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# UNITED STATESSECURITIES AND EXCHANGE COMMISSIONWASHINGTON, D.C. 20549

# FORM 20  F

|o | REGISTRATION
STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ----------------------------------------------------------------------------------------------

# OR

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

| | For
the fiscal year ended December 31, 2004
| | -------------------------------------------

# OR

|o | TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ----------------------------------------------------------------------------------------

| | For
the transition period from _________ to __________
| | ------------------------------------------------------

Commission file number
0-30070

|AUDIOCODES LTD.                                                                                        
|-------------------------------------------------------------------------------------------------------
|                                                                                                       
|(Exact name of Registrant as specified in its charterand translation of Registrant's name into English)

|ISRAEL                                         
|-----------------------------------------------
|                                               
|(Jurisdiction of incorporation or organization)

|1 Hayarden Street, Airport City Lod 70151, Israel
|-------------------------------------------------
|                                                 
|(Address of principal executive offices)         

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

|Title of each classNone |  | Name of each exchange on which registered
|----------------------- |  | -----------------------------------------

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

|Ordinary Shares, nominal value NIS 0.01 per share
|-------------------------------------------------
|                                                 
|(Title of Class)                                 

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

|None            
|----------------
|                
|(Title of Class)

Indicate
the number of outstanding shares of each of the issuers classes of capital or common
stock as of the close of the period covered by the annual report.

As
of December 31, 2004, the Registrant had outstanding 39,865,993 Ordinary Shares, nominal
value NIS 0.01 per share.

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

Yes x         No o

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

Item 17 o
     Item 18
x



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# PART I

Unless
the context  otherwise  requires,  "AudioCodes,"  "us," "we" and "our" refer to
AudioCodes Ltd. and its subsidiaries.

| | ITEM 1. | IDENTITY
OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS
| | ------- | -----------------------------------------------------

| | Not
applicable.
| | ---------------

| | ITEM 2. | OFFER STATISTICS AND EXPECTED TIMETABLE
| | ------- | ---------------------------------------

| | Not
applicable.
| | ---------------

| | ITEM 3. | KEY INFORMATION
| | ------- | ---------------

|A. | SELECTED
FINANCIAL DATA
|-- | -----------------------

We
derived the consolidated statements of operations data for the years ended December 31,
2002, 2003 and 2004 and consolidated balance sheets data as of December 31, 2003 and 2004
from the audited consolidated financial statements set forth elsewhere in this Annual
Report. We derived the consolidated statements of operations data for the years ended
December 31, 2000 and 2001 and the consolidated balance sheets data as of December 31,
2000, 2001 and 2002 from audited consolidated financial statements that are not included
in this Annual Report.

On
October 6, 2000, we effected a two-for-one stock split in the form of a stock dividend.
All share and per share data for periods prior to and including that date have been
retroactively adjusted to reflect this stock split. All figures relating to outstanding
shares exclude shares held in treasury.



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(U.S. dollars in
thousands, except share and per share data)

|                                          | Year Ended December 31,
|----------------------------------------- | -----------------------
|
|
|
|
|Statement of Operations Data:             |                        
|Revenues                                  |                        
|Cost of revenues                          |                        
|                                          |                        
|Gross profit                              |                        
|Operating expense:                        |                        
|Research and development, net             |                        
|Selling and marketing                     |                        
|General and administrative                |                        
|                                          |                        
|Total operating expenses                  |                        
|                                          |                        
|Operating income (loss)                   |                        
|Financial income, net                     |                        
|Equity in losses of an affiliated company |                        
|                                          |                        
|Income (loss) before taxes on income      |                        
|Taxes on income                           |                        
|                                          |                        
|Net income (loss)                         |                        
|                                          |                        
|Basic net earnings (loss) per share       |                        
|                                          |                        
|Diluted net earnings (loss) per share     |                        
|                                          |                        
|Weighted average number of ordinary of    |                        
|shares used in computing basic net        |                        
|earnings (loss) per share                 |                        
|                                          |                        
|Weighted average number of ordinary       |                        
|shares used in computing diluted          |                        
|net earnings per share                    |                        
|                                          |                        

|                                       | December 31,
|-------------------------------------- | ------------
|
|
|
|
|Balance Sheet Data:                    |             
|Cash and cash equivalents              |             
|Short-term bank deposits               |             
|Working capital                        |             
|Long-term bank deposits and structured |             
|notes                                  |             
|Total assets                           |             
|Senior convertible notes               |             
|Total shareholders' equity             |             

|B. | CAPITALIZATION
AND INDEBTEDNESS
|-- | -------------------------------

| | Not
applicable.
| | ---------------

- 2 -

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|C. | REASONS
FOR THE OFFER AND USE OF PROCEEDS
|-- | -----------------------------------------

| | Not
applicable.
| | ---------------

|D. | RISK
FACTORS
|-- | ------------

We
are subject to various risks and uncertainties relating to or arising out of the nature of
our business and general business, economic, financing, legal and other factors or
conditions that may affect us. We believe that the occurrence of any one or some
combination of the following factors could have a material adverse effect on our business,
financial condition, cash flows and results of operations.

