177)                                     1,859            1,701
                                                                               ------           ------
                                                                               13,792           14,656
                                                                               ======           ======

             (*)  Includes unrealized gains                                    10,891           11,864
                                                                               ======           ======
</TABLE>


                                      -16-
<PAGE>
                          VOCALTEC COMMUNICATIONS LTD.

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


NOTE 8   -    EQUIPMENT, NET

<TABLE>
<CAPTION>
                                                               ANNUAL
                                                              RATES OF                  DECEMBER 31
                                                                                        -----------
                                                            DEPRECIATION             2000           2001
                                                            ------------             ----           ----

<S>                                                         <C>                     <C>            <C>
             Computers and related equipment                   25-33%               15,446         13,120
             Office furniture, equipment and
               leasehold improvements                          7-25%                 2,773          2,611
                                                                                    ------         ------
                                                                                    18,219         15,731
             Less - accumulated depreciation                                         9,329         10,711
                                                                                    ------         ------
             Net book value                                                          8,890          5,020
                                                                                    ======         ======
</TABLE>

              The majority of property, plant and equipment is located in
              Israel.

              For the years ended December 31, 1999, 2000 and 2001, depreciation
              expense was approximately $3,584, $3,409 and $3,867, respectively.


NOTE 9   -    ACCOUNTS PAYABLE AND ACCRUED EXPENSES

<TABLE>
<CAPTION>
                                                                   DECEMBER 31
                                                                   -----------
                                                               2000           2001
                                                               ----           ----

<S>                                                           <C>            <C>
             Suppliers                                         8,225          5,093
             Employees and related expenses                    7,427          2,003
             Income taxes payable                              2,632          2,046
             Other (mainly accrued expenses)                   5,864          3,613
                                                              ------         ------
                                                              24,148         12,755
                                                              ======         ======
</TABLE>


NOTE 10  -    SEVERANCE PAY

              The Company's severance pay obligation to its employees is
              partially covered by payments to insurance companies. The accrual
              for severance pay and deposits with insurance companies in respect
              of severance pay are included in the balance sheet. Severance pay
              expenses, amounted to $537, $213 and $1,338 for the years ended
              December 31, 1999, 2000 and 2001, respectively.


                                      -17-
<PAGE>
                          VOCALTEC COMMUNICATIONS LTD.

             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, the
                     Company received and accrued participation payments from
                     the Office of the Chief Scientist of the Ministry of
                     Industry and Trade in Israel in the total amount of
                     approximately $6.4 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 (for
                     grants received under programs approved subsequent to
                     January 1, 1999, 100% plus interest at LIBOR). The
                     Company's total commitment for royalties payable with
                     respect to future sales, based on Government of Israel
                     participations received or accrued, net of royalties paid
                     or accrued, totaled approximately $4.3 million as of
                     December 31, 2001.

              B.     Certain claims, mainly for patent infringement and breach
                     of contract have been made against the Company or its U.S.
                     subsidiary. Management estimates that these claims will not
                     have a material effect upon the Company's consolidated
                     financial position or results of operations.

              C.     The Company's facilities in Israel and in the United States
                     are rented under operating leases with periods ending June
                     2002 for facilities in Israel and July 2003 for facilities
                     in the United States (some with renewal options). Rent
                     expenses amounted to $1,328, $1,446 and $1,390 for the
                     years ended December 31, 1999, 2000 and 2001, respectively.
                     Annual minimum future rental payments at balance sheet date
                     are approximately as follows:

<TABLE>
<S>                                                                        <C>
                    2002                                                     962
                    2003                                                     177
                                                                           -----
                                                                           1,139
                                                                           =====
</TABLE>


                                      -18-
<PAGE>
                          VOCALTEC COMMUNICATIONS LTD.

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


NOTE 12  -    SHARE CAPITAL

              Through December 31, 2001, 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. Options generally become exercisable within two
              to four years from the date of the grant. Options were granted at
              varying prices ranging from $0 to the fair market value at the
              date of the grant.

              In 1998, 1999, 2000 and 2001, the Company adopted stock option and
              incentive plans (the "Option Plans") which provides for the grant
              by the Company of restricted shares or 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 plan will expire 10 years after its adoption
              unless terminated earlier by the Board of Directors. The exercise
              price of stock options issued under the Option Plan will be no
              less than 95% of the fair market value of the Ordinary Shares as
              of the date of grant.

              The Ordinary Shares acquired upon exercise of an option and the
              restricted shares will be subject to certain restrictions on
              transfer, sale or hypothecation. Options will be exercisable and
              restrictions on deposition of shares will lapse pursuant to the
              terms of the individual agreements under which such options were
              granted or shares issued.

              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 pursuant to the terms of
              the Company's stock option plans. The exercise price of these new
              options will be equal to the fair market value of the Company's
              ordinary shares as reported by NASDAQ on the date the options will
              be granted, which will be at least 186 days following the
              cancellation of the previous options, but no later than February
              23, 2002. 922,387 options were cancelled under this program.


                                      -19-
<PAGE>
                          VOCALTEC COMMUNICATIONS LTD.

             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 the
              three years ended December 31, 2001 are summarized as follows:

<TABLE>
<CAPTION>
                                                                             WEIGHTED         WEIGHTED
                                                                             AVERAGE        AVERAGE FAIR
                                                                             EXERCISE         VALUE OF
                                                           NUMBER OF          PRICE            OPTIONS
                                                            SHARES          PER SHARE          GRANTED
                                                            ------          ---------          -------

<S>                                                        <C>              <C>             <C>
             Outstanding January 1, 1999                    2,007,575

               Granted                                      1,775,950        $ 10.92            $6.00
               Exercised                                     (357,882)       $  6.23
               Forfeited                                     (545,700)       $  7.66
                                                            ---------

             Outstanding December 31, 1999                  2,879,943

               Granted                                        975,400        $ 12.32            $9.31
               Exercised                                     (355,756)       $  6.24
               Forfeited                                     (430,444)       $  9.36
                                                            ---------

             Outstanding December 31, 2000                  3,069,143

               Granted                                        795,650        $  4.37            $1.83
               Exercised                                           --             --
               Forfeited                                   (1,821,216)       $ 10.67
                                                            ---------

             Outstanding December 31, 2001                  2,043,577        $  7.01
                                                            =========
</TABLE>


                                      -20-
<PAGE>
                          VOCALTEC COMMUNICATIONS LTD.

             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, 2001:

<TABLE>
<CAPTION>
                                                  OPTIONS OUTSTANDING                             OPTIONS EXERCISABLE
                              ----------------------------------------------------------   --------------------------------------
     RANGE OF EXERCISE        NUMBER OUTSTANDING     WEIGHTED-AVERAGE        WEIGHTED            NUMBER              WEIGHTED
           PRICES               AT DECEMBER 31,          REMAINING            AVERAGE        OUTSTANDING AT           AVERAGE
                                     2001            CONTRACTUAL LIFE     EXERCISE PRICES  DECEMBER 31, 2001      EXERCISE PRICES
             $                                            (YEARS)                $                                        $
     -----------------        ------------------     ----------------     ---------------  -----------------      ---------------
<S>                           <C>                    <C>                  <C>              <C>                    <C>
     0.00                                  7,500                  3.00               0.00               7,500           0.00
     1.50-1.58                           101,594                  9.5                1.53              30,623           1.53
     3.56-3.75                           319,300                  9.25               3.66              18,750           3.56
     3.95-4.88                           410,275                  4.72               4.01             338,525           4.00
     6.29-6.65                           139,962                  5.50               6.65             117,462           6.65
     6.76-7.12                            68,272                  8.25               6.99              14,500           7.00
     7.13-7.50                           298,750                  6.50               7.42             227,000           7.41
     8.19-8.63                           210,384                  8.75               8.35              68,902           8.34
     8.96-9.43                            94,169                  7.50               9.18              63,724           9.19
     10.45-11.00                          72,000                  7.50              10.50              61,500          10.48
     11.50-11.83(*)                       68,000                  7.75              11.73              44,000          11.76
     12.83-14.00                         183,371                  8.00              13.16             108,924          13.16
     15.20-16.00                          45,000                  8.00              15.91              22,500          15.82
     17.25                                25,000                  8.00              17.25               7,810          17.25
                                       ---------                                                    ---------
                                       2,043,577                                                    1,131,720
                                       =========                                                    =========
</TABLE>


       (*)    Includes 28,000 options granted to Consultants in 1999 for whom
              deferred compensation in the amount of $177 was calculated based
              on the fair value of the options on the date granted using the
              Black-Scholes option-pricing model. Under SFAS No. 123 the
              compensation cost that has been charged to operations for the year
              ended December 31, 2001 amounted to $59 (2000 - $44, 1999 - $8).


                                      -21-
<PAGE>
                          VOCALTEC COMMUNICATIONS LTD.

             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 aggregate amount of deferred compensation related to
                     options granted to employees, officers and directors
                     recorded arising from the difference between the exercise
                     price and the fair market value on the date of the grant of
                     $772 is included in shareholders' equity and is being
                     amortized over the vesting periods of the respective
                     options in accordance with APB 25. The balance of
                     unamortized compensation at December 31, 2001 is $38. Under
                     APB 25 no compensation cost has been charged to operations
                     for the year ended December 31, 2001 (2000 - $47, 1999 -
                     $27).

                     If compensation cost had been determined under the
                     alternative fair value accounting method provided Under
                     FASB Statement No. 123, "Accounting for Stock-Based
                     Compensation", the Company's net income (loss) and basic
                     and diluted net income (loss) per share would have been
                     decreased (increased) to the following pro forma amounts:

<TABLE>
<CAPTION>
                                                              FOR THE YEAR ENDED DECEMBER 31
                                                              ------------------------------
                                                           1999             2000              2001
                                                           ----             ----              ----
<S>                                                      <C>               <C>             <C>
             Net income (loss):
               As reported                               (28,386)          28,836          (31,783)
               Pro forma                                 (30,657)          24,630          (34,141)

             Basic net income (loss) per share:
                 As reported                               (2.47)            2.39            (2.62)
                 Pro forma                                 (2.67)            2.04            (2.82)

             Diluted net income (loss) per share:
                 As reported                               (2.47)            2.18            (2.62)
                 Pro forma                                 (2.67)            1.86            (2.82)
</TABLE>

              Under SFAS 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
              1999, 2000 and 2001: (1) expected life of the option of 2.2 years
              (1999 - 2.5, 2000 - 2.1); (2) dividend yield of 0% (1999, 2000 -
              same); (3) expected volatility of 68% (1999 - 95%, 2000 - 159%),
              (4) risk-free interest rate of 1.75% (1999 and 2000 - 5%).


                                      -22-
<PAGE>
                          VOCALTEC COMMUNICATIONS LTD.

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


NOTE 13  -    NET SALES
<TABLE>
<CAPTION>

                                                                                YEAR ENDED DECEMBER 31
                                                                                ----------------------
                                                                           1999           2000           2001
                                                                           ----           ----           ----
<S>                                                                      <C>             <C>            <C>
             The Company's sales by geographic areas are as follows:
                 Europe                                                  16,687          18,152         10,737
                 North America (principally
                   United States)                                         3,556           8,194          9,471
                 Far East                                                 5,573           8,058          6,661
                 Israel                                                     433           4,611          1,026
                 Other                                                      366           2,956            518
                                                                         ------          ------         ------
                                                                         26,615          41,971         28,413
                                                                         ======          ======         ======

                                                                            %               %              %
                                                                         ------          ------         ------
             Sales to a single customer exceeding 10%:
                 Customer A                                                  49              29            (*)
                 Customer B                                                   -              15             25
                 Customer C                                                 (*)              11            (*)
</TABLE>

             (*)   Less than 10%


NOTE 14  -    COST OF SALES
<TABLE>
<CAPTION>
                                                                         YEAR ENDED DECEMBER 31
                                                                         ----------------------
                                                                   1999           2000           2001
                                                                   ----           ----           ----
<S>                                                                <C>            <C>            <C>
             Cost of sales include royalties to
               the Government of Israel                             219            716            834
                                                                   ====           ====           ====
</TABLE>


NOTE 15  -    RESEARCH AND DEVELOPMENT, NET

<TABLE>
<CAPTION>
                                                                            YEAR ENDED DECEMBER 31
                                                                            ----------------------
                                                                     1999           2000            2001
                                                                     ----           ----            ----

<S>                                                                 <C>           <C>            <C>
             Payroll and related expenses                           10,055          7,665          7,747
             Subcontractors and other expenses                       5,190          5,809          5,908
                                                                    ------         ------         ------
                                                                    15,245         13,471         13,655
             Less - participations by the Government of Israel:
                 Royalty bearing participation                       1,316          2,009          2,457
                 Other participation                                   772            192            159
                                                                    ------         ------         ------
                                                                    13,157         11,270         11,039
                                                                   =======        =======        =======
</TABLE>


                                      -23-
<PAGE>
                          VOCALTEC COMMUNICATIONS LTD.

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


NOTE 16  -    MARKETING AND SELLING, NET

<TABLE>
<CAPTION>
                                                                         YEAR ENDED DECEMBER 31
                                                                         ----------------------
                                                                   1999           2000           2001
                                                                   ----           ----           ----
<S>                                                               <C>              <C>            <C>
             Includes allowance for bad and
               doubtful accounts                                  2,637            187            698
                                                                  =====            ===            ===
</TABLE>


NOTE 17   -   RESTRUCTURING COSTS

              In April 2001 and June 2001, the Board of Directors approved cost
              reduction plans. The cost reduction plan provide for the
              termination of up to approximately one hundred and twenty
              employees. Restructuring charges of $2,073 were expensed during
              the year ended December 31, 2001. This charge is comprised of
              $1,472 relating to involuntary employee terminations and $601
              relating to other exit costs (mainly facilities related expenses).

              Components of the restructuring charge and for the year ended
              December 31, 2001 amounts paid during the period and the remaining
              accrued liability as of December 31, 2001, are as follows:

<TABLE>
<CAPTION>
                                                        RESTRUCTURING                        ACCRUED
                                                           CHARGE           PAYMENTS        LIABILITY
                                                           ------           --------        ---------

<S>                                                     <C>                 <C>             <C>
             Employee terminations                         1,472             1,472              --
             Other exit costs                                601               376             225
                                                           -----             -----             ---
                                                           2,073             1,848             225
                                                           =====             =====             ===
</TABLE>


NOTE 18   -   OTHER INCOME, NET

<TABLE>
<CAPTION>
                                                                            YEAR ENDED DECEMBER 31
                                                                            ----------------------
                                                                     1999         2000            2001
                                                                     ----         ----            ----

<S>                                                                  <C>         <C>            <C>
             Net gain on sale of ITXC shares                           --        60,744            941
             Provision for decline in value of
               Investments                                             --            --         (1,296)
             Other                                                     --        (3,000)         1,296
                                                                     ----        ------          -----
                                                                       --        57,744            941
                                                                     ====        ======          =====
</TABLE>


                                      -24-
<PAGE>
                          VOCALTEC COMMUNICATIONS LTD.

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


NOTE 19  -    DISCONTINUED OPERATIONS

              On June 7, 2001, a wholly-owned subsidiary, TrulyGlobal Inc.
              ("TrulyGlobal"), ceased operations after having been unsuccessful
              in obtaining external financing. A core group of TrulyGlobal
              software engineers were integrated into VocalTec's core
              development group to enable VocalTec to retain the TrulyGlobal
              technology and know-how. After the disposal date, the Company
              incurred shutdown costs of approximately $0.6 million for
              termination and other operating expenses, plus an approximately
              $1.8 million write-off of net fixed assets. As of December 31,
              2001 no significant assets or liabilities of TrulyGlobal were
              remaining.

              The Company's consolidated financial statements have been
              reclassified to reflect TrulyGlobal as a discontinued operation
              for all periods presented.


NOTE 20  -    TAXES ON INCOME

              A.     The Company is subject to the Income Tax Law (Inflationary
                     Adjustments), 1985, measuring income on the basis of
                     changes in the Israeli Consumer Price Index.

              B.     The Company's investment in equipment in the amount of
                     approximately $1,065 has received approval in accordance
                     with the Law for the Encouragement of Capital Investments,
                     1959 ("approved enterprise" status). The Company has chosen
                     to receive its benefits through the "Alternative Benefits"
                     program, and, as such, is eligible for various benefits.
                     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. The benefits are
                     subject to the fulfillment of the conditions of the letter
                     of approval. As the Company has not yet reported any
                     taxable income, the benefits period has not yet commenced.


                                      -25-
<PAGE>
                          VOCALTEC COMMUNICATIONS LTD.

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


NOTE 20  -    TAXES ON INCOME (CONT.)

                     The regular tax rate applicable to the Company is 36%.
                     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.
                     Dividends paid by the Company out of regular income are
                     liable to 25% withholding at source. Dividends paid out of
                     the approved plan income are liable to 15% withholding at
                     source. Should the Company pay dividends out of income
                     earned during the two-year tax holiday, it will be liable
                     to 25% tax on that income (or lower rate depending on the
                     rate of foreign share ownership).

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

              D.     VocalTec Ltd. has net operating loss carryforwards for tax
                     purposes of approximately $54 million as of December 31,
                     2001 which may be carried forward indefinitely. VocalTec
                     Inc., which is subject to U.S. income taxes, has a loss for
                     tax purposes of approximately $6 million as of December 31,
                     2001. Under certain conditions this loss can be carried
                     against previous tax payments of VocalTec Inc., or can be
                     carried forward until the year 2021. Due to the uncertainty
                     of realizing the benefit of the loss carryforwards, a
                     valuation allowance for the entire deferred tax assets has
                     been recorded. Deferred taxes in respect of other temporary
                     differences are immaterial.

              E.     The subsidiaries VocalTec Inc. and TrulyGlobal Inc. are in
                     the process of merger. If the companies will merger,
                     TrulyGlobal Inc. operating loss for tax purposes will be
                     added to VocalTec Inc. operating loss for tax purposes.

              F.     Income taxes (tax benefit) in 2000 and 2001 are mainly in
                     respect of the gain on sale of ITXC shares in the U.S.
                     subsidiary, after deduction of net operating loss
                     carryforwards for tax purposes.

              G.     Deferred income taxes are in respect of unrealized gain
                     from available-for-sale shares of ITXC held by the U.S.
                     subsidiary. The change in deferred taxes is reflected in
                     accumulated other comprehensive income in the statement of
                     shareholders' equity and comprehensive income.


                                      -26-
<PAGE>
                          VOCALTEC COMMUNICATIONS LTD.

