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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2000

COMMISSION FILE NUMBER: 000-28063

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

DELAWARE 13-4006766
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(State or other jurisdiction of (I.R.S. employer
incorporation or organization) identification no.)

75 BROAD STREET, 31ST FLOOR
NEW YORK, NEW YORK 10004 10004
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(Address of principal executive offices) (Zip code)

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REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (212) 500-4850

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

None.

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

NAME OF EACH EXCHANGE ON WHICH THE
TITLE OF EACH CLASS SECURITIES ARE REGISTERED
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Class A Common Stock, par value $0.001 per share Nasdaq National Market

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

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

The aggregate market value of the Registrant's Class A common stock held by
non-affiliates of the Registrant on March 22, 2001 was approximately
$11,863,299 million. On such date, the last sale price of the Registrant's
Class A common stock was $1.25 per share. Solely for purposes of this
calculation, shares beneficially owned by directors and officers of the
Registrant and persons owning 5% or more of the Registrant's Class A common
stock have been excluded, in that such persons may be deemed to be affiliates of
the Registrant. Such exclusion should not be deemed a determination or admission
by the Registrant that such individuals or entities are, in fact, affiliates of
the Registrant.

The number of shares outstanding of the Registrant's capital stock as of
March 22, 2001 is as follows:

NUMBER OF SHARES OUTSTANDING
TITLE OF EACH CLASS AT MARCH 22, 2001
------------------- ----------------------------

Class A Common Stock, $0.001 par value 9,490,639
Class B Common Stock, $0.001 par value 19,569,459

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DELTATHREE, INC.
2000 ANNUAL REPORT ON FORM 10-K

TABLE OF CONTENTS

PAGE
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PART I
ITEM 1. Business.................................................... 2

ITEM 2. Properties.................................................. 15

ITEM 3. Legal Proceedings........................................... 15

ITEM 4. Submission of Matters to a Vote of Security Holders......... 15

PART II

ITEM 5. Market for Registrant's Common Equity and Related
Stockholder Matters....................................... 16

ITEM 6. Selected Financial Data..................................... 17

ITEM 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................. 19

ITEM 7A. Quantitative and Qualitative Disclosures About Market
Risk...................................................... 37

ITEM 8. Financial Statements and Supplementary Data................. 37

ITEM 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.................................. 37

PART III

ITEM 10. Directors and Executive Officers of the Registrant.......... 37

ITEM 11. Executive Compensation...................................... 37

ITEM 12. Security Ownership of Certain Beneficial Owners and
Management................................................ 37

ITEM 13. Certain Relationships and Related Transactions.............. 37

PART IV

ITEM 14. Exhibits, Financial Statement Schedules and Reports on Form
8-K....................................................... 37

Index to Consolidated Financial Statements............................ F-1

DELTATHREE, INC.
2000 ANNUAL REPORT ON FORM 10-K

PART I

ITEM 1. BUSINESS
GENERAL

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

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

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

RSL Communications Ltd. ("RSL COM"), a global facilities-based
telecommunications company, owns shares of our Class B common stock representing
approximately 95.5% of the combined voting power of all classes of our capital
stock and approximately 67.4% of the economic interest in our company. See "Risk
Factors--Risks Related to Our Relationship with RSL COM." Currently, we provide
carrier transmission services to RSL COM on a commercial basis. Such services
accounted for 67.2% of our total revenues in 1999 and 46% of our total revenues
in 2000.

INDUSTRY SEGMENTS

We only report in one industry segment. See "Notes to Consolidated Financial
Statements--Note 15."

THE INCREASING SIGNIFICANCE OF IP COMMUNICATIONS

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

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

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

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

International Data Corporation, a market research firm, estimates that by
2004, IP minutes (retail and wholesale) and revenues will grow to approximately
135.0 billion minutes and approximately $20.7 billion, respectively,
representing estimated compound annual growth rates of 119% and 103%,
respectively. Beyond cost savings, we believe that advanced IP communications
technologies will further the potential for the Internet to become the preferred
medium of communications and commerce.

INCREASE IN MODES OF COMMUNICATION

The global communications services industry, encompassing voice, fax and
data transmission, is experiencing significant growth. We believe the growth in
global communications services is being driven by:

- globalization of the world's economies and the worldwide trend toward
communications deregulation and liberalization

- the growth of data and Internet traffic

- declining prices and a wider choice of products and services

- technological advances and greater investment in communications
infrastructure

In addition, technological advancements have allowed for multiple modes of
communication, such as cellular, voice-mail, e-mail and fax. We expect rapid
growth in demand for services that unify and simplify the communications needs
of users.

LIMITATIONS OF EXISTING IP COMMUNICATIONS SOLUTIONS

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

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

OUR PRODUCTS AND SERVICES

PRODUCTS.

We have built a privately-managed, global network using IP technology and
offer our customers a unique suite of IP telephony products, including:

GLOBAL ROAMING. Our Global Roaming service enables businesses and
individuals to use a single account number to place phone-to-phone calls over
our privately-managed, global network from locations throughout the world using
country-specific, toll-free access numbers, thereby bypassing local access
charges. We currently offer toll-free access numbers in Austria, Canada,
Finland, France, Germany, Hong Kong, Italy, Sweden, Switzerland, the United
Kingdom and the United States.

PC-TO-PHONE. Our PC-to-Phone service enables a user to conveniently and
inexpensively place a call to a standard telephone anywhere in the world
directly from a personal computer while remaining on-line. In order to use this
service, a user need only download our software for free from our Web site and
have access to the Internet. Once the software is downloaded, the user is able
to place a call from the user's personal computer and, while browsing the Web,
speak to a party who uses a standard telephone.

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

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

IN BOX. In box is our unified messaging service that enables a user to
conveniently retrieve e-mail, voice mail and faxes, as well as send e-mail, from
a single source. We offer a user the flexibility of retrieving messages by
either logging on to a dedicated Web site or by placing a call using a standard
telephone. A user retrieving messages through a computer can conveniently access
and forward all e-mail, voice mail and faxes, while a user retrieving messages
through a standard telephone can hear voice mail and have e-mail read by a
computer-simulated voice.

CLICK IT. Our Click IT service is a Web-based e-commerce service enabling
individuals and businesses to place a link on their Web sites which, when
clicked on by a user viewing the site, automatically initiates a telephone call
from the user's computer to a designated telephone number specified by the owner
of the Web site. In addition, a pop-up screen appears which advertises the
host's products and services. This service allows e-commerce and business Web
pages to support real-time voice calls from on-line customers. Our Click IT
service can also be used to enable a user to place a call from his or her PC to
any telephone number without having to download our PC-to-Phone software. We
call this service Click IT Phone Booth.

CARRIER TRANSMISSION SERVICES. To maximize use of our available network
capacity, we offer carrier transmission services over our privately-managed IP
network to telecommunications carriers.

SERVICES.

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

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

PAYMENT PROCESSING SYSTEMS: we provide our customers with a fraud
detection and prevention system to permit secure credit card transactions
over the Web;

BILLING AND ACCOUNT MANAGEMENT: we provide our customers with
real-time, Web-based access to billing records to check billing and usage
information or to increase prepaid accounts; and

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

OUR HOSTED COMMUNICATIONS SOLUTION

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

With each new module that is added to our suite of VoIP products and
services, customers can realize new revenue streams from their existing customer
base and make their own offering even more powerful in attracting new customers.
The products and services delivered under our Hosted

Communications Solution are operative 24 hours a day, 7 days a week and are
supported at all times by our Network Operations Center ("NOC") and our customer
care center.

The following are examples of current implementations of our Hosted
Communications Solution:

EASYEVERYTHING LIMITED

BACKGROUND: easyEverything is the world's largest chain of Internet
cafes and an affiliate of the UK-based easyGroup (whose holdings include
easyJet, easyRentacar as well as a family of business units under the
easyGroup name).

CHALLENGE: easyEverything sought ways in which to derive additional
revenue per seat at each of its cafes.

SOLUTION: We are in the process of providing easyEverything with a
complete phone service solution that permits end users to place PC-to-Phone
calls over handsets located at every personal computer in the cafes and
Phone-to-Phone calls outside the cafes, all utilizing the same account,
which is purchased within the cafes at the same location where Internet
access cards are sold.

STATUS: The relationship was initiated at easyEverything's launch in
November 2000 of the world's largest Internet cafe with 800 personal
computers in Times Square, New York (open 24 hours a day, 7 days a week).
The Hosted Communications Solution is being rolled out to all of
easyEverything's 15 cafes across Europe and 6 other cafes worldwide during
2001. During February 2001, the average number of visitors was approximately
150,000 per Internet cafe location bringing the combined number of total
monthly visitors to approximately 1.4 million.

SHELL EUROPE OIL PRODUCTS LIMITED

BACKGROUND: Shell Europe was seeking ways to leverage its strong brand
and to diversify its European offering. It recently launched the portal
www.shellgeostar.com, a travel planning site for car trips within Europe.

CHALLENGE: Shell wanted to further diversify its travel offering with a
value-added product that would appeal to its large customer base.

SOLUTION: We are in the process of providing Shell with a complete
phone solution in two phases: first, an on-line Virtual Calling Card
"powered by Deltathree" and accessible through a dedicated Web site through
links on the various Shell Web sites, which allow travelers to make phone
calls, roaming on a pan-European basis, at rates generally lower than
calling rates within individual countries; and, second, an off-line global
roaming card to be sold out of Shell retail stations across Europe offering
the same features.

STATUS: We expect the Shell Web site to be launched during the second
quarter of 2001, and we will be providing the services and infrastructure,
hosting the Web pages, providing e-commerce and fraud solutions, handling
billing and rating, offering branded customer care 24 hours a day, seven
days a week and Web-based MIS tools.

NEXTCARD, INC.

BACKGROUND: NextCard is the largest on-line consumer credit company.

CHALLENGE: NextCard wanted to leverage its strong on-line customer
database to develop new revenue streams through a service that would be
attractive to their user profile.

SOLUTION: We provided NextCard with a complete private label phone
solution, offering NextCard users PC-to-Phone and Phone-to-Phone calling,
together with our full set of on-line tools, through account numbers
matching their credit card numbers. We also provided NextCard with the
efficiency tools to enable it to monitor and manage the services itself
on-line.

STATUS: We are providing the services and infrastructure, as well as
account provisioning tools, billing and rating services and branded customer
care 24 hours a day, seven days a week.

ICONNECTHERE

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

Through iConnectHere, consumer users can:

- sign up for any of our services, including PC-to-Phone, In Box and
Phone-to-Phone

- download our software

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

- send a PC-to-phone call

- retrieve and forward their voice mail, e-mail and faxes through their In
Box

- check real-time billing and usage information

- communicate by e-mail with a customer service representative

- view answers to frequently-asked questions

ICONNECTHERE MARKETING, ADVERTISING AND PROMOTIONAL PROGRAMS

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

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

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

RESELLER PROGRAM. We offer individuals and businesses the opportunity to
become resellers of our services through our reseller program. Resellers are
able to purchase bulk iConnectHere account

numbers at wholesale rates that they are then able to resell to private
individuals as either Phone-to-Phone calling cards or PC-to-Phone accounts.

FUTURE PRODUCTS--BROADBAND PHONE

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

We have been developing a next-generation product under our Hosted
Communications Solution called Broadband Phone that we believe will be one such
service that broadband providers will seek. Broadband Phone will be a phone
replacement solution available to business and consumer customers over the "last
mile" through broadband connections via cable modem, DSL or fixed wireless.
Broadband Phone will challenge the traditional PSTN and circuit switched
networks with a full VoIP solution. With our high call quality and "always on"
reliability and increased functionality provided by the high bandwidth access
line, we will be able to offer our partners and their customers some of the most
sophisticated VoIP solutions available in the market through a highly scalable,
low-cost and easily implemented product. Broadband Phone is designed to take
advantage of how people communicate, building on the current customer experience
by allowing them to use their existing phone. In addition to offering
traditional telecommunications capabilities, Broadband Phone will provide an In
Box, Web functionality, integration with calendar and memo tools and integration
between voice and data. The turnkey solution is delivered with our full back-end
infrastructure, including customer service for end users, customer service for
service providers, pricing information, billing and provisioning and fraud
services. Additionally, Broadband Phone will be a technology-neutral solution,
easily integrated (the device plugs directly into a PC or IP network) so as to
allow the broadband provider to begin delivering our voice solution rapidly.

We expect to offer Broadband Phone to the consumer and small office home
office ("SOHO") markets through iConnectHere during the second quarter of 2001.
Thereafter, we will offer a new version of Broadband Phone with added
functionality and features to the SOHO market. In the final phase of the
implementation, we will target small and medium enterprises with a fully scaled
version of Broadband Phone that provides all of the functionality at a much
lower cost and with much greater efficiencies of a traditional office phone
system. We are working to add the power of legacy Class 5 switches into our
network in this final implementation. This will enable single-user central
management such as a virtual PBX (for example, where one extension of the
virtual office network will be a Broadband Phone device located at home and
connected by xDSL, the other extension will be a cellular phone connection and
still another extension will be a hotel room connection where a customer has
authenticated this location at our location servers).

OUR NETWORK

In order to deliver hosted, unique VoIP services, we operate a
privately-managed IP telephony network. By managing our network, we have the
ability to regulate traffic volumes for its communications traffic and to
directly control the quality of service from each originating point of presence
("POP") to the termination point. In addition, our network allows us to avoid
the significant transmission delays associated with the Internet, which may
impede delivery of high quality, reliable services to our users. Since the
protocols used by the network are highly standard protocols, our IP network has
a tight connection to the Internet, allowing us to use the Internet a backup
facility. This unique situation, where our IP network is considered a
high-quality extension of the Internet, allows

our customers to enjoy best-of-breed functionality: high quality, low jitter and
low connection delay, on the one hand, and a global reach and universal access,
on the other hand.