Risks Related to Our Business and
Industry

The
slowdown in capital expenditures by telecommunications service providers has had and could
continue to have a material adverse effect on our results of operations.

A
deterioration of economies around the world and economic uncertainty in the
telecommunications market began in 2000 and continued through 2003. This resulted in a
curtailment of capital investment by telecommunications carriers and service providers as
well as by businesses that use our products, referred to as the enterprise market. It also
reduced our ability to forecast orders, also referred to as low visibility. We
cannot be sure whether increased expenditures will continue to be made in the
telecommunications industry in general or in the voice over packet portion of the market.
The decline in capital expenditures has in the past had a substantial impact on our
results of operations with our revenues declining from $71.8 million in 2000 to $27.2
million in 2002 primarily as a result of such a decline. Because a substantial portion of
our operating expenses consist of salaries, we may not be able to reduce our operating
expenses in line with any reduction in revenues or may elect not to do so for business
reasons. As a result of this downturn and our relatively stable operating expenses, we
incurred a net loss of $13.3 million in 2001, $14.2 million in 2002 and $8.4 million in
2003. We will need to continue to generate increased revenues as well as manage our costs
to maintain profitability. Any future industry downturn may increase our inventories,
decrease our revenues, result in additional pressure on the price of our products and
prolong the time until we are paid, all of which would have a material adverse effect on
the results of our operations and on our cash flow from operations.

If
new products we recently introduced or expect to introduce in the near future fail to
generate the level of demand we originally anticipated, we will realize a lower than
expected return from our investment in research and development with respect to those
products, and our results of operations may suffer.

Our
success is dependent, in part, on the willingness of our customers to transition or
migrate to new products, such as our expanded offering of Mediant and Stretto systems, or
expected future products. We are involved in a continuous process of evaluating changing
market demands and customer requirements in order to develop and introduce new products,
features and applications to meet changing demands and requirements. We need to be able to
interpret market trends and the advancement of technology in order to successfully develop
and introduce new products, features and applications. If potential customers defer
transition or migration to new products, our return on our investment in research and
development with respect to products recently introduced or expected to be introduced in
the near future will be lower than we originally anticipated and our results of our
operations may suffer.

- 3 -

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Our
industry is rapidly evolving and we may not be able to keep pace with technological
changes, which could adversely affect our business.

The
transmission of voice, data and fax over data networks is rapidly evolving. Short product
life cycles place a premium on our ability to manage the transition from current products
to new products. Our future success in generating revenues will depend on our ability to
enhance our existing products and to develop and introduce new products and product
features. These products and features must keep pace with technological developments and
address the increasingly sophisticated needs of our customers. The development of new
technologies and products is increasingly complex and uncertain. This increases the
difficulty in coordinating the planning and production process and can result in delay in
the introduction of new technologies and products.

We
are dependent on the development of the VoP market to increase our sales.

The
market for Voice over Packet, or VoP, services is currently developing. We cannot be sure
that the delivery of telephone and other communications services over packet networks
rather than over traditional telephone networks will expand. We cannot be sure that packet
based voice networks will become widespread or that connections between packet networks
and telephone networks will become commonplace. The adaptation process of connecting
packet networks and telephone networks can be time consuming and costly. In addition,
limitations of VoP technology, such as the inability to make a call during a power outage
and difficulty in accessing 911 services, could adversely affect the market for VoP
services. Sales of our VoP products will depend on the development of packet networks and
the commercialization of VoP services. If this market does not develop, or develops more
slowly than we expect, we may not be able to sell our products in significant volume.

New
industry standards, the modification of our products to meet additional existing standards
or the addition of features to our products may delay the introduction of our products or
increase our costs.

The
industry standards that apply to our products are continually evolving. In addition, since
our products are integrated into networks consisting of elements manufactured by various
companies, they must comply with a number of industry standards and practices established
by various international bodies and industry forums. Should new standards gain broad
acceptance, we will be required to adopt those standards in our products. We may also
decide to modify our products to meet additional existing standards or add features to our
products. Standards may be adopted by various industry interest groups or may be
proprietary and nonetheless accepted broadly in the industry. It may take us a significant
amount of time to develop and design products incorporating these new standards. We may
also have to pay additional fees to the developers of the technologies which constitute
the newly adopted standards.

- 4 -

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Our
customers or potential customers may develop or prefer to develop their own technical
solutions, and as a result, would not buy our products.

Our
products are primarily sold as components or building blocks to large original equipment
manufacturers, or OEMs, or network equipment providers. Our customers incorporate
our products into their product offerings, usually in conjunction with value-added
services of their own or of third parties. Customers or potential customers may prefer to
develop their own technology or purchase third party technology. They could also
manufacture their own components or building blocks that are similar to the ones we offer.
Large customers have already committed significant resources in developing integrated
product offerings. Customers may decide that this gives them greater control over
supplies, specifications and performance. Customers may therefore not buy components from
an external manufacturer such as us. This could have an adverse impact on our ability to
sell our products and our revenues.