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


NOTE 20 -     TAXES ON INCOME (CONT.)

       H.     Income (loss) from continuing operations before income taxes (tax
              benefit) is comprised as follows:

<TABLE>
<CAPTION>
                                                                        FOR THE YEAR ENDED DECEMBER 31
                                                                        ------------------------------
                                                                      1999           2000           2001
                                                                      ----           ----           ----

<S>                                                                 <C>            <C>            <C>
                    Israel                                          (11,335)       (9,705)        (20,550)
                    Foreign                                         (17,051)       54,047          (4,763)
                                                                    -------        ------         -------
                                                                    (28,386)       44,342         (25,313)
                                                                    =======        ======         =======
</TABLE>


NOTE 21-      ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)

<TABLE>
<CAPTION>
                                                                     FOR THE YEAR ENDED DECEMBER 31
                                                                     ------------------------------
                                                                   1999          2000            2001
                                                                   ----          ----            ----
<S>                                                               <C>          <C>               <C>
              Unrealized gain (loss) on available-
              for-sale securities during the period,
              net of tax                                          34,471        (2,190)          1,147
              Less - reclassification adjustment
                for gain included in net income                       --       (25,746)           (564)
                                                                  ------       -------           -----
              Net unrealized gain (loss) on
                available-for-sale securities                     34,471       (27,936)            583
                                                                  ======       =======           =====
</TABLE>


NOTE 22 -     RELATED PARTIES' BALANCES AND TRANSACTIONS

              Balances with related parties:

<TABLE>
<CAPTION>
                                                                                 DECEMBER 31
                                                                                 -----------
                                                                            2000             2001
                                                                            ----             ----

<S>                                                                        <C>               <C>
             Trade receivables (shareholder)                               4,209             1,206
</TABLE>

              Transactions with related parties:

<TABLE>
<CAPTION>
                                                               FOR THE YEAR ENDED DECEMBER 31
                                                               ------------------------------
                                                              1999             2000              2001
                                                              ----             ----              ----

<S>                                                          <C>              <C>                <C>
             Sales to shareholder                            13,092           12,204             2,273
</TABLE>


                                      -27-
<PAGE>
                          VOCALTEC COMMUNICATIONS LTD.

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


NOTE 23 -     SEGMENT REPORTING

              The Company is disclosing segment information in accordance with
              SFAS No. 131, "Disclosures About Segments of an Enterprise and
              Related Information". This standard requires the Company to
              disclose selected financial data by operating segment, defined as
              a component engaged in business activity resulting in revenues and
              expenses and that has separate financial information evaluated
              regularly by the Company's chief executive officer in determining
              resource allocation and assessing performance. The Company has
              identified three reportable segments based on its internal
              organization structure, management of operations and performance
              evaluation. These segments are: VocalTec, Surf & Call Network
              Services and Corporate.

              VocalTec is engaged in developing and marketing systems enabling
              voice, fax and multimedia communications over packetized networks,
              including both private networks and the public internet. Surf &
              Call Network Services is engaged in providing various vertical
              markets within the web-enabled call center sector with services
              based on the Company's Surf & Call Center Platform.

              Segment detail is summarized as follows:

<TABLE>
<CAPTION>
                                 VOCALTEC    SURF & CALL   DISCONTINUED     CORPORATE         TOTAL
                                               NETWORK       SEGMENT
                                              SERVICES
                                 --------    -----------   ------------     ---------         -----
<S>                              <C>         <C>           <C>              <C>             <C>
YEAR ENDED DECEMBER 31, 2001
  Net sales                       27,018        1,395           --                --         28,413
  Operating loss                 (23,563)      (4,563)          --                --        (28,126)

AS OF DECEMBER 31, 2001
  Total assets                    12,342        1,307           --            37,912         51,561

YEAR ENDED DECEMBER 31, 2000
  Net sales                       37,499        4,472           --                --         41,971
  Operating loss                 (13,569)      (3,017)          --                --        (16,586)

AS OF DECEMBER 31, 2000
  Total assets                    17,740        2,375        2,009            70,843         92,967

YEAR ENDED DECEMBER 31, 1999
  Net sales                       26,615           --           --                --         26,615
  Operating loss                 (29,288)          --           --                --        (29,288)
</TABLE>


                                 # # # # # # # #


                                         28
<PAGE>
                                   SCHEDULE II


<TABLE>
<CAPTION>
                                                                         Changes
                                         Balance at                                     Charged to
                                         beginning of    Charged to P&L               Comprehensive   Balance at
                                           period          statement     Written off     income      End of period
<S>                                      <C>             <C>             <C>          <C>            <C>
Year Ended December 31, 1999
Allowance for Unrecognized Revenue         5,526              -218             --          --           5,308
Allowance for doubtful accounts            2,255             2,637         -3,557          --           1,335



Year Ended December 31, 2000
Allowance for Unrecognized Revenue         5,308             3,440             --          --           8,748
Allowance for doubtful accounts            1,335               187           -400          --           1,122



Year Ended December 31, 2001
Allowance for Unrecognized Revenue         8,748             -3,672            --          --           5,076
Allowance for doubtful accounts            1,122               698            257          --           2,077
</TABLE>

<PAGE>
                                 EXHIBIT INDEX

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 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. Herzliya 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)   Lease Agreement Fort Lee Executive Park, by and between VocalTec
            Communications Inc. and Executive Park LLC., dated June 18, 1998,
            previously filed with the SEC on June 30, 2001 as Exhibit 4.1(f) to
            the Company's Annual Report on Form 20-F for the year ended December
            31, 2000, which is incorporated herein by reference.

8.    List of Subsidiaries.
[{"type": "20-F", "sequence": "1", "filename": "y61833e20vf.txt", "description": "VOCALTEC COMMUNICATIONS LTD.", "secsgml_size_bytes": 327696}]
{"company-data": {"conformed-name": "VOCALTEC COMMUNICATIONS LTD", "cik": "0001005699", "assigned-sic": "7373", "irs-number": "000000000", "state-of-incorporation": "L3", "fiscal-year-end": "1231"}, "filing-values": {"form-type": "20-F", "act": "34", "file-number": "000-27648", "film-number": "02688279"}, "business-address": {"street1": "1 MASKIT ST", "city": "HERZLIVA 46733 ISRAE", "state": "L3", "phone": "01197299707845"}, "mail-address": {"street1": "1 MASKIT ST", "street2": "HERZLIYA ISRAEL 46733", "city": "HERZLIYA", "state": "L3"}, "former-company": {"former-conformed-name": "VOCALTEC LTD", "date-changed": "19960109"}}
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, 2001

                                       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:

NONE.

                                     Page 1
The number of outstanding shares of each of the issuer's classes of capital or
common stock as of December 31, 2001

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
INDEX

PART ONE
Item 1.         Identity of Directors, Senior Management and Advisers  - Not applicable
Item 2.         Offer Statistics and Expected Timetable
Item 3.         Key Information  - Not applicable
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 - Not applicable
Item 14.        Material Modifications to the Rights of Security Holders and Use of
                Proceeds - Not applicable
Item 15.        [Reserved]
Item 16.        [Reserved]

PART THREE

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

SIGNATURES

EXHIBIT INDEX
Page 3
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, 2001 is
derived from our Consolidated Financial Statements, which have been audited by
Luboshitz Kasierer, a member firm of Arthur Andersen, our independent auditors.
Effective as of June 1, 2002, Luboshitz Kasierer became 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 4
STATEMENT OF OPERATIONS DATA
YEAR ENDED DECEMBER 31,
                                                  ----------------------------------------------------------------
                                                     1997          1998          1999          2000          2001
                                                  --------      --------      --------      --------      --------
                                                                (In thousands, except per share data)
Net sales                                         $ 15,683      $ 24,650      $ 26,615      $ 41,971      $ 28,413
Cost of sales                                        2,243         5,938         8,156        13,146        10,070
Inventory write off                                     --            --            --            --         1,441
Gross profit                                        13,440        18,712        18,459        28,825        16,902
Research and development expenses, net               5,519        11,192        13,157        11,270        11,039
Marketing and selling expenses, net                 13,449        18,509        27,171        26,372        24,716
General and administrative expenses                  3,196         5,204         6,592         7,769         7,200
Restructuring costs                                     --            --           827            --         2,073
Total operating expenses                            22,164        34,905        47,747        45,411        45,028
Operating (loss)                                    (8,724)      (16,193)      (29,288)      (16,586)      (28,126)
Other income (expenses), net                            --        (9,656)           --        57,744           941
Finance income, net                                  1,004         2,668           902         3,184         1,872
Income (loss) before income taxes                   (7,680)      (23,181)      (28,386)       44,342       (25,313)
Income tax (benefit)                                    --            --            --         9,013          (292)
Income (loss) from continuing operations            (7,680)      (23,181)      (28,386)       35,329       (25,021)
Loss from operations of discontinued segment            --            --            --        (6,493)       (4,403)
Loss on disposal of segment                             --            --            --            --        (2,359)
Net income (loss)                                   (7,680)      (23,181)      (28,386)       28,836       (31,783)
Basic net income (loss) per share from
continuing operations                                (0.89)        (2.08)        (2.47)         2.92         (2.06)
Diluted net income (loss) per share from
continuing operations                                (0.89)        (2.08)        (2.47)         2.67         (2.06)
Basic net income (loss) per share                    (0.89)        (2.08)        (2.47)         2.39         (2.62)
Diluted net income (loss) per share                  (0.89)        (2.08)        (2.47)         2.18         (2.62)
Weighted average number of shares outstanding        8,618        11,145        11,498        12,082        12,127
used in computation (basic)
Weighted average number of shares outstanding        8,618        11,145        11,498        13,252        12,127
used in computation (diluted)
BALANCE SHEET DATA
AS OF DECEMBER 31,
                                  1997        1998        1999        2000        2001
                                 -------     -------     -------     -------     -------
                                                     (In thousands)
Working capital                  $16,093     $42,501     $35,975     $42,673     $17,117
Total assets                      24,757      59,945      89,271      92,967      51,561
Long-term Liabilities                726       1,224      21,778       6,449       7,577
Net assets                        19,711      50,871      58,990      62,370      31,229
Total shareholders' equity        19,711      50,871      58,990      62,370      31,229
Number of shares outstanding       8,627      11,413      11,771      12,127      12,127
Page 5
3B.   CAPITALIZATION AND INDEBTEDNESS

Not applicable.

3C.   REASONS FOR THE OFFER AND USE OF PROCEEDS

Not applicable.

3D.   RISK FACTORS

PURCHASING OUR SHARES INVOLVES A HIGH DEGREE OF RISK. THE RISKS SET FORTH BELOW
SHOULD BE CAREFULLY REVIEWED BEFORE MAKING AN INVESTMENT DECISION IN OUR SHARES.
IN THE EVENT THAT ONE OR MORE OF THE RISKS SET FORTH BELOW OCCURS, OUR SHARE
PRICE COULD DECREASE AND YOU MAY LOSE ALL OR PART OF YOUR INVESTMENT.

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. The downturn in capital markets and reduction
of capital expenditures by telecom carriers 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 have a large order backlog. This makes the forecasting
of net sales inherently uncertain. This uncertainty is compounded because each
quarter's net sales are frequently from orders booked and shipped during the
last month of that quarter. Furthermore, a disproportionately large amount of
sales of the last month of each quarter are typically booked and shipped in the
latter half of the month. 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, the economic viability 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 telecom markets and in the Voice over Internet Protocol (VoIP) industry in
which we operate.

Our future results may also be affected by factors including our ability to
continue to develop, introduce and deliver enhanced and new products in a timely
manner, to offer new products at competitive 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 performance. The volatility in our operating results may
also result in significant

                                     Page 6
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 and related sectors. It is also possible that our quarterly results
or 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 EXPECT TO CONTINUE
TO INCUR OPERATING LOSSES.

Since our incorporation in 1989, we have had limited sales and have incurred
significant operating losses. In 2001, we had an operating loss of $28.13
million and a net loss of $31.78 million. In 2000, we had an operating loss of
$16.59 million, although we reported net income of $28.84 million due to a sale
of a portion of our shares in ITXC Corp. In 1999 and 1998 we incurred net losses
of approximately $28.39 million and $23.18 million (including a one-time charge
in respect to acquired research and development of $9.7 million), respectively.
Our future prospects must be considered in light of the risks, expenses and
difficulties currently encountered by companies in the depressed telecom 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, timely introduce
advanced versions and enhancements of our products and successfully market and
support such advanced versions and enhancements.

We expect to continue to incur operating losses in 2002 and may incur operating
losses thereafter due to decreased sales revenues which are insufficient to
cover sales and marketing, product development, administrative and other
expenses. If revenue levels decrease, operating results will be adversely
affected because any corresponding reduction in expenses may not be
proportionate to the reduction in revenues. There can be no assurance that we
will achieve or sustain significant sales or profitability in the future.

ANY FURTHER REDUCTION IN CAPITAL SPENDING BY TELECOMMUNICATIONS COMPANIES WILL
ADVERSELY AFFECT OUR REVENUES AND OUR FUTURE GROWTH

The turbulent economic events of the last two years have evidenced a decrease in
economic growth in all sectors of the telecommunications industry. Along with
the downturn in capital markets, these events have precluded the establishment
of new carriers, who would have represented potential new customers for us. In
addition, many existing telecom providers, including some of our customers, have
sustained significant economic losses and 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 either canceling or
delaying capacity upgrades, network expansions and the implementation of new
technologies, resulting in longer sales cycles. The downturn in capital markets
and reduction of capital expenditures by telecom carriers have resulted in
decreased market demand for our products and longer sales and procurement
cycles,

                                     Page 7
and have adversely affected our revenues. There can be no assurance there will
be no further deterioration in the telecom carrier sector, and that these events
will not continue to adversely affect our revenues and future growth.

IF OUR RELATIONSHIPS WITH OUR KEY PARTNERS ARE TERMINATED, OUR BUSINESS WILL BE
ADVERSELY AFFECTED.

Our relationship with ITXC provided for the purchase of approximately $7.1
million of our products and services by ITXC during 2001, constituting 25% of
our net sales in 2001. Our relationship with Deutsche Telekom AG provided for
the purchase of approximately $37.4 million of our products and services by
Deutsche Telekom between December 1997 and December 2001. During 2001, Deutsche
Telekom purchased $2.3 million of our products and services, constituting 8% of
our net sales in 2001. During 2000, Deutsche Telekom purchased $12.2 million of
our products and services, constituting 29% of our net sales in 2000.

If for any reason, our relationship with ITXC or Deutsche Telekom is terminated,
or if either of these key customers reduce purchases of our products, our
business, financial condition and results of operations would be materially
adversely affected. The impact of the termination or reduction of either or both
of these relationships would be intensified if we are unable to increase sales
to other customers in order to offset this termination or reduction.

WE WILL NOT ATTRACT AND RETAIN CUSTOMERS IF OUR SOLUTIONS DO NOT MEET MARKET AND
CUSTOMER REQUIREMENTS OR IF OUR PRODUCTS DO NOT ACHIEVE HOMOLOGATION
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 aggressive schedules. As the
variety and complexity of our product lines increase, the process of planning
production and inventory levels also becomes more difficult.

Short product life cycles place a premium on our ability to manage the
transition from current products to new products. Our results could be adversely
affected by factors such as development or manufacturing delays, variations in
product costs, and delays in

                                     Page 8
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, telecom carriers outside the U.S. increasingly require that VoIP
products be designed to meet local homologation requirements to demonstrate
interoperability with existing networks of incumbent telecom carriers, each of
which may have different specifications. Failure to obtain such homologation
certification for our products may result in decreased revenues, significant
warranty, support and repair costs, divert the attention of our engineering
personnel, and cause significant customer relations problems.

IF VIABLE MARKETS FOR OUR PRODUCTS AND TECHNOLOGY FAIL TO DEVELOP AND GROW, OR
OUR PRODUCTS FAIL TO ACHIEVE MARKET ACCEPTANCE EVEN IF MARKETS DO DEVELOP AND
GROW, OUR BUSINESS WILL BE ADVERSELY AFFECTED.

The markets for our products are new, are rapidly evolving technologically, and
are characterized by competitors that have developed similar products and
services. 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. Broad market demand and acceptance of our
technology, products and solutions, and interoperability of our products with
other VoIP products are critical to our success and 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 IP networks and the
PSTN will become widespread or that our products and solutions will gain market
acceptance. The adaptation process of connecting IP networks and PSTNs can be
time consuming and costly to both us and our customers and the acceptance of the
product or system may depend, to a substantial extent, on the success of the
adaptation.

The market for our VoIP products and solutions is depressed and still evolving,
it is difficult to predict its future growth rate, if any, and the size of our
market. There can be no assurance that the market for our products and services
will develop or that our products and solutions will achieve market acceptance.
If the market fails to develop, develops more slowly than expected, or if our
products and solutions do not achieve market acceptance, our business, financial
condition or results of operations will be materially adversely affected. In
addition, the market acceptance of new products by our competitors or the
emergence of new industry standards could render our products technologically
obsolete and could result in the inability to sell our products in the
marketplace and result in inventory write-downs of hardware products and
components contained in our solutions.

                                     Page 9
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.

If we do not increase our sales revenues, we may need to 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, from
strategic alliances or from the Office of the Chief Scientist of the State of
Israel (the "Chief Scientist"), 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. The recent downturn
in 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. 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.

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. In addition,
generally depressed economic conditions, and conditions relating to the
telecommunications industry in particular, pose serious risk factors that may
adversely affect our revenues and share price. Delisting procedures may be
instituted against us if our share price decreases below the NASDAQ limit, and
we may be delisted if our share price falls and remains below the limits
prescribed by NASDAQ.

In addition, global stock markets, including the NASDAQ, have been experiencing
and may continue to experience significant price and volume decreases which have
particularly affected the market prices of the stocks of high technology
companies and Israeli companies, including ourselves. Additional factors that
could cause the market price of our stock to 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 variations in actual or anticipated operating results, changes in
earnings estimates by analysts, 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 significantly affected and may continue to significantly affect the
market price of our ordinary shares. In the past, following decreases or
volatility in the market price of a company's securities, securities class
action litigation has often been instituted against

                                    Page 10
such a company. Such litigation could result in substantial costs and 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. Almost all of our current and potential
competitors have greater name recognition, larger installed customer bases 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.

Various innovative voice, audio and other communications alternatives, which may
compete with our products are often introduced, and may be introduced in the
future. Such new communication alternatives may be based on traditional
telephone lines, the Internet or cable networks and may be combined with other
computing and broadcasting capabilities.