BACKBONE

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

ORIGINATION ACCESS

Access to our network is possible through several points. Users may access
services through PSTN connections (toll free and Direct Inward Dialing) at 14 of
our POPs (yet all of our termination POPs have the technical capability to
originate as well). Carrier transmission access is aggregated through our switch
in New York or through any one of our POPs directly. Native VoIP origination is,
or will be, possible from the PC-to-Phone product, using our downloadable
software client or using a Web browser, and Broadband Phone. These calls enter
our network from the Internet through our interconnect points with the Internet.
We carefully manage each originating port and utilize innovative capacity
planning tools and techniques to provide the best, most cost effective service
to customers.

TERMINATION

Our network can terminate calls through any of our POPs in 40 different
countries. Termination decisions are based on a complex Least Cost Routing
system which applies routing rules based on origination point, time of day,
termination cost and other factors. These rules are constantly updated to ensure
maximum economic and quality efficiency. Our network has termination facilities
that enable us to interconnect with multiple carriers. This allows us to refile
traffic to our own switch, giving us the ability to route calls to virtually
anywhere in the world. Each termination port is carefully managed with
innovative capacity planning tools and techniques to provide the best but most
cost effective service to customers.

NETWORK SERVICES

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

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

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

REPORTING TOOLS. All network services are accounted for in real time,
generating Call Detail Records. These records are aggregated in real time to
both the billing systems for rating and to the

data warehouse (for accessibility by the marketing, financial, capacity planning
and operational groups through a client or Web interface using advanced OLAP
cubes).

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

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

PROPRIETARY RIGHTS

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

We have a registered trademark for "deltathree-TM-" in the United States. In
addition, we have submitted trademark applications in the United States for the
names "deltathree, the IP Communications Network-TM-" and "iConnectHere-TM-".
These applications may not result in any trademarks being issued and, if issued,
these trademarks may not provide adequate protection against competitive
technology and may not be held valid and enforceable if challenged. We do not
own any registered copyrights.

To further safeguard our intellectual property, we have a policy that
requires our employees to execute confidentiality and technology ownership
agreements when they begin their relationships with us. For a discussion of
recent litigation, see "Legal Proceedings."

REGULATORY ENVIRONMENT

REGULATION OF IP TELEPHONY

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

with applicable regulations could materially adversely affect our business,
financial condition, operating results and future prospects.

UNITED STATES. Based on information users provide to us when they sign up
to use our services, we estimate that approximately 55% of our IP communications
services are provided to carriers or users in the United States. We believe
that, under United States law, based on specific regulatory classifications and
recent regulatory decisions, the IP communications services that we provide
constitute information services (as opposed to regulated telecommunications
services). As such, our services are not currently regulated by the Federal
Communications Commission (FCC) or state agencies charged with regulating
telecommunications carriers. Nevertheless, aspects of our operations may be
subject to state or federal regulation, including regulation governing universal
service funding, payment of access charges, disclosure of confidential
communications and tax issues. However, we cannot assure you that our services
will not be regulated in the future. Several efforts have been made in the
United States to enact federal legislation that would either regulate or exempt
from regulation communications services provided over the Internet.

In addition, the FCC is currently considering whether to impose various
types of charges or other common carrier regulations upon some providers of
Internet and IP telephony, primarily those which provide Internet and IP
telephony services to end users located within the United States. Although the
FCC decided that information service providers, including Internet and IP
telephony providers, are not telecommunications carriers, various companies have
challenged that decision. Congressional dissatisfaction with the FCC's
conclusions could result in requirements that the FCC impose greater or lesser
regulation. The FCC has indicated that it would examine the question of whether
certain forms of phone-to-phone IP telephony are information services or
telecommunications services. The two are treated differently in several
respects, with certain information services being more lightly regulated and not
subject to access charges or universal service contribution obligations. The FCC
stated that as of April 1998 it did not have an adequate record on which to make
a definitive ruling, but that the record suggested that certain forms of
phone-to-phone IP telephony appear to have the same functionality as non-IP
telecommunications services and lack the characteristics that would render them
information services.

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

State regulatory authorities may also retain jurisdiction to regulate the
provision of intrastate Internet and IP telephony services. Several state
regulatory authorities have initiated proceedings to examine the regulation of
such services and Colorado's Public Utilities Commission has ruled that the use
of the Internet to provide certain intrastate services does not exempt a carrier
from paying intrastate access charges. Others could initiate proceedings to
regulate or require access charges on IP telephony.

INTERNATIONAL. The regulatory treatment of Internet and IP telephony
outside of the United States varies widely from country to country. A number of
countries that currently prohibit competition in the provision of voice
telephony may also prohibit Internet and IP telephony. Other countries permit
but regulate Internet and IP telephony. Some countries will evaluate proposed
Internet and IP telephony service on a case-by-case basis and determine whether
it should be regulated as a voice service or as another telecommunications
service. Finally, in many countries, Internet and IP telephony has not yet been
addressed by legislation or regulatory action. A 2000 survey conducted by the
International Telecommunications Union (ITU) found that 63 of the 128 respondent
countries had prohibitions against the provision of voice telephony services
over the Internet, while a further 33 countries either

lacked specific regulation or did not respond to the survey. Survey respondents
that indicated that they prohibit IP telephony include Israel, Mexico and a
number of Eastern European countries, but are primarily concentrated in Asia and
Africa. Respondent countries in Western Europe and North America (other than
Mexico) did not indicate that they prohibited IP telephony.

With respect to the European Union, we believe that our services fall
outside the classification of regulated voice telephony services. The current
European Union regulatory regime distinguishes between voice telephony services
and other telecommunications services. In January, 1998, the Commission
concluded that IP telephony did not currently meet the definition of "voice
telephony" subject to member state's regulation. However, the Commission noted
that its conclusion that IP telephony cannot be considered voice telephony may
not apply to particular forms of service provisions where, for example, an IP
telephony service is marketed as an alternative form of voice telephony service,
users can dial out to any telephone number, and the provider guarantees the
quality of the IP voice service by bandwidth reservation and claims that the
quality of the IP voice service is the same as traditional voice telephony
service. The Commission stated that it would continue to review its conclusion
that IP telephony does not constitute "voice telephony" in light of
technological and market developments. The Commission in June 2000 tentatively
concluded that IP Telephony continued to not meet the "voice telephony"
definition but it is continuing to examine this classification.

In November, 1999, the Commission stated that, "[a]ssuming that over time
the voice over the Internet service meets the key criteria for classification as
voice telephony" it would be regulated like other voice telephony services and
covered by general authorizations. As noted by the Commission, a determination
that IP telephony constitutes "voice telephony" may trigger significant
regulatory consequences with respect to, among other things, licensing
requirements and contributions to universal service funding. The Commission has
announced that it is drafting a report on regulating the quality of voice
telephony services and related consumer protection issues and another report
discussing the new Internet telecommunications services and their impact on the
European Union's regulatory and policy framework. In addition, the Commission is
in the process of revising its directives for telecommunications regulation and
could adopt directives that apply to services regardless of the technology used
by the provider. We cannot predict what the content of such reports will be, or
what impact, if any, they may have on our business.

Based on the Commission's current position, we believe that providers of IP
telephony should be subjected to no more than a general authorization or
declaration requirement by the European Union Member States. The Member States
of the European Union are: Austria, Belgium, Denmark, Finland, France, Germany,
Greece, Ireland, Italy, Luxembourg, The Netherlands, Portugal, Spain, Sweden and
the United Kingdom. However, we cannot assure you that more stringent regulatory
requirements will not be imposed by individual Member States, since the
Commission's Notice is not binding on the Member States. The Member States
therefore are not obligated to reach the same conclusions as the Commission on
this subject so long as they adhere to the definition of "voice telephony" in
the Services Directive. We cannot assure you that the services provided over our
network will not be deemed voice telephony subject to heightened regulation by
one or more EU Member States.

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

Our partners may also currently be, or in the future may become, subject to
requirements to qualify to do business in a particular foreign country, comply
with regulations, including requirements

to obtain authorizations for the provision of voice telephony or other
telecommunications services or for the operation of telecommunications networks,
or to cease providing services or conducting their business as conducted in that
country. We cannot be certain that our partners either are currently in
compliance with any such requirements, will be able to comply with any such
requirements, and/or will continue in compliance with any such requirements.

OTHER REGULATION AFFECTING THE INTERNET

UNITED STATES. Congress has recently adopted legislation that regulates
certain aspects of the Internet, including on-line content, user privacy and
taxation. For example, the Internet Tax Freedom Act prohibits certain taxes on
Internet uses through October 21, 2001. We cannot predict whether substantial
new taxes will be imposed on our services after that date. In addition, Congress
and other federal entities are considering other legislative and regulatory
proposals that would further regulate the Internet. Congress is, for example,
currently considering legislation on a wide range of issues including Internet
spamming, database privacy, gambling, pornography and child protection, Internet
fraud and privacy. Various states have adopted and are considering
Internet-related legislation.

INTERNATIONAL. The European Union has also enacted several directives
relating to the Internet. The European Union has, for example, adopted a
directive on data protection that imposes restrictions on the processing of
personal data that are more restrictive than current United States privacy
standards. Under the directive, personal data may not be collected, processed or
transferred outside the European Union unless certain specified conditions are
met. In addition, persons whose personal data is processed within the European
Union are guaranteed a number of rights, including the right to access and
obtain information about their data, the right to have inaccurate data
rectified, the right to object to the processing of their data for direct
marketing purposes and in certain other circumstances, and rights of legal
recourse in the event of unlawful processing. The Directive will affect all
companies that process personal data in, or receive personal data processed in,
the European Union, and may affect companies that collect or transmit
information over the Internet from individuals in the European Union Member
States. In particular, companies with establishments in the European Union may
not be permitted to transfer personal data to countries that do not maintain
adequate levels of data protection.

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

COMPETITION

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

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

- quality of service

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

- responsive customer care services

- price

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

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

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

- substantially greater financial, technical and marketing resources

- larger networks

- a broader portfolio of services

- stronger name recognition and customer loyalty

- well-established relationships with many of our target customers

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

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

EMPLOYEES

As of December 31, 2000, we employed 162 full-time and 58 part-time
employees, of which 153 were located in Israel, 51 were located in New York and
16 were located in the United Kingdom. We consider our relationship with our
employees to be good. None of our employees is covered by collective bargaining
agreements.

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

ITEM 2. PROPERTIES

We maintain our executive offices at 75 Broad Street, New York, New York
under a lease with an annual rent of approximately $398,000, increasing annually
to $530,000 during the final year of the lease. The lease term extends until
December 2009, with an option to extend the lease for an additional five years.
During February 2000, we signed an addendum to the lease pursuant to which an
additional floor will be leased, with the same terms, for an additional cost of
$254,000, increasing to $342,000 during the final year of the lease.

We lease a 1,440 square meter office, which houses our research and
development facilities, at the Jerusalem Technology Park, Jerusalem, Israel. The
term of this lease extends until January 31, 2003, with an option to extend the
lease for an additional five-year period. We pay annual rent of approximately
$292,000 plus Israeli value-added tax. We sublease a portion of our facility to
third parties.

Under a services agreement with RSL COM, we share space for employees and
equipment at eight locations with RSL COM, including our office in London,
England. The services agreement expires September 3, 2004 with automatic
extensions for additional one-year terms unless terminated by one of the parties
upon 30 days notice prior to the end of the term.

ITEM 3. LEGAL PROCEEDINGS

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

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

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

None.

PART II

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

MARKET INFORMATION

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

HIGH LOW
($) ($)
----------- -----------

YEAR ENDED DECEMBER 31, 2000
First quarter............................................. 62 3/8 18
Second quarter............................................ 21 3/8 5 3/4
Third quarter............................................. 15 3 9/16
Fourth quarter............................................ 5 7/16 1 3/16
YEAR ENDED DECEMBER 31, 2001
First quarter (through March 22, 2001).................... 3 1/2 1 1/32

On March 22, 2001, the last reported sale price for our common stock on the
Nasdaq National Market was $1.25 per share. The market price for our stock is
highly volatile and fluctuates in response to a wide variety of factors.

HOLDERS

As of March 22, 2001, we had approximately 64 holders of record of our
common stock. This does not reflect persons or entities who hold their stock in
nominee or "street" name through various brokerage firms.

DIVIDEND POLICY

We have never declared or paid any cash dividends on our capital stock. We
do not anticipate paying any cash dividends on our capital stock in the
foreseeable future. We currently intend to retain future earnings, if any, to
finance our operations and to expand our business. In addition, indentures
governing outstanding indebtedness of RSL COM restrict our ability to declare or
pay cash dividends, and, for the foreseeable future, effectively prohibit such
payments or declarations. Any future determination to pay cash dividends will be
at the discretion of our board of directors and will be dependent upon our
financial condition, operating results, capital requirements and other factors
that our board of directors considers appropriate.

RECENT SALES OF UNREGISTERED SECURITIES

Pursuant to an Agreement and Plan of Merger dated March 31, 1998, our
predecessor company, Delta Three, Inc. ("Old Delta Three"), was merged into RSL
Acquisition Corp., a wholly-owned subsidiary of RSL COM, the name of which new
entity was changed to Delta Three, Inc. Old Delta Three ceased to exist upon
consummation of the merger. Shareholders of Old Delta Three, other than RSL COM,
received cash and shares of RSL COM in exchange for their shares of Old Delta
Three. As of the consummation of the merger, RSL COM was the only shareholder of
Delta Three, Inc. and was issued 18,061,156 shares of common stock. Subsequent
to the merger, RSL COM exercised all the warrants and convertible notes held by
it in transactions exempt from the registration requirements of the Securities
Act pursuant to Section 4(2) thereof.

Pursuant to a stock and warrant purchase agreement, on October 18, 1999, we
issued to Yahoo! Inc. 125,275 shares of common stock and a warrant to purchase
125,275 shares of common

stock with an exercise price of $7.98 per share for $1,000,000, in a transaction
exempt from the registration requirements of the Securities Act pursuant to
Section 4(2) thereof.

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

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

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

USE OF PROCEEDS

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

For the year ended December 31, 2000, we used approximately $21 million of
the net proceeds for sales, marketing and promotional activities, $14 million
for capital expenditures and $4 million for general corporate purposes. Pending
use of the remaining net proceeds, we have invested the remaining net proceeds
in interest-bearing, investment-grade instruments, certificates of deposit, or
direct or guaranteed obligations of the United States.