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 telephone
companies and other telecommunications infrastructure providers. Additional
competitors may include companies that currently provide computer software
products and services, such as telephone, media, publishing 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 and military conditions in Israel and in other countries in
which our business are located or in which our products are sold. 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

                                    Page 11
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 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. In April 2002, Israel responded to Palestinian terrorist
attacks by undertaking military operations in Palestinian territory. 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 39 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.

                                    Page 12
Trade receivables as of December 31, 2001 amounted to approximately $5.4
million, net of allowances of approximately $7.2 million (mainly a reserve for
doubtful accounts and unrecognized revenues). Trade receivables as of May 31,
2002 amounted to approximately $5.7 million, net of allowances of approximately
$7.4 million. A portion of our receivables result from credit extended to
customers for purchases of our products. Some of these customers were proven to
be credit risks, and others may prove to be credit risks in the future. There
can be no assurance that any of our accounts receivable will be completely
collected. Any failure in the collection of 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, INCREASED WARRANTIES 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. In addition, our
customers are demanding longer product warranties that decrease our operating
margins. Further, an increasing number 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 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 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. Moreover,
the need to stock up on such components has increased our inventories and costs
of sales, and has negatively impacted our gross margins. We expect this trend to
continue in 2002 and beyond. 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 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

                                    Page 13
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, 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,

                                    Page 14
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.

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

Our marketing strategy includes sales through distributors and resellers, as
well as direct sales by our own sales force. Our marketing efforts would be
adversely affected by changes in our relationships with our distributors, value
added resellers and agents, or by other changes to their respective businesses.
There is no assurance that we will be successful in extending the duration of
our various agreements or in establishing similar relationships with other
entities if our current agreements are not extended. Although we believe that
our relationship with our distributors, value added resellers and agents is
generally good, the loss of our distributors or any event negatively affecting
their financial condition could have a material adverse effect on our business,
financial condition or results of operations

OUR EXPANSION INTO NEW INTERNATIONAL MARKETS EXPOSES US TO THE RISKS INHERENT IN
CONDUCTING BUSINESS IN INTERNATIONAL MARKETS.

A substantial portion of our sales are made directly or indirectly into
international markets, some of which are in developing countries. A key
component of our strategy is to continue to penetrate 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,
difficulties in collecting accounts receivable, 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

                                    Page 15
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.

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

As of May 31, 2002 our principal shareholders, including our directors and
certain executive officers, beneficially owned more than 30% 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.

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) which may be eliminated or
ameliorated by a QEF Election (as defined in Item 10E) that is in effect for any
year in which we are a PFIC. Each U.S. Holder will be responsible for making
this QEF Election on such holder's tax return. Failure to make a QEF Election
may 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. U.S.
Holders should consult their United States tax advisors with respect to the
United States tax consequences of investing in our ordinary shares, and the
benefits of a QEF Election, as applied to their circumstances. Although we do
not believe that we have been a PFIC for any tax year through and including
2001, we may be deemed to be a PFIC by the tax authorities for tax year 2001 as
a result of our substantial holdings of cash, cash equivalents and securities
combined with a decline in our share price and we may be deemed to be a PFIC in
future years. 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

                                    Page 16
Enterprise" status of certain existing facilities and approved programs from the
Government of Israel. In addition we benefit from participation by 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
investments in fixed assets. If we fail to meet such conditions in the future,
we could be required to refund tax benefits already received. 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 portions 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 1999, 2000 and 2001 the annual
rate of inflation was 1.3%, 0% and 1.4%, respectively, while the NIS was
devalued against the dollar by approximately -0.2%, -2.7% and 9.3%,
respectively. The rate of inflation for 2002 as of May 31, 2002 is was 4.9%, and
the NIS depreciated during 2002, until May 31, 2002, by approximately 1.3%.
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 or entities 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.

U.S. FEDERAL COMMUNICATIONS REGULATIONS

                                    Page 17
To date, the Federal Communications Commission ("FCC") has not subjected IP
telephony providers nor VOIP solutions providers to the FCC regulations that
apply to long distance telecommunications carriers. At this time it is uncertain
whether or to what extent the FCC 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 FCC action
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
+972-9-970-9700. Our website is located at http://www.vocaltec.com. Our wholly
owned U.S. subsidiary, VocalTec Communications Inc., is located at One Executive
Drive, Suite 320, Fort Lee, NJ, USA 07024-3393.

Our capital expenditures for fiscal years 2001, 2000 and 1999 amounted to $1.8
million, $6.7 million and $3.2 million, respectively. These expenditures were
primarily for computer equipment in our Israel and worldwide offices.

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 remaining operations
with our U.S. wholly owned subsidiary, VocalTec Communications Inc. As a result,
we are using most of the computer equipment of TrulyGlobal in our research and
development operations. Such equipment has a net asset value of $1.6 million,
and we anticipate a reduction in our capital expenditure requirements resulting
from our use of this equipment.

Capital expenditures for another line of business, Surf&Call, 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 we will not incur any capital expenditures for Surf&Call
after such date.

During the second quarter of 2001, we decided to implement a number of
organizational changes due to substantial reduction in market demand, based on
an ongoing review of our operations. This initiative consisted of a number of
organizational changes, including a reduction in worldwide headcount of 140
employees, or approximately 40% of our workforce, and reduction in the office
facilities used for our activities.

                                    Page 18
As of May 31, 2002, capital expenditures currently in progress consist of
approximately $0.43 million to be used in 2002 for research and development
activities.

4B.   BUSINESS OVERVIEW

We are a leading supplier of packet-based voice solutions for next generation
telecommunication networks suitable for the telecom and enterprise markets. Our
solutions incorporate carrier-class switching equipment and software that allow
voice to be delivered over packet-based networks, including the Internet. Our
solutions enable telecom 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 telecom carriers and service providers to increase their revenues
through the delivery of new and innovative web-based voice and data services
(such as voice virtual private networks) helping them to retain and expand their
customer base.

Our solutions are suitable for the telecom and enterprise markets and 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 publicly
switched telephone network ("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.

See Item 5 - Operating Review and Financial Prospects - for segmented financial
information.

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 (Internet
Protocol), 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

                                    Page 19
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.

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. To accommodate this growth,
carriers have made major investments in packet-based networks. 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:

-     Carrier class equipment that complies with telecom carriers' quality
      standards.

-     Scalable solutions that support incremental growth from entry level
      deployments to massive global networks

-     Solutions compatible with the existing infrastructure, supporting the full
      range of traditional telephone signaling variants (SS7).

-     Multi-protocol solutions, supporting SIP, MGCP, Megaco and H.323.

-     Proven interoperability with VOIP equipment of other vendors for best of
      breed solutions

-     Distributed architecture for easy management and enhanced network
      efficiency

-     Simple and rapid installation, deployment and support

                                    Page 20
THE VOCALTEC SOLUTION

We develop, market and sell a wide variety of carrier-grade, solutions based on
our award-winning softswitch architecture and VoIP products. Our solutions offer
high reliability, improved economics, interoperability, rapid deployment and an
open architecture and allow our customers to offer revenue-generating services.

We believe that our particular advantages are:

-     Strong SS7 capabilities, supporting over 50 national variants of this
      telephony signaling protocol.

-     Modular solutions for all sizes of networks.

-     Extensive next generation network experience.

-     Significant installed base with commercially deployed solutions in over
      100 countries.

-     Interoperability with many revenue-generating VoIP ports worldwide.

-     Multiple relationships with various solutions providers for the telecom
      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 VPN (Virtual Private Network). 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. This widely deployed solution is used by ITXC, one
of the world's largest international VoIP networks.

                                    Page 21
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.

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.

VOCALTEC PRODUCTS

The solutions described above are based on a wide range of flexible and scalable
VocalTec products that meet the technical and interoperability requirements of
the world's leading communication companies.

VOCALTEC SOFTSWITCH ARCHITECTURE 3000

VSM3100(TM) Service Integration Module - This carrier-grade, scaleable module
provides centralized VoIP service aggregation and integration over packet
networks. The SM3100 performs call control, routing, addressing, security and
accounting for multiple, distributed gateways.

VSM3200(TM) MGC Module - Performs call control and signaling routing for PSTN
and SS7 voice traffic. The VSM3200 frees the media gateway to serve as a pure
voice transport device. By working opposite multiple media gateways
simultaneously, the VSM3200 maximizes a network's performance,
cost-effectiveness and scalability.

VSM3300(TM) SIP Module - This module integrates SIP endpoints and applications
into today's H.323-based VoIP networks. The VSM3300 provides seamless,
standards-based interoperability between media gateways, H.323 gateways and SIP
networks. The

                                    Page 22
VSM3300 mediates between SIP endpoints and VocalTec's advanced VSM3100 Service
Integration Module.

VNM3900(TM) Network Manager - This centralized tool allows network
administrators to manage and monitor the VSA 3000 modules (VSM3100, VSM3200,
VSM3300), VocalTec gateways, and third party H.323 gateways. The VNM3900
combines remote configuration and extensive provisioning capabilities with a
web-based interface.

VNM3910(TM) Customer Network Manager - This web application enables hosted Voice
VPN customers to perform administration and subscriber provisioning activities
for multi-level VPNs. The VNM3910 allows customers to configure closed user
groups, subscriber features and assignment, and other attributes. Self
management via the web maximizes customers' accessibility, while reducing the
service provider's management costs.

VNM3920(TM) Traffic Manager - Based on near-real time monitoring and analysis of
enriched call detail record (CDR) information, VNM3920 proactively identifies
potential problems before they affect service levels. Statistical reports and
graphs facilitate traffic analysis for optimized network planning and marketing
decisions. VNM3920 reduces operational costs by ensuring maximum utilization of
network equipment.

VNM3930(TM) Billing Mediator - The VNM3930 collects and stores CDRs in a central
repository. This module formats and exports CDR files to billing and other
systems, and provides analytical tools for field-level investigations of
individual CDRs. VNM3930 increases revenues by consolidating CDRs in a single
database and preventing the loss of billable CDRs.

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-

                                    Page 23
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 Interactive Voice Response (IVR) to 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 small capacity VoIP DSP processor boards, ECI
Telecom Ltd. for the supply of large capacity VoIP DSP processor boards, and
Intel for the supply of signaling boards and components.

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 expanded our direct sales channels and currently have a direct global sales
organization with sales and support based in Israel, the United States, Japan,
Germany, China, Hong Kong, Singapore, Italy, Spain, France and Sweden. 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 and have recently
increased due to the depressed telecommunications markets and generally weak
market demand for 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.

INDUSTRY STANDARDS

We recognize that standards are important for interoperability and for providing
the

                                    Page 24
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 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 continue to participate as members in such consortia.

We actively support all the most 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. 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. For the telecommunications market, we have entered into
several agreements that provide a percentage charge of the cost of the system
purchased for technical support. 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 enables us to design
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, Avaya/Lucent Technologies Inc., Siemens, Nortel
Networks Corporation, Nuera Communications, Comworks Technologies, Sonus
Networks Inc. and Clarent Corporation.

We believe that in such a rapidly changing market, key competitive factors
include a broad base of users, strategic alliances, key reference customers,
interoperability, integration of products with vendors of complementary hardware
and software products

                                    Page 25
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 places
of incorporation are:

-     VocalTec Communications Inc. (USA)
-     VocalTec Communications Japan KK, (Japan)
-     VocalTec Communications Deutschland GmbH (Germany)
-     VocalTec Communications Hong Kong Limited (Hong Kong)
-     VocalTec Communications International B.V. (Netherlands)
-     VocalTec Communications Italy S.r.l. (Italy)
-     VocalTec Communications Singapore Pte Ltd. (Singapore)
-     VocalTec Communications France SAS (France)
-     VocalTec Communications Spain S.L. (Spain)
-     VocalTec Communications Sweden AB (Sweden)
-     VocalTec Communications Australia Pty Ltd. (Australia)

 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 49,600 square feet pursuant to a lease expiring in July 2002. We
possess an option to extend the lease on similar terms. We currently pay total
yearly rental and management fees of approximately $0.95 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 38,000 square feet are currently being used by our
company. We are subleasing approximately 2,500 square feet to Surf&Call
Solutions Ltd., and are attempting to sublease additional unused space in our
premises. We are currently re-negotiating renewal of our lease and the return of
a portion of our unused space.

We maintain car leases, and our total liability for early termination of the
leases is up to an aggregate of approximately $300,000.

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

                                    Page 26
Our subsidiary in the United States rents approximately 16,500 square feet in
Fort Lee, New Jersey under a lease expiring in July 2003. The annual rent for
these facilities is approximately $354,000. Approximately 10,000 square feet are
being used by our U.S. subsidiary, and we are currently attempting to sublease
additional unused footage in these premises and are simultaneously negotiating
with our landlord to lease smaller premises.

We lease a Network Operating Center in New York, New York, which rents
approximately 150 square feet. The annual rent for these facilities is $180,000.
The rental fees are fully paid until October 2002, at which time the lease
expires. We do not intend to renew this lease.

Our subsidiary in Japan leases approximately 2,200 square feet in Tokyo under a
lease expiring in July 2002 and will be automatically renewed. The annual rent
for the facility is approximately $100,000.

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.

Our representative office in China leases approximately 2,200 square feet in
Beijing under a lease expiring in July 2002. The annual rent for the facility is
approximately $44,500. We are currently in the process of renewing this lease.

Our subsidiary in Hong Kong leases approximately 1,900 square feet under a lease
expiring in June 2002. The annual rent for the facility is approximately
$85,000. We are currently negotiating with our landlord to lease smaller
premises.

We lease additional office space in Singapore, Italy, Spain, France, Sweden, and
Miami.

ITEM 5.     OPERATING AND FINANCIAL REVIEW AND PROSPECTS

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. These statements involve substantial risks and uncertainties. In
some cases you can identify these statements by forward-looking words such as
"anticipate," "believe," "could," "estimate," "expect," "intend," "may,"
"should," "will," and "would" or similar words. You should read statements that
contain these words carefully because they discuss future expectations, contain
projections of future results of operations or of financial position or state
other forward-looking information. The important factors listed in the section
captioned "Risk Factors," as well as any cautionary language in this report,
provide examples of risks, uncertainties and events that may cause our actual
results to differ materially from the expectations described in these
forward-looking statements. You should be aware that the occurrence of the
events described in these risk factors and elsewhere in this report, including
in the section captioned "Critical Accounting Policies," could have a material
adverse effect on the business, results of operations and

                                    Page 27
financial position of VocalTec.

Any forward-looking statements in this report are not guarantees of future
performances, and actual results, developments and business decisions may differ
from those envisaged by such forward-looking statements, possibly materially.
VocalTec disclaims any duty to update any forward-looking statements, all of
which are expressly qualified by the statements in this section.

OVERVIEW

Recent turbulent economic conditions worldwide have affected the
telecommunications industry in particular. As a result, spending in the telecom
industry has decreased substantially in 2001. Accordingly, sales of VoIP
products to telecom service providers have decreased and continue being
generally unpredictable, as fluctuation in demand for voice infrastructure
products is dependent on the service providers expansion of their networks.

The major product changes during the past three years was the introduction of
our award-winning softswitch technology and our gateway 2000 and gateway 480
products. In addition, during 2000 we stopped selling our Internet Phone
products, as these sales accounted for a small percentage of our net sales in
1999 and 1998. 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 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, and trends within our company, 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

The critical accounting policies listed below, in our opinion, materially affect
our estimates, assumptions and judgments in compiling our Consolidated Financial
Statements.

Revenue Recognition: We recognize revenue when (1) we and a creditworthy
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. This policy ensures that we report
revenues in accordance with generally accepted accounting principles in the U.S.
Factors that could materially

                                    Page 28
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.

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 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 profit and loss
statements. We include both past actual expenses and accruals for expected
expenses, along with the impairment of the value of fixed assets belonging to
these segments after the balance sheet date. Exit costs relating to continuing
operations are presented as "restructuring costs" within the operational
expenses. These exit costs include severance and notice payments to employees
and other contractual obligations.

Conservative Accounting Practices: 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

The following discussion of our financial condition and results of operations
should be read in conjunction with our 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."

NET SALES

Net sales consist of sales of VoIP turnkey solutions, products and related
support and maintenance services. We posted net sales in 2001 of $28.4 million,
32% lower than net sales in 2000 in the amount of $42 million. Revenues for 2001
were 7% higher than revenues in 1999, which were in the amount of $26.6 million.
The decrease in net sales in 2001 was primarily attributable to weakened market
demand, financial difficulties of telecom carriers and service providers, as
well as excess PSTN capacity, longer sales cycles and turbulent global economic
conditions, all of which affected the telecom

                                    Page 29
industry and resulted in decreased capital expenditures by telecom customers.
The increase in net sales in 2000 was primarily attributable to increased
capital expenditures by our customer base, our increased sales and marketing
efforts, including an increased number of sales offices, a larger, more focused,
sales force and a growing acceptance of packet-based telephony.

Sales of our turnkey solutions (consisting of software, hardware and services)
to the service provider market comprised the most significant portion of sales
in 2001. These sales resulted from increased market demand in previous years for
turnkey solutions rather than sales of product units. These turn-key solutions
accounted for approximately 75% of our net sales in 2001, compared with 54% in
2000, and 57% in 1999. Other revenues were generated by licenses, projects and
support.

During 2000 we stopped selling Internet Phone, as a result of our increased
focus on turnkey solutions and carrier markets. Sales of Internet Phone
accounted for 5% of our net sales in 1999.

In 2000 and 2001 revenues from consulting for customization services were
negligible, down from 35% of our total revenues in 1999. This decrease is
attributable to the changed composition of sales due to increased sales of
turnkey projects with less customization requirements, and the reduction in
demand for customization services by Deutsche Telekom. As our customers have
less customization requirements, we expect that future revenues from consulting
services will continue to be negligible and that we will sell more turnkey
products and projects and less consulting services.

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. In each of 2000 and 1999,
we experienced an increase in net sales through distribution channels serving
the carrier or corporate markets. These channels represented a higher percentage
of net sales in 2000 compared with 1999 due to our increased focus and marketing
efforts in such channels. In 2001 our net sales through distribution channels
decreased from 2000, in generally the same proportion as the decrease in overall
sales.

The direct sales operations to telecommunications service providers was
initiated in 1997, primarily due to a strategic business cooperation agreement
with Deutsche Telekom.

Sales to Deutsche Telekom in 2001 decreased to 8% of net sales, compared with
29% of net sales in 2000, and 49% of net sales in 1999. Sales to ITXC Corp.
accounted for 25% of revenues during 2001, compared with 15% in 2000. Sales to
ECI accounted for 4% of revenues in 2001 compared with 11% in 2000. The increase
in percentage of net sales to ITXC is a result of the decrease in sales to
Deutsche Telekom in 2001. If for any reason, our relationship with ITXC or
Deutsche Telekom is terminated, or if either of these key customers reduce
purchases of our products, our business, financial condition and results of
operations will be materially adversely affected.

                                    Page 30
Geographic revenues as a percentage of overall revenues changed as follows:

-     Sales in the Americas increased to 33% of total revenues in 2001, compared
      with 20% in 2000 and 13% in 1999.
-     Sales in Europe decreased to 38% of total revenues in 2001, compared with
      43% in 2000 and 63% in 1999.
-     Sales in Asia Pacific increased slightly to 23% of total revenues in 2001,
      compared with 19% in 2000 and 21% in 1999.
-     Sales in Israel decreased to 4% of total revenues in 2001, compared with
      11% in 2000 and 2% in 1999.

The difference in 2001 percentages in geographic revenue distribution from
previous years is mainly a result of the decrease in sales to Deutsche Telekom
in Europe in 2001.

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

COST OF SALES

Cost of sales including an inventory write-off in the amount of $1.4 million was
$11.5 million or 41% of net sales in 2001, compared with $13.1 million or 31% of
net sales in 2000 and $8.2 million, or 31% of net sales, in 1999. Cost of sales
excluding the inventory write-off was $10.1 million, or 35% of net sales. Cost
of sales primarily include the cost of hardware that we must purchase to provide
as part of our turnkey solutions, third party billing software, reserves for
price reductions of products in inventory, cost of operations for rendering
maintenance services to customers, royalties payments to third parties, warranty
reserves, and other inventory write-offs.

In 1999, 2000 and 2001, cost of sales increased in absolute numbers and as a
percentage of sales due to increased sales of turnkey solutions containing both
software and hardware components, as opposed to sales of purely software
products. We expect that cost of sales may increase in the future due to
customers' preference for full turnkey solutions containing both software and
hardware products, increasingly competitive prices, customer requirements for
longer warranty periods, and increased inventory-related costs.

In 2001, gross margins including an inventory write-off for obsolete stock, was
59%, and excluding the inventory write-off were 65%, 69% and 69% in the years
2001, 2000 and 1999, respectively. The decrease in 2001 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.

We believe that the gross margin on product sales may decrease in future periods
due to increased competition which may cause us to reduce prices of certain of
our products,

                                    Page 31
increased amounts paid for licensed technology to be incorporated in future
products and increased costs associated with providing longer customer warranty
periods, 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
$11 million, or 39% of net sales in 2001, compared with $11.3 million, or 27% of
net sales in 2000, and $13.2 million, or 49% of net sales in 1999. Although the
actual amount spent on research and development costs decreased, 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 necessary 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% - 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.

In 2001, total research and development grants from the Chief Scientist were
$2.5 million, all of which related to royalty bearing programs. Total cash
grants received from the Chief Scientist in 2001 (for years 2000 and 2001) were
$2.5 million. As of December 31, 2001 grant receivables were $0.3 million.

In 2001, we paid royalties to the Chief Scientist in an aggregate amount of
approximately $1.1 million. We currently have an additional $0.4 million in
accrued obligations to pay for royalties previously incurred under royalty
bearing programs of the Chief Scientist.

In 2000, total research and development grants from the Chief Scientist were
$2.1 million

                                    Page 32
of which $0.2 million were royalty-free and resulted from the MAGNET program
(see "Research and Development Consortia" below). Total cash grants received
from the Chief Scientist in 2000 were $4.4 million, of which $2.5 million
related to royalty bearing programs and $2.0 million related to the MAGNET
program. On December 31, 2000, grants receivables were $0.3 million.

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 1999, total research and development grants from the Chief Scientist were
$2.0 million, of which $1.3 million related to royalty bearing programs and $0.8
million resulted from the MAGNET program. Total cash grants received from the
Chief Scientist in 1999 were $1.4 million, of which $0.7 million related to
royalty bearing programs and $0.6 million resulted from the MAGNET program. On
December 31, 1999, grant receivables were $1.2 million.

In 1999, we paid royalties to the Chief Scientist in an aggregate amount of
approximately $44,000, with an additional $0.2 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. Under this program we were allocated 720,000 Euros for the two and a
half year duration of the project, all of which forms part of a non
royalty-bearing program. In 2001, total research and development grants from the
Fifth Framework Programme were 188,000 Euros. Total cash received in 2001 from
this program were 63,000 Euros. In 2000, total research and development grants
from the Fifth Framework Programme were 340,000 Euros. Total cash received in
2000 from this program 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 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.

                                    Page 33
We are a member in 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, net.

Marketing and selling expenses, net were $24.7 million, or 87% of net sales, in
2001 compared with $26.4 million, or 63% of net sales in 2000 and $27.2 million,
or 102% of net sales, in 1999. Marketing and selling expenses include salaries
and benefits, sales commissions, travel expenses and related facilities costs
for our sales, marketing, customer support and distribution personnel as well as
royalties to third parties. Marketing and selling expenses also include the
costs of programs aimed at increasing revenue, such as advertising, trade shows
and other market development programs.

The decrease in marketing and selling expenses in absolute terms in 2001 was the
result of the reduction in sales and marketing staff. 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
could not be reduced in the same proportion our revenues decreased, without
harming future revenue opportunities.

The decrease from 1999 in marketing and selling expenses in absolute terms in
2000 was the result of the separation of sales and marketing expenses of
TrulyGlobal, now presented in our financial statements in the discontinued
operations line. This amount was offset partially by the establishment and
expansion of the marketing, sales and customer support operations relating to
the carrier and service providers markets in our offices in Singapore,
Australia, Italy, France, and Hong Kong. A large number of sales and support
personnel were redeployed worldwide, in order to be based in the territories
that they serve.

In 1999, the relatively high levels of marketing and selling expenses was a
result of the establishment of sales and marketing activities in Germany and
China, expansion of the marketing, sales and customer support operations
relating to the carrier and service providers markets of our U.S. subsidiary,
VocalTec Communications Inc., as well as increased bad debts expenses.

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/production, human
resources, legal, information services, and administrative personnel. General
and administrative expenses also include

                                    Page 34
expenses associated with computer equipment and software used in the
administration operations. General and administrative expenses were $7.2 million
or 25% of net sales in 2001, compared with $7.8 million, or 19% of net sales in
2000 and $6.6 million, or 25% of net sales, in 1999. If we find it necessary to
add any systems, processes and people necessary to support overall increases in
the scope of our operations, general and administrative expenses will increase
in absolute terms.

Restructuring costs.

During the second quarter of 2001, we decided to implement a number of
organizational changes due to substantial reduction in market demand, based on
an ongoing review of our operations. This initiative consisted of a number of
organizational changes, including a reduction in worldwide headcount of 140
employees, or approximately 40% of our workforce and reduction in the office
facilities used for our activities. As most of the affected employees were
entitled to a notice period, severance payments and other benefits, we recorded
$1.6 million for these items. Payments for vacant office space for the remainder
of the lease periods were estimated at $0.4 million while another $0.1 million
was paid for other expenses, such as coverage of obligations. The total cost
associated with these charges was $2.1 million, paid mostly in cash. Of this
amount, we paid a total of $1.9 million as of December 31, 2001, and a total of
$2.0 million as of May 31, 2002. We expect that these restructuring costs along
with discontinued operations will result in lower operating expenses during
2002.

In May 1999, we made a decision to intensify our strategic market focus. This
initiative consisted of a number of organizational changes, including a
reduction in worldwide headcount of approximately 40 people and the liquidation
of VocalTec Communications UK Ltd., our U.K. subsidiary, which had focused on
research and development and product management for collaboration software
products for corporate intranets. Total costs associated with those changes were
$0.8 million.

OTHER INCOME (EXPENSE), NET

Net gain on sale of ITXC shares. In 2001, we sold 180,000 shares of ITXC Corp,
and realized net proceeds of approximately $1.05 million after taxes. During
2002, as of May 31, 2002, we sold 220,000 shares of ITXC, and realized net
proceeds of approximately $1.3 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, and other expenses of approximately $3 million.
We intend to gradually reduce our holdings in ITXC by selling a portion of our
shares each quarter subject to restrictions imposed, if any, under Rule 144 of
the Securities Act of 1933.

FINANCING  INCOME, NET

Financing income, net was $1.9 million, or 7% of net sales in 2001, compared
with $3.2 million, or 8% in 2000, and $0.9 million, or 3% in 1999. The decrease
in finance income in 2001 was as a result of lower cash balances and lower
interest rates on deposits. The

                                    Page 35
increase in finance 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

Tax benefits in the U.S. in 2001 amounted to $0.6 million, and we paid income
tax of $0.3 million for our various subsidiaries, leaving us with a net tax
benefit of $0.3 million in 2001. Capital gains taxes in 2000 were $9 million,
and income (before income taxes) was $44.3 million. These taxes were for the
gain on sale of ITXC shares, after deduction of net operating loss carryforwards
for tax purposes. Our effective corporate tax rate in 2000 was 20.4% resulting
from the one-time capital gains from our sale of ITXC shares. Due to reported
losses, our effective tax rate was 0% in 1999 and 2001.

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. If our losses in the United States continue during 2002, we may be
entitled to a tax refund for 2002.

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 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, 2001, we had net operating loss carryforwards in Israel of
approximately $54 million for tax purposes, and net operating loss carry
forwards in the U.S. of approximately $5.8 million. These net operating loss 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.

TRULYGLOBAL 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. As a result, the remaining operations, employees
and customer base of TrulyGlobal were integrated into VocalTec's operations.
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

                                    Page 36
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 US
GAAP.

NET INCOME (LOSS)

Net loss in 2001 was $31.8 million or 112% of net sales, or $2.62 per share.
This includes a charge for restructuring costs of $2.1 million, or $0.17 per
share, a charge for discontinued operations of $6.8 million or $0.56 per share,
a gain from our sale of ITXC shares of $0.94 million or $0.08 per share, a tax
benefit of $0.29 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 $35.3 million or 84% of net
sales, or $2.92 per share. Net income in 2000 was $28.84 million or 69% of net
sales, or $2.39 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
or 32% of net sales.

Net loss in 1999 was $28.39 million, or 107% of net sales, or $2.47 per share.
This includes a charge for restructuring costs of $0.83 million, or $0.07 per
share. The net loss excluding the restructuring charge was $27.56 million, or
$2.40 per share, or 104% of net sales. The net losses in 2001 were primarily
attributable to the weakness in sales due to decreased capital expenditures by
telecommunications carriers. In 2000 (excluding the income from the sale of
shares) and 1999 the net losses were primarily due to accelerated sales,
marketing and research and development activities.

Our net revenues for the first quarter of 2002 were $3.3 million, and our net
loss was $3.85 million, after tax refund benefits in the amount of $3.79 million
as detailed in the Tax Refunds and Tax Benefits section above, and $0.33 million
capital gain. This decrease in revenues in the first quarter from previous
quarters resulted from the delayed processing of orders by the T-Systems
division of the Deutsche Telekom Group, which orders arrived after the end of
the first quarter. We anticipate our net loss to continue throughout in 2002.

SEGMENT REPORTING

In the second quarter of 2000 we began operating three business units: our core
unit VocalTec, TrulyGlobal, and Surf&Call. In 2001, our core business unit,
VocalTec, posted net sales of $27 million with an operating loss of $23.6
million.

In 2001, the Surf&Call business unit (Surf&Call Network Services) posted net
sales of $1.4 million and an operating loss of $4.6 million. 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

                                    Page 37
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, and may be entitled in the future to royalties on sales
made by the new 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 will serve as
resellers of each other's products on favorable terms and conditions. The 2001
profit and loss statements does not yet reflect the carve-out. As of 2002,
Surf&Call will be presented as discontinued operations, including the $0.55
million convertible loan write-off and the write-off in the amount of $0.76
million for the transferred equipment. The Surf&Call carve-out will affect
various items in the Profit and Loss Statement for 2001, although the net loss
for 2001 will remain unchanged.

In June 2001, the third business unit, TrulyGlobal Inc. ceased operations after
being unsuccessful in obtaining external financing, and the remaining operations
and personnel were subsequently merged into VocalTec Communications, Inc.
TrulyGlobal's operating results appear in the financial statements as
discontinued operations, in accordance with U.S. GAAP. In addition, this
affected various items in the Profit and Loss Statement for 2000.

Our financial statements are reported in dollars and the vast majority of our
sales are made in 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 2001, the rate of inflation in Israel was 1.4%. The rate of
depreciation of the NIS in relation to the dollar was 9.3%. The depreciation of
the NIS in relation to the dollar led to a lower dollar cost of operations in
Israel.

LIQUIDITY AND CAPITAL RESOURCES

We believe that our revenues, cash, cash equivalents, and our shares in ITXC
provide us with the ability to timely generate adequate amounts of cash to meet
our ongoing cash requirements. During the past three years, we covered our cash
flow requirements using operating revenues, proceeds of the sale of a portion of
our holdings of ITXC shares, grants from the Chief Scientist and other cash
reserves.

On December 31, 2001, we had approximately $18.4 million in cash, cash
equivalents and short-term deposits, comprised of $9.9 million in cash and cash
equivalents and $8.5 million in short-term investments, compared to a total of
$49.2 million, comprised of

                                    Page 38
$17.5 million in cash and cash equivalents and $31.7 million in short-term
investments (deposits for periods of longer than three months and shorter than
one year) in 2000. Some of our short-term investments consist of commercial
papers currently rated A2/P2. VocalTec generally holds 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, 2001, we had working capital of approximately $17.1 million
compared with working capital of $42.7 million on December 31, 2000. The
decrease in working capital during 2001 resulted primarily from our company's
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 in 2001 decreased and were insufficient to cover
operating expenses.

Net cash used in operating activities was $30.33 million, $19.58 million and
$20.63 million for the years ending December 31, 2001, 2000 and 1999,
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 $0.05 million
in 2001 and $6.38 million in 2000.

Net cash provided by investment activities was $22.72 million, $22.77 million
and $25.56 million for the years ending December 31, 2001, 2000 and 1999,
respectively. Net cash provide by investment activities generally consists of
short-term investments which matured during the relevant year. In 2000, net cash
provided by investments included proceeds from the sale of ITXC shares. In 2001
and in 1999, net cash from short-term investments amounted to $23.18 million and
$29.64 million, respectively. In 2000, cash deposited as short-term investments
was $29.94 million. Proceeds from the sale of ITXC shares were $1.0 million in
2001 and $61.2 million in year 2000. In years 2001, 2000 and 1999 our
investments in the shares of other companies amounted to $0.7 million, $0.8
million, and $1.0 million, respectively, while cash used for purchase of
equipment was $1.8, million, $6.7 million, and $3.2 million, respectively.

In 2000, cash flows used for financing activities amounted to $17.6 million. In
1999, net cash derived from financing activities was $22.0 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.

We anticipate that operating expenses will exceed revenues, net of cost of sales
in 2002 and possibly beyond. Throughout 2001 we undertook a series of cost
reduction measures and may 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 as well as
proceeds from future sales of ITXC stock 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

                                    Page 39
industry, our sales decreasing as a result of evolving industry standards and
rapid technological changes that could result in our products being no longer in
demand, or our failure to retain our customers, we may need to reduce our
operating expenses or use more of our cash reserves and/or sell a portion of our
ITXC shares 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, utilize more of our cash reserves and/or sell a portion of
our shares in ITXC. If such measures are insufficient, we may attempt to
establish lines of credit or sell additional equity securities or debt
securities. The recent downturn in 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.

On October 1, 1999, ITXC consummated its initial public offering. In March 2000,
we sold shares of ITXC common stock in a secondary offering conducted by ITXC.
We realized net proceeds, after taxes, of approximately $50 million from the
sale. In 2001, we sold 180,000 shares of ITXC Corp, and realized net proceeds of
approximately $1.05 million after taxes. During 2002, as of May 31, 2002, we
sold 220,000 shares of ITXC Corp., and realized net proceeds of approximately
$1.3 million. We continue to hold 4,388,165 shares, or approximately 9.5% of
ITXC's outstanding common stock. For information relating to the valuation of
our investment in ITXC and the presentation of this investment on our balance
sheet, see "Item 11 - Quantitative and Qualitative Disclosures About Market
Risks".

Our holdings in ITXC are presented in the balance sheet as of December 31, 2001
as follows: the portion of 1.8 million shares "available-for-sale" during 2002
is stated at fair market value which was $7.19 per share, representing a total
of $13.0 million and the restricted portion of the shares (2.8 million shares)
is presented at cost of $1.7 million. The fair market value of this portion of
the ITXC investment, as of December 31, 2001, was approximately $20 million.

Proceeds from sales of ITXC shares are subject to capital gains tax in the
U.S., as these shares are held by our U.S. subsidiary.

In 2001 and to date, we have not incurred any debt.

Capital expenditures in 2001 were approximately $1.8 million compared with $6.7
million in 2000 and $3.2 million in 1999. 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 do not anticipate a
significant investment in capital expenditure in 2002, as we will continue to
use the computer equipment of TrulyGlobal in our research and development
operations. Such equipment has a net asset value of $1.6 million, and we
anticipate a reduction in our capital expenditures resulting from our use of
this equipment. See Item 4A for further details.

                                    Page 40
In May 2002, we finalized the carve-out of our Surf&Call operations into a
separate entity. The carve-out does not materially affect our current cash and
cash equivalent balances, but is expected to reduce our operating expenses by
approximately $0.6 million per quarter.

The cost of our solutions increased during 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, and our total liability for early termination of
the leases is in the amount of up to $300,000.

INVENTORY AND RECEIVABLES

Inventories at the end of 2001 were $3.61 million compared with $5.42 million at
the end of 2000 and $1.60 million at the end of 1999. The decrease in 2001
compared with 2000 was due to lower inventory levels and an accrual for
inventory write-off of $1.4 million. The increase in 2000 compared with 1999
resulted from increased hardware for the product developed jointly with ECI
Telecom as well as a larger quantity of evaluations units at customer sites, and
outsourcing of components integration for some products.

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 decreased to approximately
$5.4 million at the end of 2001, compared to approximately $8.4 million at the
end of 2000 and approximately $6.2 million at the end of 1999. 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
unrecognized sales and bad debts is adequate due to the short history and lack
of collection experience we have with these types of providers.