ITEM 6. SELECTED FINANCIAL DATA

We derived the selected consolidated financial data presented below from our
consolidated financial statements and related notes included in this annual
report. You should read the selected consolidated financial data together with
our consolidated financial statements and related notes and the section of this
annual report entitled "Management's Discussion and Analysis of Financial
Condition and Results of Operations." Brightman Almagor & Co., a member firm of
Deloitte Touche, independent certified public accountants, audited our
historical financial statements for the period June 1996 (inception) through
December 31, 1996 and as of and for the years ended December 31, 1997, 1998,
1999 and 2000. Their report appears elsewhere in this annual report. The
selected balance

sheet data as of December 31, 1996 is derived from an audited financial
statement not included in this annual report.

PERIOD FROM
JUNE 1996 TO
(INCEPTION) YEAR ENDED DECEMBER 31,
DECEMBER 31, -----------------------------------------
1996 1997 1998 1999 2000
------------ -------- -------- -------- --------
(IN THOUSANDS, EXCEPT SHARE DATA)

STATEMENT OF OPERATIONS DATA:
Revenues:
Affiliates.............................. $ -- $ 468 $ 3,896 $ 7,431 $ 13,977
Non-affiliates.......................... 1 778 1,742 3,621 16,399
------ ------- -------- -------- --------
Total revenues............................ 1 1,246 5,638 11,052 30,376
Costs and operating expenses:
Cost of revenues, net................... -- (892) (4,459) (9,723) (24,932)
Research and development expenses,
net................................... -- (294) (650) (1,233) (6,625)
Selling and marketing expenses.......... -- (632) (2,431) (7,403) (20,548)
General and administrative expenses
(exclusive of non-cash compensation
expense).............................. (179) (1,388) (1,842) (2,754) (6,694)
Non-cash compensation expense........... -- -- (743) (19,116) (6,331)
Depreciation and amortization........... -- (370) (2,671) (3,721) (7,919)
Impairment of goodwill.................. -- -- -- -- (8,905)
------ ------- -------- -------- --------
Total costs and operating expenses........ (179) (3,576) (12,796) (43,950) (81,954)
------ ------- -------- -------- --------
Loss from operations...................... (178) (2,330) (7,158) (32,898) (51,578)
Interest income (expense), net............ -- (37) (186) (873) 3,632
Minority interest......................... -- -- 223 -- --
Income taxes.............................. -- -- -- -- (311)
Net loss.................................. $ (178) $(2,367) $ (7,121) $(33,771) $(48,257)
====== ======= ======== ======== ========
Net loss per share -- basic and diluted... $(0.03) $ (0.19) $ (0.37) $ (1.65) $ (1.67)
====== ======= ======== ======== ========
Weighted average shares outstanding --
basic and diluted....................... 6,420 12,390 19,254 20,418 28,833

YEAR ENDED DECEMBER 31,
------------------------------------------------------
1996 1997 1998 1999 2000
---------- -------- -------- -------- --------
(IN THOUSANDS)

BALANCE SHEET DATA:
Cash and cash equivalents................. $ 130 $ 3,196 $ 1,357 $ 89,957 $ 20,857
Working capital (deficiency).............. 70 2,763 (3,232) 82,942 43,538
Total assets.............................. 396 8,403 25,676 126,832 86,169
Long-term debt due to affiliates.......... 344 -- 5,107 -- --
Total stockholder's equity (deficiency)... (30) 6,272 12,370 102,580 72,479

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

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

OVERVIEW

REVENUES

Revenues are derived from affiliates and non-affiliates. Revenues from
affiliates consist of revenues received from RSL COM for carrier transmission
and calling card services we provide to RSL COM. The majority of the services we
provide to RSL COM are resold by RSL COM to other communications companies, and
the remainder are used directly by RSL COM's customers. Revenues from
non-affiliates consist of revenues from carriers other than RSL COM for carrier
transmission services, and revenues from end-users of our enhanced IP
communications services, including PC-to-Phone and Phone-to-Phone, which are
generated by our both our consumer offering, iConnectHere, and our Hosted
Communications Solution. All revenues are recognized as the services are
performed.

Carrier transmission services to RSL COM accounted for 16.1% of our total
revenues in 2000 and 46.7% of our total revenues in 1999. Carrier transmission
services to non-affiliates accounted for 9.2% of our total revenues in 2000 and
12.7% of our total revenues in 1999. The provision of enhanced IP communications
services through iConnectHere accounted for 18.3% of our total revenues in 2000
and 18.4% in 1999, while the provision of enhanced IP communications services
through our Hosted Communications Solution sales efforts, accounted for 26.5% of
our total revenues in 2000 and 0% in 1999.

COSTS AND OPERATING EXPENSES

Costs and operating expenses consist of cost of revenues, research and
development expenses, selling and marketing expenses, general and administrative
expense, depreciation and amortization of goodwill, non-cash stock compensation
and impairment of goodwill related expenses.

- Cost of revenues consist primarily of access, termination and transmission
costs paid to carriers that we incur when providing services and fixed
costs associated with leased transmission lines. The term of our contracts
for leased transmission lines is generally one year and either party can
terminate with prior notice. We incurred extraordinary costs of
approximately $1.6 million in 1998 and $1.4 million in 1999 in integrating
the hardware and software purchased from Ericsson into our network. To
compensate us for our costs, Ericsson agreed to offset our payable to them
for network telecommunications equipment that we previously purchased from
them with a fair market value of $3 million, representing Ericsson's
reimbursement of costs incurred by us. As a result we classified this
payable as deferred revenues and costs, which we recognize as an offset to
cost of revenues and research and development expenses as they are
incurred.

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

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

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

- Amortization of goodwill consists of amortization of the goodwill related
to the purchase by RSL COM of all of the outstanding shares of our capital
stock, as well as the amortization of the goodwill related to our purchase
of YourDay.com, Inc. in February 2000. In July 1997, we issued shares
representing 51% of our outstanding share capital to RSL COM for
$5 million. No goodwill was recorded as a result of this issuance.
However, as a result of acquiring a controlling interest in us, RSL COM
recorded goodwill in the amount of $450,000, representing our net
liabilities. RSL COM then proceeded to offer to purchase from our
stockholders all of our outstanding shares it did not already own. By
April 1998, RSL COM had paid approximately $14.7 million in cash and
securities for the remaining 49% of our shares that it did not own and RSL
COM recorded goodwill in the amount of $14.7 million. As a result of these
transactions, RSL COM "pushed down" a total of approximately
$15.2 million of goodwill to our financial statements, accounted for in
our financial statements as an increase in both goodwill and additional
paid-in capital of approximately $15.2 million in the aggregate. The
goodwill is being amortized over a five-year period. The amortization of
this goodwill has been reflected as a charge to operations beginning in
1997. We have recorded amortization expense of approximately $8.7 million
through December 31, 2000. The future amortization of the unamortized
goodwill balance will result in charges of approximately $3.0 million in
2001, $3.0 million in 2002 and $460,000 in 2003.

- Impairment of goodwill is a one-time expense resulting from our
determination that events or changes in circumstances have occurred that
impact the net carrying amount of goodwill on our financial statements.
During the fourth quarter of 2000, we decided to deemphasize our

consumer offering, iConnectHere, and focus our efforts on generating
revenues primarily through sales of our Hosted Communications Solution. As
a result, the technology we acquired through our acquisition of
YourDay.com, Inc. was not incorporated into iConnectHere as originally
planned. Accordingly, we determined that a full write-off of approximately
$8.9 million was required in accordance with generally accepted accounting
principles.

We have not recorded any income tax benefit for net losses and credits
incurred for any period from inception to December 31, 2000. The utilization of
these losses and credits depends on our ability to generate taxable income in
the future. Because of the uncertainty of our generating taxable income, we have
recorded a full valuation allowance with respect to these deferred assets.

DEFERRED COMPENSATION CHARGE

We recognized approximately $24.3 million of deferred compensation charges
in 1999 related to non-cash compensation expense due to the issuance of
2,198,025 shares of our common stock to our employees granted with exercise
prices below the fair market value in periods prior to December 31, 1999. We
recorded an additional approximately $4.4 million of deferred compensation
charges in connection with our sale of common stock and warrants to both
Yahoo!, Inc. and CNET Investments, Inc. The deferred compensation charge
represents the difference between each of the purchase prices of the common
stock and the exercise price of the warrants as compared to the fair value of
the common stock at the date of sale. We began amortizing this deferred
compensation charge during the fourth quarter of 1999. The deferred compensation
charge is being amortized over a twelve-month period for Yahoo! and a
twenty-four month period for CNET.

We recognized $6.3 million in non-cash compensation expense in 2000, and we
will recognize an additional $2.6 million during the period January 1, 2001
through May 31, 2002.

RESULTS OF OPERATIONS

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

YEAR ENDED DECEMBER 31,
------------------------------------
1998 1999 2000
-------- -------- --------

Revenues:
Affiliates................................................ 69.1% 67.2% 46.0%
Non-affiliates............................................ 30.9 32.8 54.0
------ ------ ------
Total revenues.......................................... 100.0 100.0 100.0
Costs and operating expenses:
Cost of revenues, net..................................... 79.1 88.0 82.1
Research and development expenses, net.................... 11.5 11.2 21.8
Selling and marketing expenses............................ 43.1 67.0 67.6
General and administrative expenses (exclusive of non-cash
compensation expense)................................... 32.7 24.9 22.0
Non-cash compensation expense............................. 13.2 173.0 20.8
Depreciation and amortization............................. 47.4 33.7 26.1
Impairment of goodwill.................................... -- -- 29.3
------ ------ ------
Total costs and operating expenses...................... 227.0 397.6 269.8
------ ------ ------
Loss from operations........................................ (127.0) (297.6) (169.8)
Interest income (expense), net.............................. (3.3) (7.9) 12.0
Minority interests.......................................... 4.0 -- --
Income taxes................................................ -- -- 1.0
------ ------ ------
(126.3)% (305.5)% (158.9)%
====== ====== ======

COMPARISON OF FISCAL YEARS ENDED DECEMBER 31, 2000 AND 1999

REVENUES

AFFILIATES. Revenues from affiliates were $14.0 million for the year ended
December 31, 2000 compared to $7.4 million for the year ended December 31, 1999,
an increase of $6.6 million or 88.1%. The increase in revenues from affiliates
was due to an increase in sales of calling card products through our affiliate,
RSL COM USA, and an increase in sales to RSL COM due to increased demand for our
carrier transmission services, partially offset by decreases in prices.

NON-AFFILIATES. Revenues from non-affiliates were $16.4 million for the
year ended December 31, 2000 compared to $3.6 million for the year ended
December 31, 1999, an increase of $12.8 million or 352.9%. Revenues from carrier
transmission services for telecommunications carriers other than RSL COM were
$2.8 million for the year ended December 31, 2000 compared to $1.4 million for
the year ended December 31, 1999, an increase of $1.4 million. The increase was
due primarily to an increased demand from a larger customer base. Revenues from
enhanced IP communications services (including our Hosted Communications
Solution) were $13.6 million for the year ended December 31, 2000 compared to
$2.0 million for the year ended December 31, 1999, an increase of $11.6 million
or 473.8%. The increase in revenues from enhanced IP communications services was
due to integration and other service fees received from partners in our Hosted
Communications Solution as well as a greater number of PC-to-Phone and
Phone-to-Phone calls being placed by an increasing user base.

Revenues from carrier transmission services to RSL COM and other
telecommunications carriers accounted for 25.3% and 59.8% of revenues for the
years ended December 31, 2000 and December 31, 1999, respectively. As revenues
from our enhanced IP communication services continue to grow as a percentage of
total revenue, we expect that our revenues from carrier transmission services
will continue to account for a declining percentage of our revenues. Other than
RSL COM, no other customer accounted for greater than 10% of our revenues during
these periods.

COSTS AND OPERATING EXPENSES

COST OF REVENUES. Cost of revenues were $24.9 million for the year ended
December 31, 2000 compared to $9.7 million for the year ended December 31, 1999,
an increase of $15.2 million or 156.4%. The increase in cost of revenues was due
primarily to an increase in the costs associated with the increase in the amount
of traffic being terminated over our network.

RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses were
$6.6 million for the year ended December 31, 2000 compared to $1.2 million for
the year ended December 31, 1999, an increase of $5.4 million or 437.3%. The
increase in research and development expenses was due to greater costs incurred
in hiring personnel to develop several new services and enhancements to our
existing services.

SELLING AND MARKETING EXPENSES. Selling and marketing expenses were
$20.6 million for the year ended December 31, 2000 compared to $7.4 million for
the year ended December 31, 1999, an increase of $13.2 million or 177.6%. The
increase in selling and marketing expenses was due to the expansion of our
marketing and promotional activities during the first half of 2000 and an
increase in our direct sales activities during the second half of 2000.

GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
were $6.7 million for the year ended December 31, 2000 compared to $2.8 million
for the year ended December 31, 1999, an increase of $3.9 million or 143.1%. The
increase in general and administrative expenses was primarily due to additional
personnel and increased occupancy costs.

NON-CASH COMPENSATION EXPENSES. Non-cash compensation expenses were
$6.3 million for the year ended December 31, 2000 compared to $19.1 million for
the year ended December 31, 1999, a decrease of $12.8 million. The decrease in
non-cash compensation expenses was due to the completed amortization of costs
incurred during 1997. Remaining amortization of costs related to the 1998 and
1999 grants of employee stock options and warrants to Yahoo! and CNET below the
then fair market value will continue to be reflected in future financial
statements.

DEPRECIATION AND AMORTIZATION OF GOODWILL. Depreciation and amortization of
goodwill was $7.9 million for year ended December 31, 2000 compared to
$3.7 million for the year ended December 31, 1999, an increase of $4.2 million
or 112.8%. The increase in depreciation and amortization of goodwill was due to
the continued increase in our fixed assets and the acquisition of
YourDay.com, Inc. during the first quarter of 2000.

IMPAIRMENT OF GOODWILL. We incurred a one-time expense of $8.9 million for
the year ended December 31, 2000 related to the impairment of goodwill. This
one-time charge was due to the write-off of goodwill associated with the
technology acquired through our acquisition of Yourday.com, which was not
incorporated into iConnectHere as originally anticipated.

LOSS FROM OPERATIONS

Loss from operations was $51.6 million for the year ended December 31, 2000
compared to approximately $32.9 million for the year ended December 31, 1999, an
increase of $18.7 million or 56.8%. The increase in loss from operations was due
primarily to the increase in costs and operating expenses, including non-cash
compensation expenses, sales and marketing expenses, and a one-time expense for
goodwill impairment, as well as a decrease in prices we charged for carrier
transmission services. We expect to continue to incur losses for the foreseeable
future.

INTEREST (EXPENSE) INCOME, NET

Interest income was $3.6 million for the year ended December 31, 2000
compared to an interest expense of $0.9 million for the year ended December 31,
1999, an increase of $4.5 million or 515.5%. The increase in interest income was
primarily due to interest earned on the remaining proceeds from our initial
public offering, less the interest expense we incurred in connection with our
borrowings from RSL COM, which were repaid in November 2000.

INCOME TAXES, NET

We paid income taxes, net of $0.3 million for the year ended December 31,
2000 compared to no income taxes for the year ended December 31, 1999.

NET LOSS

Net loss was approximately $48.3 million for the year ended December 31,
2000 compared to $33.8 million for the year ended December 31, 1999, an increase
of $14.5 million or 42.9%. The increase in net loss was due to the foregoing
factors.

COMPARISON OF FISCAL YEARS ENDED DECEMBER 31, 1999 AND 1998

REVENUES

AFFILIATES. Revenues from affiliates were $7.4 million for the year ended
December 31, 1999 compared to $3.9 million for the year ended December 31, 1998,
an increase of $3.5 million or 89.7%. The increase in revenues from affiliates
was due to an increase in sales of our services by RSL COM to its customers. The
increase in sales by RSL COM was due to the growth in our network resulting in

our ability to provide additional capacity to RSL COM as well as to the quality
of services that we provide.

NON-AFFILIATES. Revenues from non-affiliates were $3.6 million for the year
ended December 31, 1999 compared to $1.7 million for the year ended
December 31, 1998, an increase of $1.9 million or 111.8%. Revenues from carrier
transmission services for telecommunications carriers other than RSL COM were
$1.4 million for the year ended December 31, 1999 compared to $0.3 million for
the year ended December 31, 1998, an increase of $1.1 million. The increase was
due primarily to an increased demand from a larger customer base. Revenues from
IP communications services were $2.0 million for the year ended December 31,
1999 compared to $1.2 million for the year ended December 31, 1998, an increase
of $0.8 million or 66.7%. The increase in revenues from IP communications
services was due to a greater number of PC-to-Phone and Phone-to-Phone calls
being placed by an increasing user base.

Revenues from carrier transmission services to RSL COM and other
telecommunications carriers accounted for 71.7% and 59.8% of revenues for the
years ended December 31, 1998 and December 31, 1999, respectively. Other than
RSL COM, no other customer accounted for greater than 5% of our revenues during
these periods.

COSTS AND OPERATING EXPENSES

COST OF REVENUES. Cost of revenues were $9.7 million for the year ended
December 31, 1999 compared to $4.5 million for the year ended December 31, 1998.
For the year ended December 31, 1999, we recognized $0.3 million compared to
$0.7 million for the year ended December 31, 1998 as the reimbursement of
certain costs from Ericsson, our primary equipment vendor. Such reimbursement
reduced our cost of revenues during both periods. Excluding this reimbursement,
cost of revenues would have been $10.0 million for the year ended December 31,
1999 compared to $5.2 million for the year ended December 31, 1998, an increase
of $4.8 million or 92.3%. The increase in cost of revenues (excluding the
reimbursement) was due primarily to increased costs associated with the
significant increase in carrier transmission services. During 1998, due to
difficulties in integrating the hardware and software purchased from Ericsson
into our network, we incurred significant costs and anticipate that we will
incur additional costs through the end of 1999. To compensate us for our costs,
Ericsson agreed to provide us at no cost with network telecommunications
equipment with a fair market value of $3.0 million, representing Ericsson's
participation in such research and development costs, which we recognize as an
offset to cost of revenues and research and development expenses.

RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses were
$1.2 million for the year ended December 31, 1999 compared to $0.7 million for
the year ended December 31, 1998. For the year ended December 31, 1999, we
recognized reimbursement from Ericsson for expenses we incurred in research and
development of $1.1 million compared to $0.9 million for the year ended
December 31, 1998. Excluding this reimbursement, research and development costs
would have been $2.3 million for the year ended December 31, 1999 compared to
$1.6 million for the year ended December 31, 1998, an increase of $0.7 million
or 43.8%. The increase in research and development expenses (excluding the
reimbursement) was due to greater costs incurred in hiring personnel to develop
several new services and enhancements to our existing services.

SELLING AND MARKETING EXPENSES. Selling and marketing expenses were
$7.4 million for the year ended December 31, 1999 compared to $2.4 million for
the year ended December 31, 1998, an increase of $5.0 million or 208.3%. The
increase in selling and marketing expenses was due to the expansion of our
marketing and promotional activities. Selling and marketing expenses for the
year ended December 31, 1998 included expenses related to a promotional campaign
we conducted during this period.

GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
(exclusive of non-cash compensation expenses) were $2.8 million for the year
ended December 31, 1999 compared to $1.8 million for the year ended
December 31, 1998, an increase of $1.0 million or 55.6%. The increase in general
and administrative expenses was primarily due to additional personnel and
increased occupancy costs.

NON-CASH COMPENSATION EXPENSES. Non-cash compensation expenses were
$19.1 million for the year ended December 31, 1999 compared to $0.7 million for
the year ended December 31, 1998, an increase of $18.4 million. The increase in
non-cash compensation expenses was due to the recognition of compensation
expense for grants of employee stock options and RSL COM restricted units held
by our employees that were converted into shares of our common stock or options
to purchase our common stock and the issuance of shares and warrants to both
Yahoo! and CNET

DEPRECIATION AND AMORTIZATION. Depreciation and amortization was
$3.7 million for year ended December 31, 1999 compared to $2.7 million for the
year ended December 31, 1998, an increase of $1.0 million or 37.0%. The increase
in amortization was due to an increase in goodwill that grew significantly
during 1998 as a result of RSL COM acquiring the remaining outstanding shares of
our company.

LOSS FROM OPERATIONS

Loss from operations was $32.9 million for the year ended December 31, 1999
compared to approximately $7.2 million for the year ended December 31, 1998, an
increase of $25.7 million or 356.9%. The increase in loss from operations was
due to the increase in costs and operating expenses and to a decrease in prices
we charged for carrier transmission services.

INTEREST EXPENSE, NET

Interest expense, net was $0.9 million for the year ended December 31, 1999
compared to $0.2 million for the year ended December 31, 1998, an increase of
$0.7 million or 368.9%. The increase in interest expense was due to greater
borrowings from RSL COM to finance our working capital and capital expenditure
requirements.

NET LOSS

Net loss was approximately $33.8 million for the year ended December 31,
1999 compared to $7.1 million for the year ended December 31, 1998, an increase
of $26.7 million or 376%. The increase in net loss was due to the foregoing
factors.

LIQUIDITY AND CAPITAL RESOURCES

Since our inception in June 1996, we have incurred significant operating and
net losses due in large part to the start-up and development of our operations.
As of December 31, 2000, we had an accumulated deficit of approximately
$91.7 million. We anticipate that we will continue to incur operating and net
losses as we implement our growth strategy.

As of December 31, 2000, we had cash and cash equivalents of approximately
$20.9 million, marketable securities and other short-term investments of
approximately $30.5 million and working capital of approximately $44.0 million.
We generated negative cash flow from operating activities of approximately
$23.4 million during the year ended December 31, 2000 compared with negative
cash flow from operating activities of $9.8 million during the year ended
December 31, 1999. Accounts receivable were approximately $3.3 million and
$0.9 million at December 31, 2000 and December 31, 1999, respectively. Accounts
receivable and accounts payable have increased from period to period as our
business has grown.

Our capital expenditures increased from approximately $2.8 million in the
year ended December 31, 199 compared to approximately $13.6 million in the year
ended December 30, 2000, as we expanded our domestic and international network
infrastructure.

We registered 6,900,000 shares of our Class A Common Stock on a Form S-1
registration statement, which became effective on November 22, 1999. We received
net proceeds, after deducting underwriting discounts and commissions and
offering expenses, of approximately $96,255,000 from the sale of 6,900,000
shares at the initial public offering price of $15.00 per share on November 29,
1999.

We believe that our available cash and cash equivalents will be sufficient
to meet our working capital requirements, including operating losses, and
capital expenditure requirements for at least the next fiscal year, assuming our
business plan is implemented successfully. Thereafter, we may be required to
raise additional funds. Additional financing may not be available when needed
or, if available, such financing may not be on terms favorable to us. If
additional funds are raised through the issuance of equity securities, our
existing stockholders may experience significant dilution. In addition, the
indentures governing outstanding indebtedness of RSL COM restrict our ability to
incur indebtedness. We also have agreed with RSL COM not to incur any debt
(other than intercompany debt) without its written consent so long as we are a
restricted subsidiary of RSL COM. In March 2001, RSL COM and certain of its
subsidiaries commenced insolvency proceedings, and other RSL COM subsidiaries
filed to reorganize under Chapter 11 of the U.S. Bankruptcy Code. The effect of
the outcome of these proceedings on RSL COM's and our obligations under the
indentures remains uncertain. Those limitations may require us to resort to
other sources of funding, such as the issuance of equity and we cannot assure
you that any third party will be willing or able to provide additional capital
on favorable terms or at all.

RISK FACTORS

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

RISKS RELATED TO OUR COMPANY

WE HAVE A HISTORY OF LOSSES AND WE ANTICIPATE OUR LOSSES WILL CONTINUE

We have incurred significant losses since inception, and we expect to
continue to incur significant losses for the foreseeable future. We reported a
net loss of approximately $48.3 million in 2000, and a net loss of approximately
$33.8 million in 1999. As of December 31, 2000, our accumulated deficit was
approximately $91.7 million. As a percentage of revenues, our net loss was
158.9% in 2000 and 305.5% in 1999. Our revenues may not continue to grow or even
continue at their current level. In addition, we expect to maintain our
operating expenses at current levels as we develop and expand our business. As a
result, we will need to increase our revenues significantly to become
profitable. In order to increase our revenues, we need to attract and maintain
customers to increase the fees we collect for our services. If our revenues do
not increase as much as we expect or if our expenses increase at a greater pace
than revenues, we may never be profitable or, if we become profitable, we may
not be able to sustain or increase profitability on a quarterly or annual basis.

WE HAVE A LIMITED OPERATING HISTORY UPON WHICH YOU CAN EVALUATE US

We have only a limited operating history upon which you can evaluate our
business and prospects. We commenced operations in June 1996. You should
consider our prospects in light of the risks,

expenses and difficulties we may encounter as an early stage company in the new
and rapidly evolving market for IP communications services. These risks include
our ability:

- to increase acceptance of our Hosted Communications Solution, thereby
increasing the number of users of our IP telephony services

- to compete effectively

- to develop new products and keep pace with developing technology

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

WE MAY NOT BE ABLE TO EXPAND OUR REVENUE AND ACHIEVE PROFITABILITY

Our business strategy is to expand our revenue sources to include the
provision of enhanced IP communications services to several different customer
groups. We can neither assure you that we will be able to do this or that this
strategy will be profitable. Currently, our revenues are primarily generated
from carrier transmission services for RSL COM and other communications
carriers, and from sales of enhanced IP communications services through our
direct consumer offering, iConnectHere. Carrier transmission services generated
25.3% of our total revenues in 2000 and 59.4% in 1999. Enhanced IP
communications services generated 44.8% of our total revenues in 2000 and 18.4%
in 1999. The provision of enhanced IP communications services have not been
profitable to date.

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

- sales of Hosted Communications Solution and enhanced IP communications
services

- acceptance and use of IP telephony

- expansion of service offerings

- traffic levels on our network

- the effect of competition, regulatory environment, international long
distance rates and access and transmission costs on our prices

- continued improvement of our global network quality

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

WE CANNOT ASSURE YOU THAT A MARKET FOR OUR SERVICES WILL DEVELOP

We are uncertain whether a market will develop for our Hosted Communications
Solution or our enhanced IP communications services. Our market is new and
rapidly evolving. Our ability to sell our services may be inhibited by, among
other factors, the reluctance of some end users to switch from traditional
communications carriers to IP communications carriers and by concerns with the
quality of IP telephony and the adequacy of security in the exchange of
information over the Internet. End users in markets serviced by recently
deregulated telecommunications providers are not familiar with obtaining
services from competitors of these providers and may be reluctant to use new
providers, such as our company. Our ability to increase revenues depends on the
migration of traditional telephone

network traffic to our IP network. We will need to devote substantial resources
to educate customers and end users about the benefits of IP communications
solutions in general and our services in particular. If enterprises and their
customers do not accept our Hosted Communications Solution or enhanced IP
communications services as a means of sending and receiving communications, we
will not be able to increase our number of paid users or successfully generate
revenues in the future.