Other receivables decreased to $2.5 million at the end of 2001 compared with
$3.9 million at the end of 2000, and $3.1 million at the end of 1999. The
decrease in 2001 was due to lowered 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 Scientist
receivables.

                                    Page 41
RECENT ACCOUNTING PRONOUNCEMENTS

The Financial Accounting Standards Board issued Statement No. 141, Business
Combinations and Statement No. 142, Goodwill and Other Intangible Assets in June
2001. These standards are effective for fiscal years beginning after December
15, 2001. Under these standards, goodwill and intangible assets deemed to have
indefinite lives will be subject to annual impairment tests rather than be
amortized over certain periods, while other intangible assets will continue to
be amortized accordingly. We believe that there will be no material impact on
our consolidated results of operations and financial statements from these
standards.

The Financial Accounting Standards Board issued in August 2001 Statement No.
144, Accounting for the Impairment and Disposal of Long-Lived Assets. This
standard became effective on January 1, 2002, and provides guidance on the
disposal of long-lived assets to be abandoned or sold. We believe that there
will be no material impact on our consolidated results of operations and
financial statements from these standards.

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. Several
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
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 which 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, 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 which 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 2001, we invested $8.8 million
($6.4 million without Surf&Call) in our research and development efforts for
salaried personnel, compared with $8.4 million in 2000 and $10.3 million in
1999.

                                    Page 43
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 carriers who would have represented potential new customers for
us. In addition, existing telecom 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
reduction of capital expenditures by telecom carriers have resulted in decreased
market demand for our products, and have adversely affected our revenues.

During 2001, we undertook cost reduction measures that resulted in a
restructuring charge in the second quarter of approximately $1.84 million, and
in the fourth quarter of approximately $0.23 million. Among the restructuring
measures, there was a reduction of approximately 40% of the total workforce, and
a salary reduction of an average of above 12%, among other measures.

In 2001, our wholly-owned subsidiary, TrulyGlobal, Inc., ceased operations after
having been unsuccessful in obtaining external financing, and its remaining
operations and personnel were merged into VocalTec Communications, Inc. A number
of TrulyGlobal engineers were integrated into our core development group, and
the assets and technology of TrulyGlobal was integrated into the VocalTec
technology. The merger enabled us to retain the operations, assets and
technology of TrulyGlobal, as well as some key members of the TrulyGlobal team.

In 2001, the Surf&Call business unit (Surf&Call Network Services) posted net
sales of $1.4 million and an operating loss of $4.6 million. 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

                                    Page 44
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, and may be entitled in the future to royalties on sales
made by the new 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 will serve as
resellers of each other's products on favorable terms and conditions. The 2001
profit and loss statements does not yet reflect the carve-out. As of 2002,
Surf&Call will be presented as discontinued operations, including the $0.55
million convertible loan write-off and the write-off in the amount of $0.76
million for the transferred equipment. The Surf&Call carve-out will affect
various items in the Profit and Loss Statement for 2001, although the net loss
for 2001 will remain unchanged.

The turbulent economic events commencing in 2000 have resulted in a substantial
decrease in our share price and market capitalization. Accordingly, the value of
the stock options granted to our employees was adversely affected. Since we
believe that there is great significance in maintaining the equity incentive of
our employees, we are continuously exploring new ways to provide such incentives
in today's uncertainty of the financial markets. As part of this policy, we
implemented a stock exchange option program. Under this program, each employee
was entitled to cancel all or any portion of the employee's outstanding
unexercised stock options that were issued under our various stock option plans
for new options equal to 80% of the canceled options. The exercise price for the
new options is equal to the fair market value at the time of the new grant.

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
Page 45
NAME                     POSITION
    ----                     --------
Rina Shainski            Director
    Hugo Goldman             Chief Financial Officer
    Ira Palti                Chief Operating 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.

RINA SHAINSKI has served as director since July 2000.  Ms. Shainski has been a
partner in Carmel Ventures Fund since April 2000. From September 1997 to March
2000, Ms. Shainski served as Vice President, Business Development at Clal
Industries and Investments Ltd., one of Israel largest investment and holding
companies.  From 1989 to 1996, Ms. Shainski served in a number of executive
positions in Tecnomatix Technologies Ltd., including Vice President Business
Development and Director of Research and Development.  In addition Ms. Shainski
currently serves as a director of several companies, including Fundtech
Corporation.  Ms. Shainski qualifies as an External Director according to the
Companies Law.

LIOR HARAMATY is a co-founder of our company and has served as director since
1989. Mr. Haramaty served as Senior Vice President of Commercial Development
from December 1999, Vice President of Professional Services from May 1999, Vice
President of Technical Marketing from November 1995 and Director of Technical
Marketing from 1993, to mid 2000. Prior to 1993, Mr. Haramaty was responsible
for VocalTec's research and development and operations groups.

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 currently holds the position of 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

                                    Page 46
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 Companies Law.

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.

IRA PALTI serves as our Chief Operating Officer and has served as Vice President
of Research and Development from February 1999 to November 1999. From 1997 to
1999, Mr. Palti served as the Chief Executive Officer of Automedia Ltd. From
1995 to 1997, Mr. Palti served as the Vice President of Research and Development
at Netmanage Corp. From 1984 to 1994, Mr. Palti held various management and
software development positions at Rosh/ServiceSoft Corp.

6B.     COMPENSATION OF DIRECTORS AND EXECUTIVE OFFICERS

The aggregate compensation paid to all our directors and officers as a group
during the fiscal year 2001 was approximately $1.74 million in salaries,
directors' fees, and bonuses, and 330,000 options. 30,000 of these options were
granted on January 8, 2001 at an exercise price of $3.95, 150,000 of these
options were granted on April 27, 2001 at an exercise price of $3.75, and
150,000 of these options were granted on April 27, 2001 at an exercise price of
$3.56. Options expire ten years after the date of the grant. Employees,
including those Executive Officers that are also employees, were given the
opportunity to participate in an Options Exchange Program, implemented by the
Company in August 2001. See Item 6E of this report - Share Ownership.

The aggregate total amounts set aside or accrued by the Company or its
subsidiaries to provide for severance payments is approximately $0.54 million.

6C.     BOARD PRACTICES

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 and Rina Shainski, their
respective terms as directors expire in July 2003 and may be renewed for one
additional three-year term; (b) Ami Tal's term as director expires at the 2002
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

                                    Page 47
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 providing for benefits upon termination of employment. 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 member of
senior management member.

Our audit committee is comprised of Douglas Dunn, Yoav Chelouche and Rina
Shainski. 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. The following are
examples of functions within the authority of the Audit Committee:

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

-     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.

-     To assist our Board of Directors in performing its duties to oversee our
      accounting and financial policies, internal controls, and financial
      reporting practices.

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

6D.     EMPLOYEES

At December 31, 2001, we employed 256 full time employees, including 191
employees in the core business unit, 22 employees in the Surf&Call Solutions
unit, and 43 employees in shared services and administration. Of these employees
99 were employed in research and development (compared with 142 in 2000 and 94
in 1999), 110 were employed in sales and marketing (compared with 152 in 2000
and 89 in 1999) and 47 were employed in general and administrative (compared
with 86 in 2000 and 70 in 1999). Of these employees, 187 were based in our
facilities in Israel, 31 in the United States, 27 in Asia Pacific and 11 in
Europe. As of May 31, 2002 we employed a total of 235 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 as otherwise
applicable under Israeli law. During 2001, we eliminated 140 positions as part

                                    Page 48
of our restructuring plans.

6E.     SHARE OWNERSHIP

As of May 31, 2002 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 Trading International, as well as 7,500
shares and 340,000 options held by Elon Ganor and 10,000 shares and 138,000
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) 2001 Master Stock Option Plan.

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. The exercise price per share is usually 100% of the
fair market value of the shares on the date of grant, as determined by the
closing price reported by the Nasdaq National Market on the date of grant for
incentive stock options, or 95% of the fair market value of the shares on the
date of grant, as determined by the closing price reported by the Nasdaq
National Market on the date of grant for nonqualified 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.

                                    Page 49
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 31, 2002, 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.
ORDINARY SHARES BENEFICIALLY OWNED
                                         ----------------------------------
NAME AND ADDRESS                              NUMBER          PERCENT
----------------                              ------          -------
Deutsche Telekom A.G.                       2,300,000          19%
Friedrich-Ebert-Allee 140
D-53113 Bonn, Germany

LaCresta International Trading Inc. (1)     1,267,550          10.5%
c/o L.C.I.T. S.A Dufourstrasse 131
P.O.B. 219 Zurich 8034, Switzerland

Officers and directors as a group (2)       1,480,675          12.2%
(8  persons)
(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 (i) 220,000 options for ordinary shares held by Dr. Ganor that
      are exercisable within 60 days of the date stated above and (ii) 90,000
      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) 523,125 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. Does not
      include 559,475 ordinary shares for which options granted to officers and
      directors of our company are outstanding but are not currently
      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.

                                    Page 50
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 $10.0 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
2001 under this credit line was in the amount of $9.7 million. To date,
approximately $4 million of the credit line has been used.

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

-     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.

-     In November 2001, we merged the operations of our wholly-owned
      subsidiary, TrulyGlobal Inc. into VocalTec Communications Inc.

-     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, and may be entitled in the future to royalties on
      sales made by the new 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 will serve as resellers of each other's products on
      favorable terms and conditions. The 2001 profit and loss statements do not
      yet reflect the carve-out. As of 2002, Surf&Call will be presented as
      discontinued operations, including the $0.55 million convertible loan

                                    Page 51
write-off and the write-off in the amount of $0.76 million for the
      transferred equipment. The Surf&Call carve-out will affect various items
      in the Profit and Loss Statement for 2001, although the net loss for 2001
      will remain unchanged.

-     We have been generating sales of our products to ITXC Corp. During
      calendar year 2001, such sales amounted to 25% of our gross revenues,
      compared with 15% in 2000.

In addition, we entered into an employment agreement with Dr. Elon Ganor in
October 2001, providing for the continued employment of Dr. Ganor as Chief
Executive Officer. The employment agreement continues indefinitely until notice
of termination is given by either party.

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 $27.4 million, or 96% of net sales in 2001, compared with
$37.4 million, or 89% of net sales, in 2000, and $26.2 million, or 98% of net
sales, in 1999.

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 financial condition.

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, infringed several of Multi-Tech's patents. In October 2001, we
settled the suit on terms and conditions with no material effect on the
operations of VocalTec.

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

                                    Page 52
dividends in the foreseeable future.

8B.     SIGNIFICANT CHANGES

Except as disclosed elsewhere in this report, there have been no other
significant changes since December 31, 2001.

ITEM 9.     THE OFFER AND LISTING

9A.     OFFER AND LISTING DETAILS

Through June 24, 2002 for the periods indicated, the high and low reported
trading prices of our ordinary shares as reported by Nasdaq were as follows:
HIGH       LOW
                                ----       ---
1997                           33.25       5.250
1998                           24.625      5.56
1999                           19.75       8.031
2000                           53.25       3.5
2001                            8.125      0.600

2000
First quarter                  53.25       14.94
Second quarter                 29.25       12.5
Third quarter                  26.5         9.5
Fourth quarter                 10.75        3.5

2001
First quarter                   8.13        3.00
Second quarter                  4.00        1.86
Third quarter                   2.15        0.60
Fourth quarter                  3.68        1.01

LAST SIXTH MONTHS
December                        3.68        2.34
January                         3.02        2.05
February                        2.31        1.63
March                           1.95        1.5
April                           1.82        1.05
May                             1.42        1.11
June (through June 24, 2002)    1.267       0.91
As of May 31, 2002, 12,127,058 of our ordinary shares were issued and
outstanding. At such date, the last reported sale price of the ordinary shares
was $1.26 per share, and the

                                    Page 53
ordinary shares were held by 120 record holders. Of those 120 record holders, 95
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 May 31, 2002 we believe approximately 48% 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".

9D.     SELLING SHAREHOLDERS

Not applicable.

9E.     DILUTION

Not applicable.

9F.     EXPENSES OF THE ISSUE

Not applicable.

ITEM 10.    ADDITIONAL INFORMATION

10A.    SHARE CAPITAL

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

                                    Page 54
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 2002, (b) another class to hold office until our
annual meeting of shareholders to be held in 2003 and (c) a third class to hold
office until our annual meeting of shareholders to be held in 2004.

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 which 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.

                                    Page 55
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:

      -     Any amendment to the articles of association;

      -     An increase in the company's authorized capital;

      -     A merger; or

      -     Approval of some of the acts and transactions which 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.

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

                                    Page 56
(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 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.

                                    Page 57
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 which 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 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.

                                    Page 58
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
2002, 2003 and 2004. At each shareholder meeting, the successors of each class
of directors whose terms expire are elected to hold officer 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) holder 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 voting on such matter at a General Meeting.

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, who must also be residents of Israel. 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:

      -     an employment relationship;

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

      -     control; and

      -     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.

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.

                                    Page 59
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 National Market 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
any person who is a current or former employee of a company or of any of its
affiliates, as well as any immediate family member of an executive officer of a
company or of any of its affiliates. At least three of our current directors
meet the independence standard of the Nasdaq rules.

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:

      -     the chairman of the board of directors;

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

      -     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.

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, Rina
Shainski, and Douglas Dunn, and, we believe, is independent under Nasdaq rules.

                                    Page 60
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 which 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. 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 which 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

                                    Page 61
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 which
would provide coverage for any monetary liability incurred as a result of any of
the following:

      -     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;

      -     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;

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

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

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:

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

      -     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

      -     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

                                    Page 62
Our Articles of Association provide that we may indemnify an office holder
against:

      -     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

      -     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:

      -     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

      -     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

Material contracts not in the ordinary course of business consist of the
employment agreement between our company and Elon Ganor, our CEO.

10D. EXCHANGE CONTROLS

While the State of Israel has, in the past, maintained extensive controls on
foreign currency, these regulations were, in large part, lifted in 1998. 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.

                                    Page 63
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 which 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 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.

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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 an FIC, which is at
least 25% owned by non-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 there under 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

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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.

From time to time, the Government of Israel has discussed reducing the benefits
available to companies under the Investment Law. 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.
However, grants made available to our company by the Israeli Government are not
included in the amount of the R&D expenses.

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Under the law for the Encouragement of Industrial Research and Development, 1984
(the "Research Law"), research and development programs which 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 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.

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.

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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.

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

                                    Page 68
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

Israeli law generally imposes a capital gains tax on the sale of securities and
any other capital asset. The basic tax rate applicable to corporations is
currently 36% in 1997 and thereafter. From 1994, the maximum tax rate for
individuals was fixed at 50%. These rates are subject to the provisions of any
applicable bilateral double taxation treaty. The treaty concerning double
taxation between the United States and Israel (the "Treaty") is discussed below.

Under existing regulations, as long as our ordinary shares are quoted on Nasdaq
(or listed on a stock exchange recognized by the Israeli Ministry of Finance)
and we continue to qualify as an Industrial Company under the Industry Law,
capital gains on the sale of the ordinary shares by individuals, will generally
be exempt from Israeli capital gains tax. There can be no assurance that we will
maintain such listing or qualification. Notwithstanding the foregoing, dealers
in securities in Israel are taxed at regular tax rates applicable to business
income. The foregoing exemption does not apply to companies subject to the
Inflationary Adjustments Law.

Individuals who are non-residents of Israel are subject to a graduated income
tax on income 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. 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.

U.S. 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 U.S. 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

                                    Page 69
not address the U.S. federal income tax consequences of purchasing, holding or
disposing of ordinary shares to shareholders who own (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 taxpayers whose
functional currency is not the dollar. The following discussion also does not
address any aspect of state, local or non-U.S. tax laws. Further, this summary
generally considers only a U.S. Holder (as defined below) that will own ordinary
shares as capital assets (generally, assets held for investment) and does not
consider the tax treatment of persons who will hold ordinary shares through a
partnership or other pass-through entity. Each prospective investor is advised
to consult such person's own tax advisor with respect to the specific U.S.
federal, state and local tax consequences to such person of purchasing, holding
or disposing of ordinary shares.

TAXATION OF U.S. HOLDERS

For purposes of this discussion, a "U.S. Holder" is any holder of ordinary
shares who is: (i) a citizen or resident of the United States: (ii) a
corporation partnership or limited liability company 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 U.S. federal income
tax purposes regardless of source; or (iv) a trust, generally if a U.S. court is
able to exercise primary supervision over its administration and one or more
U.S. fiduciaries have the authority to control all of its substantial decisions.

Distributions. While it is not anticipated that we will pay dividends in the
foreseeable future, the gross amount of any distribution from our company
received by a U.S. Holder which is treated as a dividend for U.S. federal income
tax purposes (before reduction for any Israeli tax withheld at source), will be
included in such U.S. Holder's gross income, will be subject to tax at the rates
applicable to ordinary income and will not qualify for the dividends received
deductions applicable in certain cases to U.S. corporations. To the extent that
such distribution exceeds our earnings and profits and provided that we are not
a PFIC as to such U.S. Holder, such distribution will be treated as a
non-taxable return of capital to the extent of the U.S. Holder's adjusted basis
in the ordinary shares and thereafter as taxable capital gain. For U.S. federal
income tax purposes, the amount of any dividend paid in NIS by our company 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 U.S.
source ordinary income or loss.

Credit for Israeli Taxes Withheld. Any dividends paid by our company to a U.S.
Holder with respect to the ordinary shares generally will be treated for U.S.
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 the ordinary shares generally

                                    Page 70
will be eligible for credit against the U.S. Holder's U.S. 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 U.S. federal income taxes otherwise
payable with respect to such classes of income. Subject to the particular
circumstances of a U.S. Holder, dividends distributed by our company with
respect to ordinary shares generally will be classified as "passive income."

Alternatively, a U.S. Holder may elect to claim a U.S. tax deduction for 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. In addition, a non-corporate U.S. holder
may not 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 ordinary shares will be U.S.- source income or loss
for purposes of the U.S. federal foreign tax credit limitation. However, a U.S.
Holder who is also a U.S. Treaty Resident and who sells the ordinary shares in
Israel may elect to treat gain from the sale or other disposition of ordinary
shares as foreign-source income for purposes of the U.S. 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 ordinary
shares as a foreign-source for purposes of such tax credit limitation. U.S.
Holders should consult their own tax advisors regarding the application of the
U.S. federal foreign tax credit limitation to gain or loss recognized on the
disposition of 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 ordinary
shares.