OUR FUTURE SUCCESS DEPENDS ON THE GROWTH IN THE USE OF THE INTERNET AS A MEANS
OF COMMUNICATIONS

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

- inconsistent quality or speed of service

- traffic congestion on the Internet

- potentially inadequate development of the necessary infrastructure

- lack of acceptable security technologies

- lack of timely development and commercialization of performance
improvements

- unavailability of cost-effective, high-speed access to the Internet

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

WE WILL NEED ADDITIONAL CAPITAL TO FINANCE OUR OPERATIONS IN THE FUTURE

We intend to continue to enhance and expand our network in order to maintain
our competitive position and meet the increasing demands for service quality,
capacity and competitive pricing. Also, the introduction of our new Broadband
Phone service will require significant marketing and promotional expenses that
we often incur before we begin to receive the related revenue. If our cash flow
from operations is not sufficient to meet our capital expenditure and working
capital requirements, we will need to raise additional capital from other
sources. Although we are neither the debtor nor the guarantor under any of the
indentures that govern a substantial amount of RSL COM's debt, we are a
"restricted subsidiary" under these indentures. The limitations under RSL COM's
restrictive indenture covenants prohibit RSL COM and its restricted
subsidiaries, including us, from incurring any significant amount of additional
debt. We have agreed with RSL COM not to take any action that would cause RSL
COM to default under its indentures and not to incur any debt, other than
inter-company debt, without its written consent so long as we are a restricted
subsidiary of RSL COM. In March 2001, RSL COM and certain of its subsidiaries
commenced insolvency proceedings, and other RSL COM subsidiaries filed to
reorganize under Chapter 11 of the U.S. Bankruptcy Code. The effect of the
outcome of these proceedings on RSL COM's and our obligations under the
indentures remains uncertain. These limitations may require us to resort to
other sources of funding, such as the issuance of equity. If we issue additional
equity, investors could experience dilution. If we are unable to obtain

additional capital, we may be required to reduce the scope of our business or
our anticipated growth, which would reduce our revenues.

POTENTIAL FLUCTUATIONS IN OUR QUARTERLY FINANCIAL RESULTS MAKE IT DIFFICULT FOR
INVESTORS TO PREDICT OUR FUTURE PERFORMANCE

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

- the rate at which we are able to attract users to purchase our Hosted
Communications Solution and enhanced IP communications services

- the amount and timing of expenses to enhance marketing and promotion
efforts and to expand our infrastructure

- the timing of announcements or introductions of new or enhanced services
by us

The factors outside our control include:

- the timing of announcements or introductions of new or enhanced services
by our competitors

- technical difficulties or network interruptions in the Internet or our
privately-managed network

- general economic and competitive conditions specific to our industry

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

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

OUR NETWORK MAY NOT BE ABLE TO ACCOMMODATE OUR CAPACITY NEEDS

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

WE FACE A RISK OF FAILURE OF COMPUTER AND COMMUNICATIONS SYSTEMS USED IN OUR
BUSINESS

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

OUR COMPUTER SYSTEMS AND OPERATIONS MAY BE VULNERABLE TO SECURITY BREACHES

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

THIRD PARTIES MIGHT INFRINGE UPON OUR PROPRIETARY TECHNOLOGY

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

OUR SERVICES MAY INFRINGE ON THE INTELLECTUAL PROPERTY RIGHTS OF OTHERS

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

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

OPERATING INTERNATIONALLY EXPOSES US TO ADDITIONAL AND UNPREDICTABLE RISKS

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

- potentially weaker protection of intellectual property rights

- political instability

- unexpected changes in regulations and tariffs

- fluctuations in exchange rates

- varying tax consequences

- uncertain market acceptance and difficulties in marketing efforts due to
language and cultural differences

WE HAVE EXPERIENCED LOSSES AS A RESULT OF FRAUD

We have experienced losses due to fraud. In 2000, we experienced losses from
fraud of approximately less than 1% of our revenues. Callers have obtained our
services without rendering payment by unlawfully using our access numbers and
personal identification numbers. Although we have implemented anti-fraud
measures in order to control losses relating to these practices, these measures
may not be sufficient to effectively limit all of our exposure in the future
from fraud and we continue to experience losses from fraud. While we have
established reserves for bad debts in accordance with historical levels of
uncollectible receivables resulting primarily from these fraudulent practices,
our losses may exceed our reserves and could rise significantly above
anticipated levels.

INTENSE COMPETITION COULD REDUCE OUR MARKET SHARE AND HARM OUR FINANCIAL
PERFORMANCE

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

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

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

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

DECREASING TELECOMMUNICATIONS RATES MAY DIMINISH OR ELIMINATE OUR COMPETITIVE
PRICING ADVANTAGE

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

GOVERNMENT REGULATION AND LEGAL UNCERTAINTIES RELATING TO IP TELEPHONY COULD
HARM OUR BUSINESS

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

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

WE MAY NOT BE ABLE TO KEEP PACE WITH RAPID TECHNOLOGICAL CHANGES IN THE
COMMUNICATIONS INDUSTRY

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

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

RISKS RELATED TO OUR RELATIONSHIP WITH RSL COM

RSL COM AND CERTAIN OF ITS SUBSIDIARIES HAVE COMMENCED INSOLVENCY AND
REORGANIZATION PROCEEDINGS

In March 2001, RSL COM commenced insolvency proceedings in Bermuda. The
outcome of this proceeding may result in either a restructuring of RSL COM's
obligations or the sale of RSL COM's assets. A wholly-owned, non-operating
subsidiary of RSL COM and an indirect subsidiary of RSL COM also initiated
insolvency proceedings in the United Kingdom. In addition, RSL COM's principal
operating subsidiary in the United States and another of its subsidiaries filed
to reorganize under Chapter 11 of the U.S. Bankruptcy Code. The outcomes of
these insolvency and reorganization proceedings may have an adverse effect on
our business, including the termination of or default under our intercompany
agreements with RSL COM. Both our services agreement and management agreement
with RSL COM may be terminated in the event of bankruptcy or insolvency of RSL
COM. In addition, if, in connection with the outcome of its insolvency
proceedings, RSL COM's sale of its assets includes the sale of its ownership
interest in our company, both our management agreement and intercompany
compliance agreement with RSL COM terminate, and RSL COM will have the right to
terminate our services agreement if it holds less than 50% of our capital stock.

WE DEPEND ON SALES TO RSL COM

We have historically depended on sales to RSL COM, our controlling
stockholder, for revenues. RSL COM accounted for 69.1%, 67.2% and 46.0% of our
revenues for the years ended December 31, 1998, 1999 and 2000, respectively. RSL
COM is not contractually required to purchase services from us, other than a
minimum of 50 million minutes per year pursuant to the services agreement for
two years through November 29, 2001. If we cease to be a subsidiary of RSL COM,
this minimum purchase obligation no longer applies to RSL COM, even if the
services agreement is not terminated. We cannot assure you that, during the
pendancy of the insolvency and reorganization proceedings of RSL COM and its
subsidiaries or after the resolution of such proceedings, that RSL COM will
fulfill its obligations under this agreement or that the contract will be
renewed upon its expiration. RSL COM resells a significant portion of the
carrier transmission services it purchases from us to third parties. Although we
could market our services directly to these third parties if RSL COM ceased
purchasing services from us, we cannot assure you that we would succeed in
attracting these customers or that these customers would purchase our services
in the same volume or on the same terms as from RSL COM.

WE DEPEND ON THE SERVICES RSL COM PROVIDES TO US

We are currently dependent upon RSL COM for leased line capacity, data
communications facilities, traffic termination services and physical space for
our equipment. Through our relationship

with RSL COM, which owns or leases substantial bandwidth for its own business,
we have access to bandwidth. We are able to take advantage of RSL COM's volume
discounts and achieve cost efficiencies that we could not achieve on our own.
Although we have entered into a services agreement with RSL COM for it to
provide these services through 2004, if RSL COM becomes unwilling or unable to
provide its current level of services to us during the term of such agreement or
thereafter, we may not be able to find replacement service providers on a timely
basis. In addition, the outcomes of the insolvency and reorganization
proceedings of RSL COM and its subsidiaries may prevent RSL COM from providing
these services to us and may cause the services agreement to be terminated. If
we are required to change providers, we would likely experience delays,
operational difficulties and increased expenses, and our ability to provide
services to our users or expand our operations may be impaired.

The inter-company agreements with RSL COM were made in the context of a
parent-subsidiary relationship and were not negotiated on an arm's length basis.
As a result, the terms of such agreement may be better or worse than the terms
that would have been negotiated by unaffiliated third parties for similar
arrangements.

RSL COM WILL CONTROL ALL MATTERS SUBMITTED TO A STOCKHOLDER VOTE

RSL COM owns all of our Class B common stock and therefore owns
approximately 95.5% of the voting power of our company.

As long as RSL COM continues to beneficially own shares of capital stock
representing more than 50% of the voting power of our outstanding capital stock,
RSL COM will be able to exercise a controlling influence over decisions
affecting our company, including:

- composition of our board of directors and, through it, the direction and
policies of our company, including the appointment and removal of officers

- mergers or other business combinations involving our company

- acquisitions or dispositions of assets by our company

- future issuances of capital stock or other securities by our company

- incurrence of debt by our company

- amendments, waivers and modifications to any agreements between us and RSL
COM

- payment of dividends on our capital stock

- approval of our business plans and general business development

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

WE ARE SUBJECT TO THE COVENANTS OF RSL COM'S INDENTURES WHICH RESTRICT OUR
ABILITY TO CONDUCT OUR BUSINESS

Although we are neither the debtor nor the guarantor under any of the
indentures that govern a substantial amount of RSL COM's debt, we are subject to
covenants by reason of our status as a restricted subsidiary of RSL COM under
such indentures. As of March 1, 2001, RSL COM had approximately $1.4 billion of
debt outstanding under these indentures. This debt is unsecured. These
restrictions significantly limit the ability of RSL COM and its restricted
subsidiaries, including our company, to incur additional indebtedness or create
liens on their assets. The limitations on indebtedness under the indentures
generally are based on the application of tests derived from RSL

COM's consolidated financial statements. Effectively, our ability to incur
indebtedness is limited by the amount of indebtedness that RSL COM and its
restricted subsidiaries, including our company, are permitted to incur under the
indentures. The limitations under RSL COM's restrictive indenture covenants
currently prohibit us from incurring any significant amount of additional debt.
We have also agreed with RSL COM not to take any action which would cause RSL
COM to default under its indentures and not to incur any debt, other than
inter-company debt, without its written consent so long as we are a restricted
subsidiary of RSL COM. In addition, currently the restrictions under the RSL COM
indentures effectively prohibit us from paying dividends and limit our ability
to make other distributions in respect of our capital stock, sell assets, engage
in mergers or acquisitions or make some types of investments. Such restrictions
also limit the ability of a third party to acquire a controlling interest in our
company. These restrictions may prohibit transactions that would otherwise be
beneficial to our company. The effect of the outcomes of the insolvency and
reorganization proceedings of RSL COM and its subsidiaries on RSL COM's and our
obligations under the indentures remains uncertain.

THE INTERESTS OF RSL COM MAY CONFLICT WITH OUR INTERESTS

The interests of RSL COM, our controlling stockholder and principal
customer, may conflict with our interests. We have entered into a services
agreement with RSL COM for the provision of traffic termination services,
colocation rights and other network support services. We provide carrier
transmission services to RSL COM. Because of these transactions and RSL COM's
controlling position in our company, conflicts of interest could arise relating
to the nature, quality and pricing of services or products provided by us to RSL
COM or by RSL COM to us.

RSL COM MAY COMPETE WITH OUR COMPANY

RSL COM is in the communications business and may compete with us under some
circumstances. Under the services agreement between us and RSL COM, RSL COM is
prohibited from competing with us in providing Internet telephony services as
described in the services agreement, provided that we provide RSL COM with any
requested Internet telephony services promptly and with quality assurance.
However, this non-competition provision terminates on September 3, 2001 and the
scope of such provision is subject to the following limitations:

- RSL COM and its subsidiaries may acquire up to 20% in an entity providing
Internet telephony services

- RSL COM and its subsidiaries may be stockholders in entities providing
Internet telephony services,

- the non-competition provision does not apply to RSL COM's subsidiaries
that become publicly traded companies

- Internet telephony services under the non-competition provision are
limited to (1) Phone-to-Phone services marketed as IP to the general
public, including both individuals and businesses and (2) the following
enhanced IP communications services: PC-to-Phone, In Box, Click IT, Global
Roaming, IP-initiated conference calls, Phone-to-PC, information services
and white boarding

RSL COM'S CLASS B COMMON STOCK MAY BE TRANSFERRED TO A THIRD PARTY THAT WOULD
EFFECTIVELY CONTROL US

Although our Class B common stock generally converts to common stock
automatically upon transfer, RSL COM may transfer our Class B common stock to
permitted transferees, including entities controlled by RSL COM or its principal
stockholder, Ronald S. Lauder, and successors in interest of RSL COM. The
outcome of RSL COM's insolvency proceeding may affect the ownership of RSL COM's
assets, including its ownership of shares of our Class B common stock. As a
result, a third party

could acquire our Class B common stock and may become party to our intercompany
agreements. We cannot assume that a third party would maintain good relations
with us or maintain or renew our agreements with RSL COM.

RISKS RELATED TO OUR STOCK

A THIRD PARTY MAY BE DETERRED FROM ACQUIRING OUR COMPANY

The disproportionate voting rights of our Class B common stock relative to
our common stock could delay, deter or prevent a third party from attempting to
acquire control of us. This provision may have the effect of discouraging a
third party from making a tender offer or otherwise attempting to obtain control
of our company, even though such a change in ownership would be economically
beneficial to our company and our stockholders.

VOLATILITY OF OUR STOCK PRICE COULD ADVERSELY AFFECT OUR STOCKHOLDERS

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

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

- announcements by us or our competitors of technological innovations

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

- changes in financial estimates by securities analysts

- conditions or trends in the Internet industry

- changes in the market valuations of other Internet companies

- announcements by us or our competitors of significant acquisitions

- our entry into strategic partnerships or joint ventures

- sales of our capital stock by RSL COM

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

Investors may not be able to resell their shares of our common stock
following periods of volatility because of the market's adverse reaction to such
volatility. In addition, the stock market in general, and the market for
Internet-related and technology companies in particular, has been highly
volatile. The trading prices of many Internet-related and technology companies'
stocks have reached historical highs within the last 52 weeks and have reflected
relative valuations substantially above historical levels. During the same
period, such companies' stocks have also been highly volatile and have recorded
lows well below such historical highs. We cannot assure you that our stock will
trade at the same levels of other Internet stocks or that Internet stocks in
general will sustain their current market prices. We also cannot assure you that
our stock will continue to be quoted on the Nasdaq National Market if the price
of our stock should fall below $1 for a period of 30 consecutive days.