PASSIVE FOREIGN INVESTMENT COMPANY STATUS

Generally a foreign 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 (U.S. or foreign) in which such corporation
is considered to own 25% or more of the ordinary shares 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 fair
market value of the assets of any company in which such corporation is
considered to own 25% or more of the ordinary shares 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 2001. 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 Internal
Revenue Service that address these questions, there is uncertainty with respect
to the appropriate method for implementing the asset test.

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Based upon an independent valuation of our assets, we believe that we were not a
PFIC during 2001. Based in part on advice from our professional advisors, we
believe that the total asset value method for such purpose is an appropriate
method, and under such method we were not a PFIC in 2001.

However, the U.S. Internal Revenue Service may disagree with this conclusion,
asserting that were characterized as a PFIC during 2001 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.

In view of this uncertainty and the complexity of the issues regarding our
treatment as a PFIC for 2001 and possibly for subsequent years, US holders are
urged to consult their own tax advisors for guidance. For those U.S. Holders
whose tax advisors believe that we were a PFIC for 2001 or for any subsequent
years and notify us in writing of their request for the information required to
effectuate the QEF Election described below, we will make such information
available to them.

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 neither a "QEF election" or
a "mark-to-market election" (as described below):

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

-     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;

-     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;

-     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, ordinary shares; and

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

                                    Page 72
shares in the corporation at any time during a year when the corporation was a
PFIC and who made neither a QEF election nor mark-to-market election (as
discussed below) with respect to such shares with their tax return that included
the last day of the corporation's first taxable year as 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 are deemed to be a PFIC for 2001, if a U.S. Holder makes a
valid QEF election with respect to ordinary shares:

-     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) net
      ordinary earnings as ordinary income and (ii) net capital gain as
      long-term capital gain, in each case computed under U.S. 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;

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

-     the U.S. Holder would not be required under these rules 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 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 warrants or rights 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.

Under certain circumstances, a U.S. Holder may also obtain treatment similar to
that afforded a shareholder who has made a timely QEF election by making an
election in a year subsequent to the first year during the U.S. Holder's holding
period that we are classified as a PFIC to treat such holder's interest as
subject to a deemed sale and recognizing gain, but not loss, on such deemed sale
in accordance with the general PFIC rules, including the interest charge
provisions, described above and thereafter treating such interest in VocalTec 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, an amount equal to the
difference between the shareholder'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

                                    Page 73
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 would not be subject
to deemed ratable allocations of gain, the interest charge, and the denial of
basis step-up at death described above. Subject to the ordinary shares ever
ceasing to be marketable, a mark-to-market election is irrevocable without
obtaining the consent of the IRS and would continue to apply even in years that
we are no longer a PFIC.

U.S. HOLDERS OF ORDINARY SHARES ARE URGED TO CONSULT THEIR TAX ADVISORS ABOUT
PFIC RULES, INCLUDING THE ADVISABILITY, PROCEDURE AND TIMING OF MAKING A QEF
ELECTION, IN CONNECTION WITH THEIR HOLDING OF ORDINARY SHARES, INCLUDING
WARRANTS OR RIGHTS TO ACQUIRE ORDINARY SHARES.

TAXATION OF NON-U.S. HOLDERS

Subject to the discussion below with respect to the U.S. backup withholding tax,
a non-U.S. Holder (i.e., any person other than a U.S. Holder) generally will not
be subject to U.S. federal income tax on dividends from our company, 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
U.S. trade or business, or 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, U.S. tax information reporting and
"backup withholding" of U.S. federal income tax at a 31% on dividends on, and
the proceeds of dispositions of, ordinary shares may apply to both U.S. and
non-U.S. Holders. Backup withholding will not apply, however, to a Holder who
furnishes a 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 U.S. backup
withholding rules will be allowed as a refund or credit against the U.S.
Holder's or non-U.S. Holder's U.S. federal income tax liability, provided the
required information is furnished to the IRS.

10F. DIVIDENDS AND PAYING AGENTS

Not applicable.

10G. STATEMENT BY EXPERTS

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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.

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:

                                    Page 75
FAIR MARKET VALUE ON DECEMBER 31, 2001
                      (IN THOUSANDS, EXCEPT INTEREST RATES)
DEC 31, 2001    FY 2002
                                                 ------------    -------
Total Portfolio                     18,356       18,356
                  Average Interest Rate                2.76%        2.76%
                  Average Duration (Month)              1.00         1.00
                  Cash Equivalents (up to three
                  months maturity)                    16,385
                  Average Interest Rate                2.74%
                  Short Term Investments
                  (three-twelve months maturity)       1,970
                  Average Interest Rate                2.96%
ITXC HOLDINGS

Our holdings in ITXC are presented in the balance sheet as of December 31, 2001
as follows: the portion of 1.8 million shares "available-for-sale" during 2002
is stated at fair market value which was $7.19 per share, representing a total
of $13.0 million and the restricted portion of the shares (2.8 million shares)
is presented at cost of $1.7 million. The fair market value of this portion of
the ITXC investment, as of December 31, 2001, was approximately $20 million. See
Item 5 for a detailed description of our shareholdings in ITXC Corp.

ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES

Not applicable.

                                     Page 76
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.    RESERVED

ITEM 16.    RESERVED

                                    Page 77
PART THREE

ITEM 17.    FINANCIAL STATEMENTS

Not applicable.

ITEM 18.    FINANCIAL STATEMENTS

            CONSOLIDATED FINANCIAL STATEMENTS AS OF DECEMBER 31, 2001

                                    CONTENTS
PAGE
                                                                    ----
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS                              2

CONSOLIDATED FINANCIAL STATEMENTS

  Consolidated Balance Sheets                                       3 - 4

  Consolidated Statements of Operations                               5

  Consolidated Statements of Shareholders' Equity and
    Comprehensive Income                                              6

  Consolidated Statements of Cash Flows                               7

  Notes to the Consolidated Financial Statements                   8 - 28
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 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. Herzliya lease, dated July 20, 1998, previously
            filed

                                    Page 78
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)   Lease Agreement Fort Lee Executive Park, by and between VocalTec
            Communications Inc. and Executive Park LLC., dated June 18, 1998,
            previously filed with the SEC on June 30, 2001 as Exhibit 4.1(f) to
            the Company's Annual Report on Form 20-F for the year ended December
            31, 2000, which is incorporated herein by reference.

8.    List of Subsidiaries.

                                   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.

Name:   Elon Ganor
        ------------------------

Title:  Chairman of the Board of
        Directors and CEO
        ------------------------

VOCALTEC COMMUNICATIONS LTD.

   June 27, 2002

                                    Page 79
VOCALTEC COMMUNICATIONS LTD.

                        CONSOLIDATED FINANCIAL STATEMENTS
                             AS OF DECEMBER 31, 2001
VOCALTEC COMMUNICATIONS LTD.

            CONSOLIDATED FINANCIAL STATEMENTS AS OF DECEMBER 31, 2001

                                    CONTENTS
PAGE
                                                                       ----
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS                                 2

CONSOLIDATED FINANCIAL STATEMENTS

  Consolidated Balance Sheets                                          3 - 4

  Consolidated Statements of Operations                                  5

  Consolidated Statements of Shareholders' Equity and
    Comprehensive Income                                                 6

  Consolidated Statements of Cash Flows                                  7

  Notes to the Consolidated Financial Statements                      8 - 28
# # # # # #
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To the Shareholders of
VocalTec Communications Ltd.:

We have audited the accompanying consolidated balance sheets of VocalTec
Communications Ltd. (an Israeli Corporation) and subsidiaries (the Company) as
of December 31, 2000 and 2001, and the related consolidated statements of
operations, shareholders' equity and comprehensive income and cash flows for
each of the three years in the period ended December 31, 2001. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.

We conducted our audits in accordance with auditing standards generally accepted
in the United States and in Israel, including those prescribed under the
Auditors' Regulations (Auditor's Mode of Performance), 1973. 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 VocalTec
Communications Ltd. and subsidiaries as of December 31, 2000 and 2001, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 2001, in conformity with accounting principles
generally accepted in the United States.

                                                      LUBOSHITZ KASIERER
                                                        Arthur Andersen

Tel-Aviv, Israel
January 22, 2002

                                      -2-
VOCALTEC COMMUNICATIONS LTD.

                           CONSOLIDATED BALANCE SHEETS
                In thousands of U.S. dollars (except share data)
DECEMBER 31
                                                                                        ---------------------
                                                                       NOTE             2000             2001
                                                                       ----             ----             ----
CURRENT ASSETS
  Cash and cash equivalents                                            (3)             17,473            9,860
  Short-term investments                                               (4)             31,673            8,496
  Trade receivables, net                                               (5)              8,372            5,406
  Other receivables                                                    (6)              3,879            2,502
  Inventories                                                                           5,424            3,608
                                                                                       ------           ------
  Total current assets                                                                 66,821           29,872
                                                                                       ------           ------

INVESTMENTS AND LONG-TERM DEPOSITS
  Investments in companies                                             (7)             14,620           14,912
  Bank deposits                                                                         1,000                -
  Deposits with insurance companies                                   (10)              1,636            1,757
                                                                                       ------           ------
                                                                                       17,256           16,669
                                                                                       ------           ------

EQUIPMENT, NET                                                         (8)              8,890            5,020
                                                                                       ------           ------

                                                                                       92,967           51,561
                                                                                       ======           ======
-3-
DECEMBER 31
                                                                        -----------
                                                         NOTE        2000         2001
                                                         ----        ----         ----
CURRENT LIABILITIES
  Accounts payable and accrued expenses                    (9)      24,148       12,755
                                                                   -------      -------

LONG-TERM LIABILITIES
  Deferred income taxes                                   (20)       4,356        4,745
  Accrued severance pay                                   (10)       2,093        2,832
                                                                   -------      -------
                                                                     6,449        7,577
                                                                   -------      -------

  Total liabilities                                                 30,597       20,332
                                                                   -------      -------

COMMITMENTS AND CONTINGENCIES                             (11)

SHAREHOLDERS' EQUITY
    Share capital                                         (12)
      Ordinary shares of NIS 0.01 par value:
       Authorized - 30,000,000 shares;
       Issued and outstanding - 12,127,058 shares                       36           36
       as of December 31, 2000 and 2001
    Additional paid-in capital                                      97,015       97,015
    Deferred share-based compensation                                  (97)         (38)
    Accumulated other comprehensive income                (21)       6,535        7,118
    Accumulated deficit                                            (41,119)     (72,902)
                                                                   -------      -------
  Total shareholders' equity                                        62,370       31,229
                                                                   -------      -------

                                                                    92,967       51,561
                                                                   =======      =======
-------------------------------------                   ------------------------
             ELON A. GANOR                                   HUGO GOLDMAN
 Chief Executive Officer and Chairman                   Chief Financial Officer
             of the Board

Date of approval:
January 22, 2002

       THE ACCOMPANYING NOTES FORM AN INTEGRAL PART OF THESE CONSOLIDATED
                             FINANCIAL STATEMENTS.

                                      -4-
VOCALTEC COMMUNICATIONS LTD.

                      CONSOLIDATED STATEMENTS OF OPERATIONS
         In thousands of U.S. dollars (except share and per share data)
YEAR ENDED DECEMBER 31
                                                                               ------------------------------------
                                                                NOTE           1999            2000            2001
                                                                ----           ----            ----            ----
Net sales                                                       (13)           26,615          41,971          28,413
                                                                              -------          ------         -------
Cost of sales
  Cost of goods sold                                            (14)            8,156          13,146          10,070
  Inventory write-off                                                               -               -           1,441
                                                                              -------          ------         -------
                                                                                8,156          13,146          11,511
                                                                              -------          ------         -------

       Gross profit                                                            18,459          28,825          16,902
                                                                              -------          ------         -------

Operating expenses:
  Research and development, net                                 (15)           13,157          11,270          11,039
  Marketing and selling, net                                    (16)           27,171          26,372          24,716
  General and administrative                                                    6,592           7,769           7,200
  Restructuring costs                                           (17)              827               -           2,073
                                                                              -------          ------         -------
       Total operating expenses                                                47,747          45,411          45,028
                                                                              -------          ------         -------

       Operating loss                                                         (29,288)        (16,586)        (28,126)

Other income, net                                                                   -          57,744             941
Financing income, net                                           (18)              902           3,184           1,872
                                                                              -------          ------         -------
       Income (loss) from continuing operations
         before income taxes                                                  (28,386)         44,342         (25,313)

Income taxes (tax benefit)                                      (20)                -           9,013            (292)
                                                                              -------          ------         -------
  Income (loss) from continuing operations                                    (28,386)         35,329         (25,021)

Discontinued operations:                                        (19)
  Loss from operations of discontinued segment                                      -          (6,493)         (4,403)
  Loss on disposal of segment                                                       -               -          (2,359)
                                                                              -------          ------         -------
      Net income (loss)                                                       (28,386)         28,836         (31,783)
                                                                              =======          ======         =======

Net basic income (loss) per ordinary share:
  Net income (loss) from continuing operations                                 (2.47)           2.92           (2.06)
  Loss from discontinued operations                                                 -          (0.53)          (0.56)
                                                                              -------          ------         -------
  Net income (loss)                                                            (2.47)           2.39           (2.62)
                                                                              =======          ======         =======

Net diluted income (loss) per ordinary share:
  Net income (loss) from continuing operations                                 (2.47)           2.67           (2.06)
  Loss from discontinued operations                                             -              (0.49)          (0.56)
                                                                              -------          ------         -------
  Net income (loss)                                                            (2.47)           2.18           (2.62)
                                                                              =======          ======         =======

Weighted average number of ordinary shares used
  in computing per share amounts (in thousands):
    Basic                                                                      11,498          12,082          12,127
                                                                              =======          ======         =======
    Diluted                                                                    11,498          13,252          12,127
                                                                              =======          ======         =======
THE ACCOMPANYING NOTES FORM AN INTEGRAL PART OF THESE CONSOLIDATED
                             FINANCIAL STATEMENTS.

                                      -5-
VOCALTEC COMMUNICATIONS LTD.

                    CONSOLIDATED STATEMENTS OF SHAREHOLDERS'
                         EQUITY AND COMPREHENSIVE INCOME
                In thousands of U.S. dollars (except share data)
NUMBER    SHARE    ADDITIONAL    DEFERRED     ACCUMULATED
                                            OF      CAPITAL   PAID-IN    COMPENSATION      OTHER
                                          SHARES              CAPITAL                  COMPREHENSIVE
                                                                                          INCOME
                                        ----------  ------   ----------  ------------  -------------
Balance as of January 1, 1999           11,413,420      35     92,696          (291)          --
Comprehensive Income:
  Net loss                                      --      --         --            --           --
  Unrealized gain from available-for-
    sale securities                             --      --         --            --       34,471

  Total comprehensive income                    --      --         --            --           --

Shares issued                              357,882      --      1,999            --           --
Deferred compensation                           --      --        177          (177)          --
Amortization of deferred compensation           --      --       (245)          280           --
                                        ----------      --     ------           ---       ------

Balance as of December 31, 1999         11,771,302      35     94,627          (188)      34,471
Comprehensive income:
  Net income                                    --      --         --            --           --
  Unrealized loss from available-for-
    sale securities net of
    reclassification adjustment                 --      --         --            --      (27,936)

  Total comprehensive income                    --      --         --            --           --

Shares issued                              355,756       1      2,388            --           --
Amortization of deferred compensation           --      --         --            91           --
                                        ----------      --     ------           ---       ------
Balance as of December 31, 2000         12,127,058      36     97,015           (97)       6,535
Comprehensive Income:
  Net loss                                      --      --         --            --           --
  Unrealized gain from available-for-
    sale securities net of
    reclassification adjustment
    (see disclosure)                            --      --         --            --          583

  Total comprehensive loss                      --      --         --            --           --

Amortization of deferred compensation           --      --         --            59           --
                                        ----------      --     ------           ---       ------
Balance as of December 31, 2001         12,127,058      36     97,015           (38)       7,118
                                        ==========      ==     ======           ===        =====
ACCUMULATED      TOTAL        TOTAL
                                            DEFICIT    COMPREHENSIVE
                                                          INCOME

                                          -----------  -------------    -----
Balance as of January 1, 1999               (41,569)                    50,871
Comprehensive Income:
  Net loss                                  (28,386)     (28,386)      (28,386)
  Unrealized gain from available-for-
    sale securities                              --       34,471        34,471
                                                         --------
  Total comprehensive income                     --        6,085
                                                         ========
Shares issued                                    --                      1,999
Deferred compensation                            --                         --
Amortization of deferred compensation            --                         35
                                             ------                     ------

Balance as of December 31, 1999             (69,955)                    58,990
Comprehensive income:
  Net income                                 28,836       28,836        28,836
  Unrealized loss from available-for-
    sale securities net of
    reclassification adjustment                  --      (27,936)      (27,936)
                                                         --------
  Total comprehensive income                     --          900
                                                         ========
Shares issued                                    --                      2,389
Amortization of deferred compensation            --                         91
                                             ------                     ------
Balance as of December 31, 2000             (41,119)                    62,370
Comprehensive Income:
  Net loss                                  (31,783)     (31,783)      (31,783)
  Unrealized gain from available-for-
    sale securities net of
    reclassification adjustment
    (see disclosure)                             --          583           583
                                                         --------
  Total comprehensive loss                       --      (31,200)
                                                         ========
Amortization of deferred compensation            --                         59
                                             ------                     ------
Balance as of December 31, 2001             (72,902)                    31,229
                                            =======                     ======
THE ACCOMPANYING NOTES FORM AN INTEGRAL PART OF THESE CONSOLIDATED
                             FINANCIAL STATEMENTS.

                                      -6-
VOCALTEC COMMUNICATIONS LTD.

                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                          In thousands of U.S. dollars
YEAR ENDED DECEMBER 31
                                                                               ---------------------------------
                                                                                 1999         2000         2001
                                                                               -------      -------      -------
CASH FLOWS FROM OPERATING ACTIVITIES
  Net income (loss)                                                            (28,386)      28,836      (31,783)
  Adjustments to reconcile net income (loss) to net cash used in operating
    activities -
      Expenses not affecting operating cash flows:
       Decline in value of investments                                              --           --        1,290
       Loss on disposal of segment                                                  --           --        1,758
       Amortization of deferred compensation                                        35           91           59
       Severance pay, net                                                          303           25          618
       Depreciation                                                              3,584        3,409        3,867
       Gain on sale of ITXC shares                                                  --      (60,744)        (941)
       Other                                                                        24           --           36
      Changes in operating assets and liabilities:
       Decrease (increase) in trade receivables, net                             2,849       (2,209)       2,966
       Decrease (increase) in other receivables                                    254         (811)       1,377
       Decrease (increase) in inventories                                           51       (3,822)       1,816
       Increase (decrease) in accounts payable and accrued expenses                653       15,645      (11,393)
                                                                               -------      -------      -------
         Net cash used in operating activities                                 (20,633)     (19,580)     (30,330)
                                                                               -------      -------      -------

CASH FLOWS FROM INVESTING ACTIVITIES
  Short-term investments, net                                                   29,644      (29,943)      23,177
  Proceeds from sale of investment in  ITXC                                         --       61,217        1,049
  Investment in companies                                                       (1,000)        (828)        (718)
  Purchase of equipment                                                         (3,228)      (6,680)      (1,797)
  Proceeds from sale of equipment                                                  143           --            6
  Long-term bank deposits                                                           --       (1,000)       1,000
                                                                               -------      -------      -------
         Net cash provided by (used in) investing activities                    25,559       22,766       22,717
                                                                               -------      -------      -------

CASH FLOWS FROM FINANCING ACTIVITIES
  Long-term bank loans received from (repaid to) banks                          20,000      (20,017)          --
  Proceeds from options exercised                                                1,999        2,389           --
                                                                               -------      -------      -------
         Net cash provided by financing activities                              21,999      (17,628)          --
                                                                               -------      -------      -------

INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS                                26,925      (14,442)      (7,613)
CASH AND CASH EQUIVALENTS AT  BEGINNING OF YEAR                                  4,990       31,915       17,473
                                                                               -------      -------      -------
CASH AND CASH EQUIVALENTS AT END OF YEAR                                        31,915       17,473        9,860
                                                                               =======      =======      =======

NON-CASH ACTIVITY

  Unrealized gain (loss) from available-for-sale securities, net                34,471      (27,936)         583
                                                                               =======      =======      =======

SUPPLEMENTAL CASH FLOWS INFORMATION:
  Cash paid for income taxes                                                        --        6,381           45
                                                                               =======      =======      =======
THE ACCOMPANYING NOTES FORM AN INTEGRAL PART OF THESE CONSOLIDATED
                             FINANCIAL STATEMENTS.

                                      -7-
VOCALTEC COMMUNICATIONS LTD.

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

NOTE 1   -    GENERAL

              A.     The Company, an Israeli corporation, is a leading supplier
                     of Internet Telephony solutions, credited with launching
                     the VOIP (Voice Over Internet Protocol) industry in 1995.
                     The core business of the company is providing turnkey IP
                     (Internet Protocol) telephony solutions to service
                     providers.

              B.     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 in non-Israeli currencies (mainly
                     the U.S. dollar). A majority of the costs and expenses are
                     incurred outside Israel in non-Israeli currencies,
                     primarily in U.S. dollars. Thus, the functional currency of
                     the Company is the U.S. dollar.

                     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 (which are immaterial for each reported period) are
                     reflected in the statement of operations. The
                     representative rate of exchange at December 31, 2001 was
                     U.S. $1.00 - 4.416 New Israeli Shekel (NIS) (2000 and 1999
                     - NIS 4.041 and NIS 4.153, respectively).

                                      -8-
VOCALTEC COMMUNICATIONS LTD.

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

NOTE 2   -    SIGNIFICANT ACCOUNTING POLICIES

              The financial statements have been prepared in conformity with
              accounting principles generally accepted in the United States. The
              significant accounting policies followed in the preparation of the
              financial statements, applied on a consistent basis, are as
              follows:

              A.     PRINCIPLES OF CONSOLIDATION

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

              B.     CASH AND CASH EQUIVALENTS

                     For the purpose of the statements of cash flows, all highly
                     liquid investments are considered cash equivalents if the
                     investments mature within three months from the date of
                     acquisition.

              C.     INVENTORIES

                     Inventories, consisting principally of components, are
                     stated at the lower of cost or market. Inventory cost is
                     determined by the average - cost method.

              D.     ALLOWANCE FOR DOUBTFUL ACCOUNTS

                     Allowance for doubtful accounts is computed for specific
                     accounts the collectibility of which is doubtful and based
                     upon the Company's experience.

                                      -9-
VOCALTEC COMMUNICATIONS LTD.

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

NOTE 2   -    ACCOUNTING POLICIES (CONT.)

              E.     FAIR VALUE OF FINANCIAL INSTRUMENTS

                     The carrying amount of cash and cash equivalents, trade
                     receivables, other receivables, credit from banks and
                     others, liabilities to suppliers and others are equivalent
                     to, or approximate their fair value due to the short-term
                     maturity of these instruments.

              F.     INVESTMENT IN COMPANIES

                     The non-restricted portion of an investment in a
                     publicly-traded company which is available-for-sale is
                     recorded at fair market value in accordance with Statement
                     of Financial Accounting Standards ("SFAS") No. 115
                     "Accounting for Certain Investments in Debt and Equity
                     Securities". The difference between the fair market value
                     and cost (unrealized gain) is included as a separate
                     component of comprehensive income.

                     Investments in private companies and the restricted portion
                     of the investment in the above mentioned publicly traded
                     company are stated at cost less write-down for any declines
                     in value which is other than temporary, if applicable.

              G.     EQUIPMENT

                     Equipment is stated at cost. Depreciation is computed by
                     the straight-line method over the estimated useful life of
                     the assets.

              H.     RESEARCH AND DEVELOPMENT COSTS

                     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
                     operations as incurred. Software development costs are
                     considered for capitalization when technological
                     feasibility is established in accordance with SFAS 86,
                     "Accounting for the Costs of Computer Software to be Sold,
                     Leased or Otherwise Marketed." Costs incurred subsequent to
                     achievement of technological feasibility in the process of
                     software production have not been material. Therefore, the
                     Company has not capitalized any of its research and
                     development expenses and does not anticipate that its
                     development process will differ materially in the future.

                                      -10-
VOCALTEC COMMUNICATIONS LTD.

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

NOTE 2   -    ACCOUNTING POLICIES (CONT.)

              I.     INCOME TAXES

                     The Company accounts for income taxes under the liability
                     method of accounting. Under the liability method, deferred
                     taxes are determined based on the differences between the
                     financial statement and tax bases of assets and liabilities
                     at enacted tax rates in effect in the year in which the
                     differences are expected to reverse. Valuation allowances
                     are established, when necessary, to reduce deferred tax
                     assets to amounts expected to be realized.

              J.     REVENUE RECOGNITION

                     Revenues from products are generally recognized upon
                     delivery, provided there is persuasive evidence of an
                     agreement, the fee is fixed or determinable and collection
                     of the related receivable is probable. Amounts received
                     where revenue recognition criteria have not been fully met,
                     and thus the revenue is not yet earned, are reflected as
                     deferred revenue. Amounts billed where revenue recognition
                     criteria have not been fully met, and thus revenue is not
                     yet earned, are reflected as allowance for unrecognized
                     income and netted with the related trade receivables.

                     Revenue from maintenance contracts is recognized ratably
                     over the term of the maintenance contract. Revenues related
                     to services are recognized as the services are rendered.

              K.     SHARE-BASED COMPENSATION

                     The Company has adopted the disclosure provisions of SFAS
                     No. 123, "Accounting for Stock-Based Compensation," and the
                     accounting rules set forth in Accounting Principles Board
                     ("APB") Opinion 25, "Accounting for Stock Issued to
                     Employees" including the FASB issued interpretation No. 44,
                     "Accounting for Certain Transactions Involving Stock
                     Compensation an interpretation of APB 25." The Company has
                     provided the necessary pro forma disclosures as if the fair
                     value method had been applied (See Note 12).

                                      -11-
VOCALTEC COMMUNICATIONS LTD.

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

NOTE 2   -    ACCOUNTING POLICIES (CONT.)

              L.     NET INCOME (LOSS) PER SHARE

                     The Company computes net income (loss) per share in
                     accordance with SFAS No. 128, "Earnings per Share". Under
                     the provisions of SFAS No. 128, basic net income (loss) per
                     share ("Basic EPS") is computed by dividing net income
                     (loss) by the weighted average number of ordinary shares
                     outstanding. Diluted net income (loss) per share ("Diluted
                     EPS") is computed by dividing net income (loss) by the
                     weighted average number of shares and dilutive share
                     equivalents then outstanding. The total number of shares
                     related to the outstanding options excluded from the
                     calculations of diluted net loss per share were 2,879,943
                     and 2,069,114 for the years ended December 31, 1999 and
                     2001, respectively. A reconciliation between the numerator
                     and denominator of Basic EPS and Diluted EPS for the year
                     ended December 31, 2000, follows:
Net Income                                                              28,836
                    Basic:
                      Weighted average shares used in computing
                        basic net income per share                                      12,081,598
                                                                                        ==========

                    Basic net income per share                                                2.39
                                                                                        ==========

                    Diluted:
                      Shares used above                                                 12,081,598
                      Adjustment to reflect weighted effect of diluted
                        shares due to share options                                      1,170,279
                                                                                        ----------
                                                                                        13,251,877
                                                                                        ==========

                    Diluted net income per share                                              2.18
                                                                                        ==========
M.     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 reported amounts of assets and liabilities and
                     disclosure of contingent assets and liabilities at the date
                     of the financial statements and the reported amounts of
                     revenues and expenses during the reporting period. Actual
                     results could differ from those estimates.

                                      -12-
VOCALTEC COMMUNICATIONS LTD.

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

NOTE 2   -    ACCOUNTING POLICIES (CONT.)

              N.     RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

                     In July 2001, the Financial Accounting Standards Board
                     issued Statements of Financial Accounting Standards No.
                     141, Business Combinations ("SFAS 141") and No. 142,
                     Goodwill and Other Intangible Assets ("SFAS 142"). SFAS 141
                     requires all business combinations initiated after June 30,
                     2001, to be accounted for using the purchase method. Under
                     SFAS 142, goodwill and intangible assets with indefinite
                     lives are no longer amortized but are reviewed annually (or
                     more frequently if impairment indicators arise) for
                     impairment. All other intangible assets will continue to be
                     amortized over their estimated useful lives. The
                     amortization provisions of SFAS 142 apply to goodwill and
                     intangible assets acquired after June 30, 2001. With
                     respect to goodwill and intangible assets acquired prior to
                     July 1, 2001, the Company is required to adopt SFAS 142
                     effective January 1, 2002. The adoption of SFAS No. 142
                     will not have a material effect on the Company's
                     consolidated financial statements.

                     In August 2001, the Financial Accounting Standards Board
                     issued Statement of Financial Accounting Standards No. 144,
                     Accounting for the Impairment or Disposal of Long-Lived
                     Assets ("SFAS 144"). Although SFAS 144 supersedes FASB
                     Statement No. 121, it retains the requirements of SFAS 121
                     regarding recognition of impairment loss for long-lived
                     assets to be held and used (based on undiscounted cash
                     flows) and resolves certain implementation issues. Also,
                     the accounting model used in SFAS 121 for long-lived assets
                     to be disposed of by sale (lower of carrying amount or fair
                     value less cost to sell) is broadened by SFAS 144 to
                     include discontinued operations and supersedes APB Opinion
                     No. 30. Therefore, discontinued operations will no longer
                     be measured on a net realizable value basis and future
                     operating losses will no longer be recognized before they
                     occur. SFAS 144 also broadens the presentation of
                     discontinued operations to include a component of an entity
                     (rather than a segment of a business). The provisions of
                     SFAS 144 are effective for financial statements issued for
                     fiscal years beginning after December 15, 2001, and interim
                     periods within those years. The Company believes that the
                     adoption of SFAS 144 will not have a material impact on the
                     Company's consolidated financial statements.

                                      -13-
VOCALTEC COMMUNICATIONS LTD.

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

NOTE 2   -    ACCOUNTING POLICIES (CONT.)

              O.  DERIVATIVE FINANCIAL INSTRUMENTS

                     Effective January 1, 2001, the Company adopted Statement of
                     Financial Accounting Standards ("SFAS") No. 133 "Accounting
                     for Derivative Instruments and Hedging Activities". The
                     Company's derivative financial instruments consist of
                     foreign currency forward exchange and option contracts.
                     These contracts are utilized by the Company, from time to
                     time, to manage risk exposure to movements in foreign
                     exchange rates. None of these contracts have been
                     designated as hedging instruments. These contracts are
                     recognized as assets or liabilities on the balance sheet at
                     their fair value, which is the estimated amount at which
                     they could be settled based on market prices or dealer
                     quotes, where available, or based on pricing models.
                     Changes in fair value are recognized currently in earnings.
                     The adoption of SFAS No. 133 had no material impact on
                     reported earning for the year ended December 31, 2001.

NOTE 3   -    CASH AND CASH EQUIVALENTS
DECEMBER 31
                                                                -----------
                                                             2000          2001
                                                             ----          ----
Cash in banks                                   4,532         4,159
             Bank deposits                                  12,941         5,701 (*)
                                                            ------         -----
                                                            17,473         9,860
                                                            ======         =====
(*) Mainly bearing annual interest of 1.9% to 5.3%.

NOTE 4   -    SHORT-TERM INVESTMENTS
DECEMBER 31
                                                                2000          2001
                                                                ----          ----
Bank deposits                                     31,673         3,000 (*)
             Commercial papers                                     --         5,496
                                                               ------         -----
                                                               31,673         8,496
                                                               ======         =====
(*) Mainly bearing annual interest of 2.4% to 7.0%.

                                      -14-
VOCALTEC COMMUNICATIONS LTD.

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

NOTE 5   -    TRADE RECEIVABLES, NET
DECEMBER 31
                                                      -----------
                                                    2000       2001
                                                   ------     ------
Trade Receivables                     18,242     12,559
             Less -
               Allowance for doubtful accounts      1,122      2,077
               Unrecognized revenue                 8,748      5,076
                                                   ------     ------
                                                    8,372      5,406
                                                   ======     ======
NOTE 6   -    OTHER RECEIVABLES
DECEMBER 31
                                                           -----------
                                                          2000      2001
                                                         -----     -----
Prepaid expenses                            1,169       664
             Government participation receivables          590       285
             Accrued interest                              950       184
             Government institute receivable               473       346
             Other                                         697     1,023
                                                         -----     -----
                                                         3,879     2,502
                                                         =====     =====
-15-
VOCALTEC COMMUNICATIONS LTD.

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

NOTE 7   -    INVESTMENTS IN COMPANIES
DECEMBER 31
                                                                  -----------
                                                             2000             2001
                                                             ----             ----
ITXC                                           13,792           14,656
             Other                                             828              256
                                                            ------           ------
                                                            14,620           14,912
                                                            ======           ======
The Company, through its wholly owned U.S. subsidiary, has 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 the net amount
              of $61,217 and recorded a net gain of $60,744 (see Note 18). In
              November 2001, the Company sold 180,000 shares of ITXC in the
              amount of $1,049 and recorded a gain of $941 (see Note 18). The
              Company's remaining investment in ITXC is subject to Rule 144
              under the Securities Act of 1933 which restricts the number of
              shares of ITXC that the Company may sell during specified future
              periods. As of December 31, 2000 and 2001, the portion of the
              Company's investment in ITXC which is not restricted is classified
              as "available-for-sale" and stated at fair market value. The
              remaining shares are presented at cost. Income tax expenses are
              deducted from the unrealized gain on available-for-sale
              securities. The investment in ITXC is presented in the balance
              sheet as follows:
DECEMBER 31
                                                                                      -----------
                                                                                2000             2001
                                                                                ----             ----
At fair market value (*)                                          11,933           12,955
             At cost (fair market value at
               December 31, 2001 - $20,177)                                     1,859            1,701
                                                                               ------           ------
                                                                               13,792           14,656
                                                                               ======           ======

             (*)  Includes unrealized gains                                    10,891           11,864
                                                                               ======           ======
-16-
VOCALTEC COMMUNICATIONS LTD.

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

NOTE 8   -    EQUIPMENT, NET
ANNUAL
                                                              RATES OF                  DECEMBER 31
                                                                                        -----------
                                                            DEPRECIATION             2000           2001
                                                            ------------             ----           ----
Computers and related equipment                   25-33%               15,446         13,120
             Office furniture, equipment and
               leasehold improvements                          7-25%                 2,773          2,611
                                                                                    ------         ------
                                                                                    18,219         15,731
             Less - accumulated depreciation                                         9,329         10,711
                                                                                    ------         ------
             Net book value                                                          8,890          5,020
                                                                                    ======         ======
The majority of property, plant and equipment is located in
              Israel.

              For the years ended December 31, 1999, 2000 and 2001, depreciation
              expense was approximately $3,584, $3,409 and $3,867, respectively.

NOTE 9   -    ACCOUNTS PAYABLE AND ACCRUED EXPENSES
DECEMBER 31
                                                                   -----------
                                                               2000           2001
                                                               ----           ----
Suppliers                                         8,225          5,093
             Employees and related expenses                    7,427          2,003
             Income taxes payable                              2,632          2,046
             Other (mainly accrued expenses)                   5,864          3,613
                                                              ------         ------
                                                              24,148         12,755
                                                              ======         ======
NOTE 10  -    SEVERANCE PAY

              The Company's severance pay obligation to its employees is
              partially covered by payments to insurance companies. The accrual
              for severance pay and deposits with insurance companies in respect
              of severance pay are included in the balance sheet. Severance pay
              expenses, amounted to $537, $213 and $1,338 for the years ended
              December 31, 1999, 2000 and 2001, respectively.

                                      -17-
VOCALTEC COMMUNICATIONS LTD.

             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, the
                     Company received and accrued participation payments from
                     the Office of the Chief Scientist of the Ministry of
                     Industry and Trade in Israel in the total amount of
                     approximately $6.4 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 (for
                     grants received under programs approved subsequent to
                     January 1, 1999, 100% plus interest at LIBOR). The
                     Company's total commitment for royalties payable with
                     respect to future sales, based on Government of Israel
                     participations received or accrued, net of royalties paid
                     or accrued, totaled approximately $4.3 million as of
                     December 31, 2001.

              B.     Certain claims, mainly for patent infringement and breach
                     of contract have been made against the Company or its U.S.
                     subsidiary. Management estimates that these claims will not
                     have a material effect upon the Company's consolidated
                     financial position or results of operations.

              C.     The Company's facilities in Israel and in the United States
                     are rented under operating leases with periods ending June
                     2002 for facilities in Israel and July 2003 for facilities
                     in the United States (some with renewal options). Rent
                     expenses amounted to $1,328, $1,446 and $1,390 for the
                     years ended December 31, 1999, 2000 and 2001, respectively.
                     Annual minimum future rental payments at balance sheet date
                     are approximately as follows:
2002                                                     962
                    2003                                                     177
                                                                           -----
                                                                           1,139
                                                                           =====
-18-
VOCALTEC COMMUNICATIONS LTD.