WE DO NOT INTEND TO PAY DIVIDENDS

We have never declared or paid any cash dividends on our common stock. We
intend to retain any future earnings to finance our operations and to expand our
business and, therefore, do not expect to pay any cash dividends in the
foreseeable future. In addition, indentures governing outstanding indebtedness
of RSL COM restrict our ability to declare or pay cash dividends, and, for the
foreseeable future, effectively prohibit such payments or declarations.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS

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

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

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

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

None.

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

The information required by this Item is incorporated herein by reference to
the section entitled "Management" and "Principal Stockholders" in the proxy
statement for our 2001 Annual Meeting of Stockholders.

ITEM 11. EXECUTIVE COMPENSATION

The information required by this Item is incorporated herein by reference to
the section entitled "Executive Compensation" in the proxy statement for our
2001 Annual Meeting of Stockholders.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The information required by this Item is incorporated herein by reference to
the section entitled "Principal Stockholders" in the proxy statement for our
2001 Annual Meeting of Stockholders.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The information required by this Item is incorporated herein by reference to
the sections entitled "Related Party Transactions" in the proxy statement for
our 2001 Annual Meeting of Stockholders.

PART IV

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

(a)(1) Financial Statements.

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

(a)(2) Financial Statement Schedules.

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

(a)(3) Exhibits.

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

EXHIBIT
NUMBER DEXCRIPTION
- --------------------- -----------

3.1 (*) Form of Amended and Restated Certificate of Incorporation of
deltathree, Inc.

3.2 (*) Form of Amended and Restated By-laws of deltathree, Inc.

4.1 (*) Specimen Certificate of Common Stock.

4.2 (*) Specimen Certificate of Class B Common Stock.

4.3 (*) Registration Rights Agreement, dated September 1, 1999,
between RSL Communications, Ltd. and deltathree, Inc.

10.1 (*) Amended and Restated Services Agreement, dated September 3,
1999, between RSL Communications, Ltd. and deltathree, Inc.

10.2 (*) Form of deltathree, Inc. 1999 Stock Incentive Plan.

10.3 (*) Form of deltathree, Inc. 1999 Employee Stock Purchase Plan.

10.4 (*) Form of deltathree, Inc. 1999 Performance Incentive Plan.

10.5 (*) Form of deltathree, Inc. 1999 Directors' Plan.

10.6 (*) Employment Agreement, effective as of April 1, 1999, between
Noam Bardin and deltathree, Inc.

10.7 (***) Amendment No. 1 to Employment Agreement, effective as of
June 1, 2000, between Noam Bardin and deltathree, Inc.

10.8 (*) Employment Agreement, effective as of April 1, 1999, between
Shimmy Zimels and deltathree, Inc.

10.9 (***) Amendment No. 1 to Employment Agreement, effective as of
June 1, 2000, between Shimmy Zimels and deltathree, Inc.

10.10 (***) Employment Agreement, effective as of May 2000, between Mark
Gazit and deltathree, Inc.

10.11 (***) Amendment No. 1 to Employment Agreement, effective as of
June 1, 2000, between Mark Gazit and deltathree, Inc.

10.12 (***) Employment Agreement, effective as of August 28, 2000,
between Paul White and deltathree, Inc.

10.13 (***) Employment Agreement, effective as of August 30, 2000,
between Lisa J. Indovino and deltathree, Inc.

10.14 (*) Investor Rights Agreement, dated as of September 29, 1999,
between Yahoo! Inc. and deltathree, Inc.

10.15 (*) Form of Warrant issued to Yahoo! Inc on October 18, 1999.

10.16 (*) Management Agreement, dated as of November 1, 1999, between
deltathree, Inc. and RSL Communications, Ltd.

10.17 (*) Amendment to Services Agreement by and between RSL
Communications, Ltd. and deltathree, Inc., dated November 1,
1999.

EXHIBIT
NUMBER DEXCRIPTION
- --------------------- -----------

10.18 (*) Investor Rights Agreement dated as of October 20, 1999
between CNET Investments, Inc. and deltathree, Inc.

10.19 (*) Form of Warrant issued to CNET Investments, Inc. on October
20, 1999.

10.20 (*) Intercompany Compliance Agreement, dated as of November 1,
1999, between RSL Communications, Ltd., RSL Communications
PLC and deltathree, Inc.

10.21 (*) Development and Promotion Agreement, effective as of
September 22, 1999, between CNET, Inc. and deltathree, Inc.

10.22 (*) Form of Proposed Release and Indemnification Agreement
between RSL Communications, Ltd. and deltathree, Inc.

10.23 (**) Agreement and Plan of Merger, dated as of February 3, 2000,
between deltathree, Inc., YourDay Acquisition Corp.,
YourDay.com, Inc. and SenseNet Inc.

23.1 Consent of Brightman Almagor & Co.

24.1 Power of Attorney (included on Signature Page).

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

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

** Incorporated by reference to the Company's quarterly report on Form 10-Q
filed on May 15, 2000.

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

(b) Reports on Form 8-K.

During fiscal 2000, we did not file any reports on Form 8-K.

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

DELTATHREE, INC.

Independent Auditors' Report................................ F-2

Consolidated Balance Sheets as of December 31, 2000 and
1999...................................................... F-3

Consolidated Statements of Operations for the years ended
December 31, 2000, 1999 and 1998.......................... F-4

Statements of Changes in Stockholders' Equity for the years
ended
December 31, 2000, 1999 and 1998.......................... F-5

Consolidated Statements of Cash Flows for the years ended
December 31, 2000, 1999 and 1998.......................... F-6

Notes to Consolidated Financial Statements.................. F-7

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

All financial statement schedules have been omitted because (i) the required
information is not present in amounts sufficient to require submission of such
schedules, (ii) the information required is included in the Consolidated
Financial Statements or the Notes thereto or (iii) the information required in
the schedules is not applicable to the Company.

F-1

INDEPENDENT AUDITORS' REPORT

To the stockholders of
deltathree, Inc.

We have audited the accompanying consolidated balance sheets of
deltathree, Inc. (the "Company") as of December 31, 2000 and 1999 and the
related consolidated statements of operations, changes in stockholders' equity
and cash flows for each of the three years in the period ended December 31,
2000. These consolidated financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.

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

In our opinion, such consolidated financial statements present fairly, in
all material respects, the consolidated financial position of the Company as of
December 31, 2000 and 1999, and the consolidated results of its operations and
cash flows for each of the three years in the period ended December 31, 2000 in
conformity with generally accepted accounting principles.

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

Tel Aviv, Israel
February 11, 2001, except
for Note 16 as to which the
date is March 19, 2001

F-2

DELTATHREE, INC.

CONSOLIDATED BALANCE SHEETS

DECEMBER 31,
-------------------
2000 1999
-------- --------
($ IN THOUSANDS)

ASSETS
CURRENT ASSETS:
Cash and cash equivalents................................. $20,857 $ 89,957
Short-term investments.................................... 30,542 11,276
Accounts receivable, net (Note 3)......................... 3,245 903
Due from affiliates (Note 4).............................. 331 1,760
Prepaid expenses and other current assets (Note 5)........ 2,084 3,090
------- --------
Total current assets.................................. 57,059 106,986
------- --------
INVESTMENTS................................................. -- 90
------- --------
PROPERTY AND EQUIPMENT: (NOTE 6)
Telecommunications equipment.............................. 14,686 8,940
Furniture, fixtures and other............................. 2,169 412
Leasehold improvements.................................... 4,927 309
Computers hardware & software............................. 4,579 904
------- --------
26,361 10,565
Less accumulated depreciation............................. (4,091) (1,066)
------- --------
Property and equipment, net........................... 22,270 9,499
------- --------
GOODWILL, NET (NOTE 7)...................................... 6,425 9,457
------- --------
DEPOSITS.................................................... 415 800
------- --------
Total assets.............................................. $86,169 $126,832
======= ========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Short-term debt due to affiliates......................... $ -- $ 14,752
Accounts payable.......................................... 5,236 2,580
Due to affiliates (Note 4)................................ 2,721 626
Deferred revenues......................................... 251 538
Other current liabilities (Note 8)........................ 5,313 5,548
------- --------
Total current liabilities............................. 13,521 24,044
------- --------
LONG-TERM LIABILITIES:
Severance pay obligations (Note 9)........................ 169 208
------- --------
Total liabilities..................................... 13,690 24,252
------- --------
COMMITMENTS AND CONTINGENCIES (NOTE 10)

STOCKHOLDERS' EQUITY: (NOTE 11)
Class A Common stock, -- par value $0.001; authorized
200,000,000 shares; issued and outstanding 9,465,099 at
December 31, 2000; 8,918,132 at December 31, 1999....... 9 9
Class B Common stock -- par value $0.001; authorized
200,000,000; issued and outstanding 19,569,460 at
December 31, 2000 and 1999.............................. 20 20
Preferred stock, par value $0.001; authorized 25,000,000
shares; no shares issued and outstanding at December 31,
2000 and 1999........................................... -- --
Additional paid-in capital................................ 166,733 157,891
Receivable for capital stock.............................. -- (1,232)
Deferred compensation..................................... (2,588) (10,670)
Accumulated deficit....................................... (91,695) (43,438)
------- --------
Total stockholder's equity............................ 72,479 102,580
------- --------
Total liabilities and stockholder's equity............ $86,169 $126,832
======= ========

The accompanying notes are an integral part of these financial statements.

F-3

DELTATHREE, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

YEAR ENDED DECEMBER 31,
------------------------------------
2000 1999 1998
---------- ---------- ----------
($ IN THOUSANDS, EXCEPT SHARE DATA)

Revenues (Note 15):
Affiliates............................................. $ 13,977 $ 7,431 $ 3,896
Non-affiliates......................................... 16,399 3,621 1,742
---------- ---------- ----------
Total revenues....................................... 30,376 11,052 5,638
Costs and operating expenses:
Cost of revenues, net.................................. 24,932 9,723 4,459
Research and development expenses, net (Note 12)....... 6,625 1,233 650
Selling and marketing expenses......................... 20,548 7,403 2,431
General and administrative expenses (exclusive of
non-cash compensation expense shown below)........... 6,694 2,754 1,842
Non-cash compensation expense.......................... 6,331 19,116 743
Depreciation and amortization.......................... 7,919 3,721 2,671
Impairment of goodwill (Note 13)....................... 8,905 -- --
---------- ---------- ----------
Total costs and operating expenses................... 81,954 43,950 12,796
---------- ---------- ----------
Loss from operations..................................... (51,578) (32,898) (7,158)
Interest income (expense), net........................... 3,632 (873) (186)
Minority interest........................................ -- -- 223
---------- ---------- ----------
Loss before income taxes................................. (47,946) (33,771) (7,121)
Income taxes (Note 14)................................... 311 -- --
---------- ---------- ----------
Net loss................................................. $ (48,257) $ (33,771) $ (7,121)
========== ========== ==========
Net loss per share--basic and diluted.................... $ (1.67) $ (1.65) $ (0.37)
========== ========== ==========
Weighted average shares outstanding--basic and diluted... 28,832,708 20,418,457 19,253,855
========== ========== ==========

The accompanying notes are an integral part of these financial statements.

F-4

DELTATHREE, INC.
STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
($ IN THOUSANDS, EXCEPT SHARE DATA)

CLASS A CLASS B RECEIVABLE
COMMON STOCK COMMON STOCK ADDITIONAL FOR
--------------------- ---------------------- PAID-IN CAPITAL ACCUMULATED
SHARES AMOUNT SHARES AMOUNT CAPITAL STOCK DEFICIT
---------- -------- ----------- -------- ---------- ---------- ------------

Balance at January 1, 1998......... -- -- 18,938,249 $19 $ 8,799 -- $ (2,546)
Conversion of debt and warrants to
equity........................... 631,210 1 657
Deferred compensation expense...... 1,809
Amortization of deferred
compensation expense.............
Recognition of pushdown of
goodwill......................... 11,819
Net loss........................... (7,121)
--------
Balance at December 31, 1998....... -- -- 19,569,459 20 23,084 -- (9,667)

Issuance of common stock in initial
public offering, net of expenses
(including over-allotment of
shares).......................... 6,900,000 7 93,855
Issue of shares to employees....... 748,288 1 232 (232)
Issue of shares to Yahoo!.......... 183,901 * 1,000 (1,000)
Issue of shares to CNET............ 1,085,943 1 11,000
Deferred compensation expense to
Yahoo! and CNET.................. 4,397
Deferred compensation expense to
employees........................ 24,323
Amortization of deferred
compensation expense.............
Net loss........................... (33,771)
--------
Balance at December 31, 1999....... 8,918,132 9 19,569,459 $20 $157,891 (1,232) (43,438)
========== ======== =========== === ======== ======= ========
Issuance of common stock in
purchase of subsidiary........... 227,738 10,500
Issuance expenses.................. (272)
Cancellation of options............ (2,751)
Exercise of employee options....... 319,229 1,365 232
Offset of receivable against debt
to
Yahoo! for services rendered..... 1,000
Amortization of deferred
compensation expense.............
Net loss........................... (48,257)
---------- -------- ----------- --- -------- ------- --------
Balance at December 31, 2000....... $9,465,099 $ 9 19,569,459 $20 $166,733 $ -- $(91,695)
========== ======== =========== === ======== ======= ========

TOTAL
STOCKHOLDERS'
DEFERRED EQUITY
COMPENSATION (DEFICIENCY)
------------- -------------

Balance at January 1, 1998......... -- $ 6,272
Conversion of debt and warrants to
equity........................... 658
Deferred compensation expense...... (1,809) --
Amortization of deferred
compensation expense............. 743 743
Recognition of pushdown of
goodwill......................... 11,819
Net loss........................... (7,121)
---------
Balance at December 31, 1998....... (1,066) 12,371
Issuance of common stock in initial
public offering, net of expenses
(including over-allotment of
shares).......................... 93,862
Issue of shares to employees....... 1
Issue of shares to Yahoo!.......... *
Issue of shares to CNET............ 11,001
Deferred compensation expense to
Yahoo! and CNET.................. (4,397) --
Deferred compensation expense to
employees........................ (24,323) --
Amortization of deferred
compensation expense............. 19,116 19,116
Net loss........................... (33, 771)
---------
Balance at December 31, 1999....... (10,670) 102,580
======== =========
Issuance of common stock in
purchase of subsidiary........... 10,500
Issuance expenses.................. (272)
Cancellation of options............ 2,751 --
Exercise of employee options....... 1,597
Offset of receivable against debt
to
Yahoo! for services rendered..... 1,000
Amortization of deferred
compensation expense............. 5,331 5,331
Net loss........................... (48,257)
-------- ---------
Balance at December 31, 2000....... $ (2,588) $ 72,479
======== =========

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

* Less than $1,000.

The accompanying notes are an integral part of these financial statements.

F-5

DELTATHREE, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

YEAR ENDED DECEMBER 31,
------------------------------
2000 1999 1998
-------- -------- --------
($ IN THOUSANDS)

CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss.................................................... $(48,257) $(33,771) $(7,121)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization........................... 7,919 3,721 2,671
Impairment of goodwill.................................. 8,905 -- --
Amortization of deferred compensation................... 6,331 19,116 743
Write-down of investment................................ 11 -- 25
Minority interest....................................... -- (21) (224)
Increase (decrease) in liability for severance pay...... (39) (25) 148
Provision for losses on accounts receivable............. 199 (275) 227
Changes in assets and liabilities:........................ --
Decrease (increase) in accounts receivable.............. (2,541) (85) 78
Decrease in other current assets and due from
affiliates............................................. (168) (2,037) (2,270)
Increase (decrease) in accounts payable................. 2,656 (793) 1,734
Decrease in deferred revenues........................... (287) (1,072) (1,595)
Increase in current liabilities and due to affiliates... 1,860 5,467 1,827
-------- -------- -------
24,846 23,996 3,364
-------- -------- -------
Net cash used in operating activities................... (23,411) (9,775) (3,757)
-------- -------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment...................... (13,585) (2,848) (3,003)
Proceeds from disposal of property and equipment........ 54 -- --
Proceeds from sale of investment........................ 150 -- --
Increase (decrease) in deposits......................... 385 (685) (61)
Equity investments...................................... -- -- (25)
Other................................................... -- -- 15
-------- -------- -------
Net cash used in investing activities................... (12,996) (3,533) (3,074)
-------- -------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Decrease in short-term investments........................ (19,266) (11,276) --
Proceeds from issuance of capital stock................... -- 104,864 --
Proceeds (repayment) of short-term debt from affiliates... (14,752) 8,320 5,000
Expenses relating to share issuance in 1999............... (272) -- --
Payment of other long-term debt........................... -- -- (8)
Proceeds from exercise of employee options................ 1,597 -- --
-------- -------- -------
Net cash provided by (used in) financing activities......... (32,693) 101,908 4,992
-------- -------- -------
Increase (decrease) in cash and cash equivalents............ (69,100) 88,600 (1,839)
Cash and cash equivalents at beginning of year.............. 89,957 1,357 3,196
-------- -------- -------
CASH AND CASH EQUIVALENTS AT END OF YEAR.................... $ 20,857 $ 89,957 $ 1,357
======== ======== =======
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid for:
Interest................................................ $ 1,332 $ -- $ --
Taxes................................................... $ 311 $ -- $ --
SUPPLEMENTAL SCHEDULE OF NON CASH INVESTING AND FINANCING
ACTIVITIES:
Conversion of convertible notes and warrants into capital
stock................................................... $ -- $ -- $ 658
Assets purchased in exchange of a receivable (See note
6)...................................................... $ 2,500 $ -- $ --
Assets purchased in exchange of shares (See note 13)...... $ 10,500 $ -- $ --
Assets acquired with vendor credits....................... $ -- $ -- $ 3,000
Recognition of pushdown of goodwill....................... $ -- $ -- $11,819

The accompanying notes are an integral part of these financial statements

F-6

DELTATHREE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1--THE COMPANY

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

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

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

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

Since the Company's initial public offering in November 1999, RSL COM owns
100% of the outstanding Class B common stock, which represents approximately
95.5% of the combined voting power of all the Company's outstanding capital
stock and approximately 67.4% of the economic interest in the Company. In March
2001, RSL COM commenced insolvency proceedings in Bermuda. The outcome of this
proceeding may result in either a restructuring of RSL COM's obligations or the
sale of RSL COM's assets.

NOTE 2--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

A. PRINCIPLES OF CONSOLIDATION AND BASIS OF PRESENTATION

The consolidated financial statements include the accounts of
deltathree, Inc. and its subsidiaries. All significant intercompany accounts and
transactions have been eliminated in consolidation.

B. USE OF ESTIMATES

The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions, primarily for allowances for doubtful accounts receivable and the
useful lives of fixed assets and intangible assets, that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the

F-7

DELTATHREE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 2--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
financial statements, and the reported amounts of revenues and expenses during
the reporting period. Actual results could differ from those estimates.

C. CASH AND CASH EQUIVALENTS

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

D. REVENUE RECOGNITION AND DEFERRED REVENUE

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

E. COST OF REVENUES

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

F. RESEARCH AND DEVELOPMENT EXPENSES

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

G. ADVERTISING EXPENSES

Advertising expenses are expensed as incurred. For the years ended
December 31, 2000, 1999 and 1998, advertising expenses were approximately
$170,000, $87,000 and $124,000, respectively.

H. ALLOWANCE FOR DOUBTFUL ACCOUNTS

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

I. PROPERTY AND EQUIPMENT AND RELATED DEPRECIATION

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

J. GOODWILL AND RELATED AMORTIZATION

Goodwill represents the excess of cost over the fair value of the Company's
net assets, which have been "pushed down" by RSL COM's acquisitions of the
Company in 1997 and 1998, and is being amortized using the straight-line method
over five years.

F-8

DELTATHREE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 2--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
K. IMPAIRMENT OF LONG-LIVED ASSETS AND GOODWILL

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

L. INCOME TAXES

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

M. NET LOSS PER SHARE

Basic and diluted net loss per share have been computed in accordance with
SFAS No. 128, "Earnings Per Share", using the weighted average number of shares
outstanding. Outstanding common stock options are not included in the net loss
per share calculation as their effect is anti-dilutive.

N. CONCENTRATION OF CREDIT RISK

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

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

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

O. FAIR VALUE OF FINANCIAL INSTRUMENTS

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

P. EFFECTS OF RECENTLY ISSUED ACCOUNTING STANDARDS

SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities," as amended standardizes the accounting for derivative instruments
and hedging activities by requiring that an entity

F-9

DELTATHREE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 2--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
recognize all derivatives as either assets or liabilities in the statement of
financial position and measure those instruments at fair value. When certain
criteria are met, SFAS No. 133 also provides for matching the timing of gain or
loss recognition on the derivative hedging instrument with the recognition of
(a) the changes in the fair value or cash flows of the hedged asset or liability
attributable to the hedged risk or (b) the earnings effect of the hedged
forecasted transaction. This statement will be adopted effective January 1,
2001, but is not expected to materially impact the Company's financial
statements.

Q. STOCK-BASED COMPENSATION

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

R. RECLASSIFICATIONS

Certain previously reported amounts have been reclassified to conform with
the 2000 presentation.

NOTE 3--ACCOUNTS RECEIVABLE, NET

Accounts receivable are stated net of an allowance for doubtful accounts of
$251,000 and $52,000 at December 31, 2000 and 1999, respectively.

NOTE 4--DUE FROM/TO AFFILIATES

The balances due from and due to affiliates are for services rendered by and
to the Company and are non-interest bearing.

NOTE 5--PREPAID EXPENSES AND OTHER CURRENT ASSETS

Prepaid expenses and other current assets consist of the following:

DECEMBER 31,
-----------------------
2000 1999
-------- --------
($ IN THOUSANDS)

Government of Israel (VAT refund and other).............. $ 59 $ 55
Deposits with suppliers.................................. 189 150
Prepaid expenses......................................... 1,141 1,333
Loan to employee......................................... -- 977
Other.................................................... 695 575
------ ------
Total prepaid expenses and other current assets........ $2,084 $3,090
====== ======

NOTE 6--PROPERTY AND EQUIPMENT

In December 2000, the Company purchased from one of its customers, in
exchange for an outstanding balance of $2.5 million owed to the Company, the
source code of a Web-based document

F-10

DELTATHREE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 6--PROPERTY AND EQUIPMENT (CONTINUED)
management system that allows an organization to create, modify and utilize any
type of electronic documents with any Web-based browser.

NOTE 7--GOODWILL, NET

Goodwill consists of the following:

DECEMBER 31,
-------------------
2000 1999
-------- --------
($ IN THOUSANDS)

Goodwill from acquisition of the Company by RSL COM
(see Note 1)............................................ $15,158 $15,158
Less--accumulated amortization............................ (8,733) (5,701)
------- -------
Total goodwill, net................................... $ 6,425 $ 9,457
======= =======

NOTE 8--OTHER CURRENT LIABILITIES

Other current liabilities consist of the following:

DECEMBER 31,
-----------------------
2000 1999
-------- --------
($ IN THOUSANDS)

Accrued expenses......................................... $3,461 $2,971
Employees and related expenses........................... 1,099 2,451
Deposits from customers.................................. -- 15
Other.................................................... 753 111
------ ------
Total other current liabilities........................ $5,313 $5,548
====== ======

NOTE 9--SEVERANCE PAY OBLIGATIONS

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

Expenses relating to employee termination benefits were $101,000 $42,000 and
$148,000 for the years ended December 31, 2000, 1999 and 1998, respectively.

NOTE 10--COMMITMENTS AND CONTINGENCIES

A. SERVICES AGREEMENT WITH RSL COM

In July 1997, the Company entered into a three-year services agreement with
RSL COM, which was subsequently amended and restated as of September 1999 to
extend to September 2004. Pursuant to this agreement, RSL COM is required to use
its reasonable best efforts to provide the Company

F-11

DELTATHREE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 10--COMMITMENTS AND CONTINGENCIES (CONTINUED)
with certain office and equipment space and to assist the Company in obtaining
Internet, frame-relay and dedicated lines from third parties. In addition, RSL
COM is required under the agreement to provide the Company with various
communications services at rates set forth in the agreement. The agreement also
provides that the Company is required, at RSL COM's request, to use up to 50% of
its network capacity to route RSL COM's international telecommunications traffic
at rates set forth in the agreement.

Based on a cost analysis performed by the Company, management believes that
the amounts reflected in the financial statements pursuant to the above services
agreement do not materially differ from amounts which the Company would have
recognized or incurred in providing or obtaining equivalent services on an
arms-length basis.

B. OTHER MARKETING AND COOPERATION AGREEMENTS

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

C. INDENTURES GOVERNING DEBT OF RSL COM

The Company is subject to covenants by reason of its status as a restricted
subsidiary of RSL COM under the indentures governing a substantial amount of RSL
COM's debt. These restrictions significantly limit the ability of the Company to
incur additional indebtedness or create liens on its assets. The Company's
ability to incur indebtedness is limited by the amount of indebtedness that RSL
COM and the Company are permitted to incur under the indentures. Such
restrictions also limit the Company's ability to pay dividends or make other
distributions in respect of the Company's capital stock, sell assets, engage in
mergers or acquisitions or make some types of investments. These restrictions
also limit the ability of a third party to acquire a controlling interest in the
Company. These restrictions may prohibit transactions that would otherwise be
beneficial to the Company. In March 2001, RSL COM and certain of its
subsidiaries commenced insolvency proceedings and other RSL COM subsidiaries
filed to reorganize under Chapter 11 of the U.S. Bankruptcy Code. The effect of
the outcome of these proceedings on RSL COM's and the Company's obligations
under the indentures is uncertain.

D. LEASE COMMITMENTS

In December 1999, the Company entered into a lease for headquarters of its
United States operations with an initial cost of $398,000, increasing to
$530,000 during the final year of the lease. The lease extends until
December 2009 with an option to extend the lease for an additional five years.
During February 2000, the Company signed an addendum to the lease pursuant to
which an additional floor was leased, with the same terms, for an initial cost
of $254,000, increasing to $342,000 during the final year of the lease.

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

In addition, the Company leases offices in Israel at an annual cost of
$240,000 plus Israeli value-added tax. The lease term extends until
February 2003, with an option to extend the lease for an additional five years.
The Company has entered into a lease for additional space in its existing
location in Israel at an annual cost of $52,000. The term of the lease extends
until January 31, 2003, with an option to extend the lease for an additional
five years.

F-12

DELTATHREE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 10--COMMITMENTS AND CONTINGENCIES (CONTINUED)

E. LEGAL PROCEEDINGS

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

NOTE 11--STOCKHOLDERS' EQUITY

A. SHARE CAPITAL

Following the Company's initial public offering in November 1999, the
Company's Class A common stock is listed on the Nasdaq National Market System.

Each share of Class B common stock is convertible into one share of Class A
common stock at any time. The holders of the Class B common stock are entitled
to ten votes per share. The holders of the Class A common stock are entitled to
one vote per share.

B. YAHOO! INC. TRANSACTION

On October 18, 1999, the Company issued to Yahoo! Inc. 125,275 shares of
Class A common stock and a warrant to purchase 125,275 shares of Class A common
stock at an exercise price of $7.98 per share. The Company recorded the
$1 million purchase price of the 125,275 Class A common stock as a receivable.
The Company had a legal and enforceable right to collect the $1 million in cash.
The Company elected to offset the Yahoo! receivable against the first
$1 million due under a separate advertising and promotional agreement, as
described below. In December 1999 Yahoo! exercised the warrant utilizing a
cashless exercise, and the Company issued to Yahoo! 58,626 shares of Class A
common stock. The Company recorded approximately $1,007,000 of deferred
compensation expense in 1999 related to the issuance of the shares representing
the difference between each of the purchase price of the Class A common stock as
compared to the initial public offering price of the Class A common stock and
the fair value of the warrant. The fair value of the warrant has been measured
by utilizing the Black-Scholes option pricing model. The deferred compensation
was amortized over the one-year life of the Yahoo! advertising and promotion
agreement described below.