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

NOTE 12  -    SHARE CAPITAL

              Through December 31, 2001, 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. Options generally become exercisable within two
              to four years from the date of the grant. Options were granted at
              varying prices ranging from $0 to the fair market value at the
              date of the grant.

              In 1998, 1999, 2000 and 2001, the Company adopted stock option and
              incentive plans (the "Option Plans") which provides for the grant
              by the Company of restricted shares or 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 plan will expire 10 years after its adoption
              unless terminated earlier by the Board of Directors. The exercise
              price of stock options issued under the Option Plan will be no
              less than 95% of the fair market value of the Ordinary Shares as
              of the date of grant.

              The Ordinary Shares acquired upon exercise of an option and the
              restricted shares will be subject to certain restrictions on
              transfer, sale or hypothecation. Options will be exercisable and
              restrictions on deposition of shares will lapse pursuant to the
              terms of the individual agreements under which such options were
              granted or shares issued.

              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 pursuant to the terms of
              the Company's stock option plans. The exercise price of these new
              options will be equal to the fair market value of the Company's
              ordinary shares as reported by NASDAQ on the date the options will
              be granted, which will be at least 186 days following the
              cancellation of the previous options, but no later than February
              23, 2002. 922,387 options were cancelled under this program.

                                      -19-
VOCALTEC COMMUNICATIONS LTD.

             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 the
              three years ended December 31, 2001 are summarized as follows:
WEIGHTED         WEIGHTED
                                                                             AVERAGE        AVERAGE FAIR
                                                                             EXERCISE         VALUE OF
                                                           NUMBER OF          PRICE            OPTIONS
                                                            SHARES          PER SHARE          GRANTED
                                                            ------          ---------          -------
Outstanding January 1, 1999                    2,007,575

               Granted                                      1,775,950        $ 10.92            $6.00
               Exercised                                     (357,882)       $  6.23
               Forfeited                                     (545,700)       $  7.66
                                                            ---------

             Outstanding December 31, 1999                  2,879,943

               Granted                                        975,400        $ 12.32            $9.31
               Exercised                                     (355,756)       $  6.24
               Forfeited                                     (430,444)       $  9.36
                                                            ---------

             Outstanding December 31, 2000                  3,069,143

               Granted                                        795,650        $  4.37            $1.83
               Exercised                                           --             --
               Forfeited                                   (1,821,216)       $ 10.67
                                                            ---------

             Outstanding December 31, 2001                  2,043,577        $  7.01
                                                            =========
-20-
VOCALTEC COMMUNICATIONS LTD.

             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, 2001:
OPTIONS OUTSTANDING                             OPTIONS EXERCISABLE
                              ----------------------------------------------------------   --------------------------------------
     RANGE OF EXERCISE        NUMBER OUTSTANDING     WEIGHTED-AVERAGE        WEIGHTED            NUMBER              WEIGHTED
           PRICES               AT DECEMBER 31,          REMAINING            AVERAGE        OUTSTANDING AT           AVERAGE
                                     2001            CONTRACTUAL LIFE     EXERCISE PRICES  DECEMBER 31, 2001      EXERCISE PRICES
             $                                            (YEARS)                $                                        $
     -----------------        ------------------     ----------------     ---------------  -----------------      ---------------
0.00                                  7,500                  3.00               0.00               7,500           0.00
     1.50-1.58                           101,594                  9.5                1.53              30,623           1.53
     3.56-3.75                           319,300                  9.25               3.66              18,750           3.56
     3.95-4.88                           410,275                  4.72               4.01             338,525           4.00
     6.29-6.65                           139,962                  5.50               6.65             117,462           6.65
     6.76-7.12                            68,272                  8.25               6.99              14,500           7.00
     7.13-7.50                           298,750                  6.50               7.42             227,000           7.41
     8.19-8.63                           210,384                  8.75               8.35              68,902           8.34
     8.96-9.43                            94,169                  7.50               9.18              63,724           9.19
     10.45-11.00                          72,000                  7.50              10.50              61,500          10.48
     11.50-11.83(*)                       68,000                  7.75              11.73              44,000          11.76
     12.83-14.00                         183,371                  8.00              13.16             108,924          13.16
     15.20-16.00                          45,000                  8.00              15.91              22,500          15.82
     17.25                                25,000                  8.00              17.25               7,810          17.25
                                       ---------                                                    ---------
                                       2,043,577                                                    1,131,720
                                       =========                                                    =========
(*)    Includes 28,000 options granted to Consultants in 1999 for whom
              deferred compensation in the amount of $177 was calculated based
              on the fair value of the options on the date granted using the
              Black-Scholes option-pricing model. Under SFAS No. 123 the
              compensation cost that has been charged to operations for the year
              ended December 31, 2001 amounted to $59 (2000 - $44, 1999 - $8).

                                      -21-
VOCALTEC COMMUNICATIONS LTD.

             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 aggregate amount of deferred compensation related to
                     options granted to employees, officers and directors
                     recorded arising from the difference between the exercise
                     price and the fair market value on the date of the grant of
                     $772 is included in shareholders' equity and is being
                     amortized over the vesting periods of the respective
                     options in accordance with APB 25. The balance of
                     unamortized compensation at December 31, 2001 is $38. Under
                     APB 25 no compensation cost has been charged to operations
                     for the year ended December 31, 2001 (2000 - $47, 1999 -
                     $27).

                     If compensation cost had been determined under the
                     alternative fair value accounting method provided Under
                     FASB Statement No. 123, "Accounting for Stock-Based
                     Compensation", the Company's net income (loss) and basic
                     and diluted net income (loss) per share would have been
                     decreased (increased) to the following pro forma amounts:
FOR THE YEAR ENDED DECEMBER 31
                                                              ------------------------------
                                                           1999             2000              2001
                                                           ----             ----              ----
Net income (loss):
               As reported                               (28,386)          28,836          (31,783)
               Pro forma                                 (30,657)          24,630          (34,141)

             Basic net income (loss) per share:
                 As reported                               (2.47)            2.39            (2.62)
                 Pro forma                                 (2.67)            2.04            (2.82)

             Diluted net income (loss) per share:
                 As reported                               (2.47)            2.18            (2.62)
                 Pro forma                                 (2.67)            1.86            (2.82)
Under SFAS 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
              1999, 2000 and 2001: (1) expected life of the option of 2.2 years
              (1999 - 2.5, 2000 - 2.1); (2) dividend yield of 0% (1999, 2000 -
              same); (3) expected volatility of 68% (1999 - 95%, 2000 - 159%),
              (4) risk-free interest rate of 1.75% (1999 and 2000 - 5%).

                                      -22-
VOCALTEC COMMUNICATIONS LTD.

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

NOTE 13  -    NET SALES
YEAR ENDED DECEMBER 31
                                                                                ----------------------
                                                                           1999           2000           2001
                                                                           ----           ----           ----
The Company's sales by geographic areas are as follows:
                 Europe                                                  16,687          18,152         10,737
                 North America (principally
                   United States)                                         3,556           8,194          9,471
                 Far East                                                 5,573           8,058          6,661
                 Israel                                                     433           4,611          1,026
                 Other                                                      366           2,956            518
                                                                         ------          ------         ------
                                                                         26,615          41,971         28,413
                                                                         ======          ======         ======

                                                                            %               %              %
                                                                         ------          ------         ------
             Sales to a single customer exceeding 10%:
                 Customer A                                                  49              29            (*)
                 Customer B                                                   -              15             25
                 Customer C                                                 (*)              11            (*)
(*)   Less than 10%

NOTE 14  -    COST OF SALES
YEAR ENDED DECEMBER 31
                                                                         ----------------------
                                                                   1999           2000           2001
                                                                   ----           ----           ----
Cost of sales include royalties to
               the Government of Israel                             219            716            834
                                                                   ====           ====           ====
NOTE 15  -    RESEARCH AND DEVELOPMENT, NET
YEAR ENDED DECEMBER 31
                                                                            ----------------------
                                                                     1999           2000            2001
                                                                     ----           ----            ----
Payroll and related expenses                           10,055          7,665          7,747
             Subcontractors and other expenses                       5,190          5,809          5,908
                                                                    ------         ------         ------
                                                                    15,245         13,471         13,655
             Less - participations by the Government of Israel:
                 Royalty bearing participation                       1,316          2,009          2,457
                 Other participation                                   772            192            159
                                                                    ------         ------         ------
                                                                    13,157         11,270         11,039
                                                                   =======        =======        =======
-23-
VOCALTEC COMMUNICATIONS LTD.

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

NOTE 16  -    MARKETING AND SELLING, NET
YEAR ENDED DECEMBER 31
                                                                         ----------------------
                                                                   1999           2000           2001
                                                                   ----           ----           ----
Includes allowance for bad and
               doubtful accounts                                  2,637            187            698
                                                                  =====            ===            ===
NOTE 17   -   RESTRUCTURING COSTS

              In April 2001 and June 2001, the Board of Directors approved cost
              reduction plans. The cost reduction plan provide for the
              termination of up to approximately one hundred and twenty
              employees. Restructuring charges of $2,073 were expensed during
              the year ended December 31, 2001. This charge is comprised of
              $1,472 relating to involuntary employee terminations and $601
              relating to other exit costs (mainly facilities related expenses).

              Components of the restructuring charge and for the year ended
              December 31, 2001 amounts paid during the period and the remaining
              accrued liability as of December 31, 2001, are as follows:
RESTRUCTURING                        ACCRUED
                                                           CHARGE           PAYMENTS        LIABILITY
                                                           ------           --------        ---------
Employee terminations                         1,472             1,472              --
             Other exit costs                                601               376             225
                                                           -----             -----             ---
                                                           2,073             1,848             225
                                                           =====             =====             ===
NOTE 18   -   OTHER INCOME, NET
YEAR ENDED DECEMBER 31
                                                                            ----------------------
                                                                     1999         2000            2001
                                                                     ----         ----            ----
Net gain on sale of ITXC shares                           --        60,744            941
             Provision for decline in value of
               Investments                                             --            --         (1,296)
             Other                                                     --        (3,000)         1,296
                                                                     ----        ------          -----
                                                                       --        57,744            941
                                                                     ====        ======          =====
-24-
VOCALTEC COMMUNICATIONS LTD.

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

NOTE 19  -    DISCONTINUED OPERATIONS

              On June 7, 2001, a wholly-owned subsidiary, TrulyGlobal Inc.
              ("TrulyGlobal"), ceased operations after having been unsuccessful
              in obtaining external financing. A core group of TrulyGlobal
              software engineers were integrated into VocalTec's core
              development group to enable VocalTec to retain the TrulyGlobal
              technology and know-how. After the disposal date, the Company
              incurred shutdown costs of approximately $0.6 million for
              termination and other operating expenses, plus an approximately
              $1.8 million write-off of net fixed assets. As of December 31,
              2001 no significant assets or liabilities of TrulyGlobal were
              remaining.

              The Company's consolidated financial statements have been
              reclassified to reflect TrulyGlobal as a discontinued operation
              for all periods presented.

NOTE 20  -    TAXES ON INCOME

              A.     The Company is subject to the Income Tax Law (Inflationary
                     Adjustments), 1985, measuring income on the basis of
                     changes in the Israeli Consumer Price Index.

              B.     The Company's investment in equipment in the amount of
                     approximately $1,065 has received approval in accordance
                     with the Law for the Encouragement of Capital Investments,
                     1959 ("approved enterprise" status). The Company has chosen
                     to receive its benefits through the "Alternative Benefits"
                     program, and, as such, is eligible for various benefits.
                     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. The benefits are
                     subject to the fulfillment of the conditions of the letter
                     of approval. As the Company has not yet reported any
                     taxable income, the benefits period has not yet commenced.

                                      -25-
VOCALTEC COMMUNICATIONS LTD.

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

NOTE 20  -    TAXES ON INCOME (CONT.)

                     The regular tax rate applicable to the Company is 36%.
                     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.
                     Dividends paid by the Company out of regular income are
                     liable to 25% withholding at source. Dividends paid out of
                     the approved plan income are liable to 15% withholding at
                     source. Should the Company pay dividends out of income
                     earned during the two-year tax holiday, it will be liable
                     to 25% tax on that income (or lower rate depending on the
                     rate of foreign share ownership).

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

              D.     VocalTec Ltd. has net operating loss carryforwards for tax
                     purposes of approximately $54 million as of December 31,
                     2001 which may be carried forward indefinitely. VocalTec
                     Inc., which is subject to U.S. income taxes, has a loss for
                     tax purposes of approximately $6 million as of December 31,
                     2001. Under certain conditions this loss can be carried
                     against previous tax payments of VocalTec Inc., or can be
                     carried forward until the year 2021. Due to the uncertainty
                     of realizing the benefit of the loss carryforwards, a
                     valuation allowance for the entire deferred tax assets has
                     been recorded. Deferred taxes in respect of other temporary
                     differences are immaterial.

              E.     The subsidiaries VocalTec Inc. and TrulyGlobal Inc. are in
                     the process of merger. If the companies will merger,
                     TrulyGlobal Inc. operating loss for tax purposes will be
                     added to VocalTec Inc. operating loss for tax purposes.

              F.     Income taxes (tax benefit) in 2000 and 2001 are mainly in
                     respect of the gain on sale of ITXC shares in the U.S.
                     subsidiary, after deduction of net operating loss
                     carryforwards for tax purposes.

              G.     Deferred income taxes are in respect of unrealized gain
                     from available-for-sale shares of ITXC held by the U.S.
                     subsidiary. The change in deferred taxes is reflected in
                     accumulated other comprehensive income in the statement of
                     shareholders' equity and comprehensive income.

                                      -26-
VOCALTEC COMMUNICATIONS LTD.

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

NOTE 20 -     TAXES ON INCOME (CONT.)

       H.     Income (loss) from continuing operations before income taxes (tax
              benefit) is comprised as follows:
FOR THE YEAR ENDED DECEMBER 31
                                                                        ------------------------------
                                                                      1999           2000           2001
                                                                      ----           ----           ----
Israel                                          (11,335)       (9,705)        (20,550)
                    Foreign                                         (17,051)       54,047          (4,763)
                                                                    -------        ------         -------
                                                                    (28,386)       44,342         (25,313)
                                                                    =======        ======         =======
NOTE 21-      ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)
FOR THE YEAR ENDED DECEMBER 31
                                                                     ------------------------------
                                                                   1999          2000            2001
                                                                   ----          ----            ----
Unrealized gain (loss) on available-
              for-sale securities during the period,
              net of tax                                          34,471        (2,190)          1,147
              Less - reclassification adjustment
                for gain included in net income                       --       (25,746)           (564)
                                                                  ------       -------           -----
              Net unrealized gain (loss) on
                available-for-sale securities                     34,471       (27,936)            583
                                                                  ======       =======           =====
NOTE 22 -     RELATED PARTIES' BALANCES AND TRANSACTIONS

              Balances with related parties:
DECEMBER 31
                                                                                 -----------
                                                                            2000             2001
                                                                            ----             ----
Trade receivables (shareholder)                               4,209             1,206
Transactions with related parties:
FOR THE YEAR ENDED DECEMBER 31
                                                               ------------------------------
                                                              1999             2000              2001
                                                              ----             ----              ----
Sales to shareholder                            13,092           12,204             2,273
-27-
VOCALTEC COMMUNICATIONS LTD.

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

NOTE 23 -     SEGMENT REPORTING

              The Company is disclosing segment information in accordance with
              SFAS No. 131, "Disclosures About Segments of an Enterprise and
              Related Information". This standard requires the Company to
              disclose selected financial data by operating segment, defined as
              a component engaged in business activity resulting in revenues and
              expenses and that has separate financial information evaluated
              regularly by the Company's chief executive officer in determining
              resource allocation and assessing performance. The Company has
              identified three reportable segments based on its internal
              organization structure, management of operations and performance
              evaluation. These segments are: VocalTec, Surf & Call Network
              Services and Corporate.

              VocalTec is engaged in developing and marketing systems enabling
              voice, fax and multimedia communications over packetized networks,
              including both private networks and the public internet. Surf &
              Call Network Services is engaged in providing various vertical
              markets within the web-enabled call center sector with services
              based on the Company's Surf & Call Center Platform.

              Segment detail is summarized as follows:
VOCALTEC    SURF & CALL   DISCONTINUED     CORPORATE         TOTAL
                                               NETWORK       SEGMENT
                                              SERVICES
                                 --------    -----------   ------------     ---------         -----
YEAR ENDED DECEMBER 31, 2001
  Net sales                       27,018        1,395           --                --         28,413
  Operating loss                 (23,563)      (4,563)          --                --        (28,126)

AS OF DECEMBER 31, 2001
  Total assets                    12,342        1,307           --            37,912         51,561

YEAR ENDED DECEMBER 31, 2000
  Net sales                       37,499        4,472           --                --         41,971
  Operating loss                 (13,569)      (3,017)          --                --        (16,586)

AS OF DECEMBER 31, 2000
  Total assets                    17,740        2,375        2,009            70,843         92,967

YEAR ENDED DECEMBER 31, 1999
  Net sales                       26,615           --           --                --         26,615
  Operating loss                 (29,288)          --           --                --        (29,288)
# # # # # # # #

                                         28
SCHEDULE II
Changes
                                         Balance at                                     Charged to
                                         beginning of    Charged to P&L               Comprehensive   Balance at
                                           period          statement     Written off     income      End of period
Year Ended December 31, 1999
Allowance for Unrecognized Revenue         5,526              -218             --          --           5,308
Allowance for doubtful accounts            2,255             2,637         -3,557          --           1,335

Year Ended December 31, 2000
Allowance for Unrecognized Revenue         5,308             3,440             --          --           8,748
Allowance for doubtful accounts            1,335               187           -400          --           1,122

Year Ended December 31, 2001
Allowance for Unrecognized Revenue         8,748             -3,672            --          --           5,076
Allowance for doubtful accounts            1,122               698            257          --           2,077
EXHIBIT INDEX

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 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. Herzliya 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)   Lease Agreement Fort Lee Executive Park, by and between VocalTec
            Communications Inc. and Executive Park LLC., dated June 18, 1998,
            previously filed with the SEC on June 30, 2001 as Exhibit 4.1(f) to
            the Company's Annual Report on Form 20-F for the year ended December
            31, 2000, which is incorporated herein by reference.

8.    List of Subsidiaries.