In addition, on October 18, 1999, the Company entered into a binding
advertising and promotion agreement whereby Yahoo! Inc. provided 226,038,600
page views to the Company over a one-year period commencing in December 1999. In
consideration for such page views, the Company paid Yahoo! $ 5,000,000. Under
the terms of the advertising and promotion agreement, the Company made a cash
payment of $1,600,000 on the effective date of the agreement and an addition
twelve cash payments of

F-13

DELTATHREE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 11--STOCKHOLDERS' EQUITY (CONTINUED)
$283,333 over the twelve months following the effective date. The $5,000,000 was
charged to expense using the straight-line basis over the one-year life of the
contract.

C. CNET TRANSACTION

On October 20, 1999, the Company issued to CNET Investments, Inc. 1,085,943
shares of Class A common stock and a warrant to purchase 466,028 shares of
Class A common stock at an exercise price of $19.31 per share, or approximately
$11.0 million in the aggregate, which was received in cash by the Company upon
the issuance of the shares. The Company recorded approximately $2.7 million of
deferred compensation expense in 1999 related to the issuance of the shares
representing the difference between each of the purchase price of the Class A
common stock as compared to the initial public offering price of the Class A
common stock and the issuance of the warrant (using the Black-Scholes option
pricing model for determining the fair value of the warrant). Amortization of
the deferred compensation for the year ended December 31, 2000 amounted to
$1,062,000.

In addition, the Company entered into a binding development and promotion
agreement with CNET in September 1999, which was amended effective July 1, 2000,
whereby CNET provides various promotions to the Company to assist in promoting
its PC-to-Phone product and related services. In consideration for these
services, the Company is obligated to pay CNET a total of $11,000,000. Through
December 31, 2000, the Company had paid CNET a total of $4,839,566. The Company
will pay CNET an additional $146,677 per month through June 30, 2004.

D. YOURDAY.COM TRANSACTION

In February 2000, the Company issued 227,738 shares of Class A common stock,
at an average market price of $46 per share, amounting to $10,500,000 in the
aggregate to acquire all the outstanding shares of YourDay.com, Inc.

The acquisition was accounted for as a purchase and the purchase price has
been allocated on the basis of the estimated fair value of the assets acquired
and liabilities assumed, as follows:

Current liabilities......................................... $ (32)
Property and equipment...................................... 370
Intangible assets goodwill related to acquired technology... 10,162
-------
$10,500
=======

E. RESTRICTED UNITS

Through April 1999, a total of 1,121,324 restricted units had been granted
to employees of the Company under the 1997 RSL COM Stock Incentive Plan. The
restricted units were convertible into shares of RSL COM Class A common stock or
cash (at RSL's discretion) based on the value of the Company on December 31 of
each year, as determined with reference to the value of RSL COM. Of these
restricted units, 836,147 have an exercise price of $0.0004 and were granted in
1997 and 1998 and 189,262 have an exercise price of $2.08, and were granted in
1998. In April 1999, an additional 95,915 restricted units were granted to
employees of the Company with an exercise price of $5.11. The majority of the
restricted units vest over a three-year period from the date of grant and were
exercisable for a period of seven years from the date of grant. Upon completion
of the Company's initial public offering, the Company issued shares of Class A
common stock in exchange for vested restricted units on a one-for-one basis upon
payment of the related exercise price and issued options to

F-14

DELTATHREE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 11--STOCKHOLDERS' EQUITY (CONTINUED)
purchase shares of Class A common stock in exchange for unvested restricted
units on a one-for-one basis, with the same exercise prices and vesting
schedules as the corresponding restricted units.

Pursuant to generally accepted accounting principles, the restricted units
were considered variable awards. Consequently, the changes in the fair value of
the underlying shares at each balance sheet date affected the aggregate amount
of deferred compensation recorded by the Company. The Company recorded deferred
compensation in connection with the restricted unit grants of approximately
$1,800,000 through December 31, 1998 and an additional $14,393,000 during the
year ended December 31, 1999. The additional amount for 1999, resulting from the
difference between the fair value of restricted units and the initial offering
price of $15, was included as a reduction of stockholders' equity and is being
amortized by charges to operations over the vesting period.

F. STOCK OPTIONS

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

The Company recorded deferred compensation related to the stock options of
approximately $9,930,000 as of December 31, 1999, representing the difference
between the exercise price and the initial offering price of $15.00. Such amount
is included as a reduction in stockholders' equity and is being amortized by
charges to operations over the three-year vesting period.

In November 1999, the Company adopted the 1999 Stock Incentive Plan ("the
Plan"). Under the Plan, 4,000,000 shares of Class A were reserved for issuance
upon exercise of awards to be granted. In addition, the Company's compensation
committee may grant both incentive and non-incentive stock options for shares of
Class A common stock of the Company. The options generally have a term of seven
years and become exercisable in three years in equal installments commencing on
the first anniversary of the date of the grant. The purchase price per share
payable upon exercise of an option is no less than the fair market value of the
share at the date of grant. As of December 31, 2000, options to purchase 977,800
shares of Class A were outstanding with exercise prices ranging between $6.78
and $47.50 per share.

A summary of the status of the Company's stock option plans as of
December 31, 2000 and 1999 and changes during the years then ended, is presented
below:

DECEMBER 31,
-----------------------------------------------------------
2000 1999
---------------------------- ----------------------------
WEIGHTED AVERAGE WEIGHTED AVERAGE
SHARES EXERCISE PRICE SHARES EXERCISE PRICE
--------- ---------------- --------- ----------------

Options outstanding at beginning
of year......................... 1,952,537 $7.54 -- $ --
Granted during the year........... 475,000 7.85 1,952,537 7.54
Exercised during the year......... 319,229 4.10 -- --
Forfeited during the year......... 481,465 6.54 -- --
--------- ----- --------- ------
1,626,843 $8.72 1,952,537 $ 7.54
========= ===== ========= ======
Weighted average fair value of
options granted during the
year............................ $ 4.00 $ 9.00
========= =========

F-15

DELTATHREE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 11--STOCKHOLDERS' EQUITY (CONTINUED)
If compensation cost for the Company's stock options and restricted units
had been determined based on fair value at the grant date in accordance with
SFAS No. 123, the Company's pro forma basic and diluted net loss and pro forma
diluted net loss per share would have been as follows:

YEAR ENDED DECEMBER 31,
------------------------------------
2000 1999 1998
---------- ---------- ----------
($ IN THOUSANDS, EXCEPT SHARE DATA)

Net loss:
As reported................................... $(48,257) $(33,771) $(7,121)
Pro forma..................................... $(50,453) $(34,357) $(6,475)
Net loss per share--basic and diluted:
As reported................................... $ (1.67) $ (1.65) $ (0.37)
Pro forma..................................... $ (1.75) $ (1.68) $ (0.34)

For the purpose of presenting pro forma information required under SFAS
No. 123, the fair value of each restricted unit and option grant has been
estimated on the date of grant using the minimum value method for grants in 1997
and 1998 and the period to November 22, 1999 (the date of the Company's initial
public offering) and the Black-Scholes option pricing model for grants made
after the Company became a public entity. The following assumptions were used:
dividend yield of 0.00%; risk-free interest rate of 6%; an expected life of
three years; and a volatility rate of 70%.

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

G. EMPLOYEE STOCK PURCHASE PLAN

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

All full-time employees who have been employed by the Company for at least
one calendar quarter are eligible to participate in the ESPP. Employee stock
purchases are made through payroll deductions. Under the terms of the ESPP,
employees may not deduct an amount that exceeds $25,000 in total value of stock
in any one year. The purchase price of the stock will be the lower of 85% of the
fair market value on the first trading day of the offering period or the last
trading day of the purchase period. The ESPP shall terminate upon the first to
occur of (i) December 31, 2009 or (ii) the date on which the ESPP is terminated
by the Board of Directors. During 2000, there were aggregate purchases of 1,072
shares under the ESPP.

F-16

DELTATHREE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 12--RESEARCH AND DEVELOPMENT EXPENSES, NET

A. RESEARCH AND DEVELOPMENT EXPENSES CONSIST OF THE FOLLOWING:

YEAR ENDED DECEMBER 31,
------------------------------
2000 1999 1998
-------- -------- --------
($ IN THOUSANDS)

Salaries and related expenses........................ $5,388 $1,735 $ 948
Consulting and advisory fees......................... -- 225 197
Travel............................................... 344 125 146
Other................................................ 893 253 260
------ ------ -----
6,625 2,338 1,551
Less--reimbursement by Ericsson...................... -- (1,105) (901)
------ ------ -----
Total research and development expenses........ $6,625 $1,233 $ 650
====== ====== =====

B. TECHNOLOGY AND MARKETING AGREEMENT WITH ERICSSON INC.

In October 1997, the Company entered into a technology and marketing
alliance with Ericsson Inc. for the development and deployment of advanced IP
telephony gateways and communications software. Under this agreement, the
Company is entitled to purchase hardware and software on preferential terms.

During 1998 and 1999, due to difficulties in integrating the hardware and
software purchased from Ericsson into the Company's network, the Company
incurred significant costs. To compensate the Company for its costs, Ericsson
agreed to offset amounts owed by the Company to Ericsson for network
telecommunications equipment previously purchased from Ericsson with a fair
value of $3 million. This offset represents Ericsson's reimbursement of the
costs previously incurred by the Company. For the year ended December 31, 1999,
the Company recognized $1,105,000 as an offset to research and development
expenses, and $299,000 as an offset to cost of revenues incurred in respect of
the network telecommunications equipment.

NOTE 13--IMPAIRMENT OF GOODWILL

In February 2000, the Company issued 227,738 shares of Class A common stock,
at an average market price of $46.00 per share, amounting to $10,500,000 in the
aggregate to acquire all the outstanding shares of YourDay.com, Inc.

In November 2000, the Company decided to deemphasize its consumer business
and communications portal, and focus on generating revenues primarily through
sales of its Hosted Communications Solution. As a result, the Yourday.com
technology was not incorporated into the Company's offerings. Accordingly, the
Company made a full write-off of the Yourday.com technology in the amount of
$8,905,000.

NOTE 14--INCOME TAXES

A. TAX LOSS CARRYFORWARDS

As of December 31, 2000, the Company had net operating loss carryforwards
generated in the U.S. and Israel of approximately $94,859,000 and $1,869,000,
respectively. The Company's U.S. net operating loss carryforwards will expire at
various dates beginning in 2011 if not utilized. In addition, a portion of

F-17

DELTATHREE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 14--INCOME TAXES (CONTINUED)
those net operating loss carryforwards could be subject to limitation due to RSL
COM's acquisition of the Company. The Company's net operating losses generated
in Israel may be carried forward indefinitely.

B. IN ACCORDANCE WITH SFAS NO. 109, THE COMPONENTS OF DEFERRED INCOME TAXES ARE
AS FOLLOWS:

DECEMBER 31,
------------------------------
2000 1999 1998
-------- -------- --------
($ IN THOUSANDS)

Net operating losses carryforwards................ $34,822 $14,403 $3,500
Less valuation allowance.......................... (34,822) (14,403) (3,500)
------- ------- ------
Net deferred tax assets......................... $ -- $ -- $ --
======= ======= ======

As of December 31, 2000, 1999 and 1998, a valuation allowance of
$34,822,000, $14,403,000 and $3,500,000, respectively, is provided as the
realization of the deferred tax assets are not assured.

NOTE 15--SEGMENT REPORTING, GEOGRAPHICAL INFORMATION AND MAJOR CUSTOMERS

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

YEAR ENDED DECEMBER 31,
------------------------------
2000 1999 1998
-------- -------- --------
(US$ IN THOUSANDS)

Revenues by geographical location:
United States............................................. $20,862 $ 7,521 $4,922
Europe.................................................... 5,289 1,326 528
South America............................................. -- 113 34
Asia...................................................... 3,162 1,174 --
Other..................................................... 1,063 918 154
------- ------- ------
Total revenues........................................ $30,376 $11,052 $5,638
------- ------- ------
Revenues from principal customers:
Affiliates................................................ $13,977 $ 7,431 $3,896
======= ======= ======

DECEMBER 31,
-------------------
2000 1999
-------- --------
($ IN THOUSANDS)

Long-lived assets:
United States............................................. $14,972 $4,933
Israel.................................................... 3,251 1,899
Europe.................................................... 2,747 435
Other..................................................... 1,300 2,232
------- ------
Total long-lived assets............................... $22,270 $9,499
======= ======

F-18

DELTATHREE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 16--SUBSEQUENT EVENT

F-19

SIGNATURES

Pursuant to the requirements of Sections 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this annual report to be
signed on its behalf by the undersigned, thereunto duly authorized, in the City
of New York, New York on the 30th day of March, 2001.

DELTATHREE, INC.

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

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

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

SIGNATURE TITLE DATE
--------- ----- ----

Chief Executive Officer,
/s/ NOAM BARDIN President and Director
------------------------------------------- (Principal Executive March 30, 2001
Noam Bardin Officer)

/s/ PAUL C. WHITE Chief Financial Officer
------------------------------------------- (Principal Accounting and March 30, 2001
Paul C. White Financial Officer)

------------------------------------------- Chairman of the Board of
Paul Domorski Directors

------------------------------------------- Director
Avery S. Fischer

/s/ ITZHAK FISHER
------------------------------------------- Director March 29, 2001
Itzhak Fisher

/s/ ROBERT R. GRUSKY
------------------------------------------- Director March 30, 2001
Robert R. Grusky

/s/ YADIN KAUFMANN
------------------------------------------- Director March 30, 2001
Yadin Kaufmann

SIGNATURE TITLE DATE
--------- ----- ----

/s/ JACOB Z. SCHUSTER
------------------------------------------- Director March 30, 2001
Jacob Z. Schuster

------------------------------------------- Director
Nir Tarlovsky

------------------------------------------- Director
Oakleigh Thorne

/s/ ERIC ZINTERHOFER
------------------------------------------- Director March 30, 2001
Eric Zinterhofer