We
have depended on a small number of large customers. The loss of one of these customers or
the reduction in purchases by a significant customer could have a material adverse effect
on our revenue.

Historically,
a substantial portion of our revenue has been derived from large purchases by a small
number of OEMs and network equipment providers, systems integrators and distributors. For
example, our top three customers accounted for approximately 29.0% of our revenues in
2004, 26.9% of our revenues in 2003 and 22.4% of our revenues in 2002. Sales to Nortel
Networks accounted for 18.6% of our revenues in 2004 compared to 14.3% of our revenues in
2003 and 1.4% of our revenues in 2002. We do not enter into sales agreements in which the
customer is obligated to purchase a set quantity of our products. Based on our experience,
we expect that our customer base may change from period to period. If we lose a large
customer and fail to add new customers there could be a material adverse effect on our
results of operations.

Our
quarterly results of operations have fluctuated in the past and we expect these
fluctuations to continue. Fluctuations in our results of operations may disappoint
investors and result in a decline in our share price.

We
have experienced and expect to continue to experience significant fluctuations in our
quarterly results of operations. In some periods, our operating results may be below
public expectations. If this occurs, the market price of our ordinary shares could
decline.

The
following factors have affected our quarterly results of operations in the past and are
likely to affect our quarterly results of operations in the future:

| |  | size,
timing and pricing of orders, including order deferrals and delayed shipments;
| | - | ------------------------------------------------------------------------------------

| |  | launching
of new product generations;
| | - | -------------------------------------

| |  | length
of approval processes or market testing;
| | - | -----------------------------------------------

| |  | technological
changes in the telecommunications industry;
| | - | ---------------------------------------------------------

- 5 -

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| |  | competitive
pricing pressures;
| | - | ------------------------------

| |  | the
timing and approval of government research and development grants;
| | - | ----------------------------------------------------------------------

| |  | accuracy
of telephone  company,  distributor and original  equipment  manufacturer  forecasts of
their               customers' demands;
| | - | ----------------------------------------------------------------------------------------------------------------------------------------

| |  | changes
in our operating expenses;
| | - | ----------------------------------

| |  | disruption
in our sources of supply; and
| | - | ----------------------------------------

| |  | general
economic conditions.
| | - | ----------------------------

Therefore,
the results of any past periods may not be relied upon as an indication of our future
performance.

We
have a limited order backlog. If revenue levels for any quarter fall below our
expectations, our results of operations will be adversely affected.

We
have a limited order backlog, which makes revenues in any quarter substantially dependent
on orders received and delivered in that quarter. A delay in the recognition of revenue,
even from one customer, may have a significant negative impact on our results of
operations for a given period. We base our decisions regarding our operating expenses on
anticipated revenue trends, and our expense levels are relatively fixed, or require some
time for adjustment. Because only a small portion of our expenses varies with our
revenues, if revenue levels fall below our expectations, our results of operations will be
adversely affected.

Generally,
we sell to original equipment manufacturers, or OEMs, network equipment providers or
system integrator customers, as well as to distributors. As a result, we have less
information with respect to the actual requirements of end users and their utilization of
equipment. We also have less influence over the choice of equipment by these end users.

We
typically sell to OEM customers, network equipment providers, and system integrators, as
well as to distributors. Our customers usually purchase equipment from several suppliers
and may be trying to fulfill one of their customers specific technical
specifications. We rely heavily on our customers for sales of our products and to inform
us about market trends and the needs of their customers. We cannot be certain that this
information is accurate. If the information we receive is not accurate, we may be
manufacturing products that do not have a customer or fail to manufacture products that
end users want. Because we are selling products to OEMs, system integrators and
distributors rather than directly to end users, we have less control over the ultimate
selection of products by end users.

The
markets we serve are highly competitive and many of our competitors have much greater
resources, which may make it difficult for us to maintain profitability.

Competition
in our industry is intense and we expect competition to increase in the future. Our
competitors currently sell products that provide similar benefits to those that we sell.

- 6 -

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Our
principal competitors in the sale of signal processing chips are Texas Instruments,
Broadcom Infineon, Centillium, Mindspeed, Netergy and VoicePump, a subsidiary of DSP
Group. Several large manufacturers of generic signal processors, such as Motorola, Agere
Systems and Intel have begun, or are expected to begin market competing processors.
Competition for our module level products include semiconductor manufacturers such as
Texas Instruments, Mindspeed, Centillium, Performance Technologies Inc., and Spectrum
Signal Processing Inc. Our principal competitors in the communications board market are
NMS Communications, Intel, Motorola, Brooktrout, Inc., Acculab and PIKA Technologies, Inc.

Our
principal competitors in the area of analog media gateways (2 to 24 ports) for access and
enterprise are Cisco Systems Inc., Mediatrix Telecom, Inc., Vega Stream Limited, Samsung,
Innovaphone AG, Quintum Technologies, Tainet Communication System Corp., Welltech, Ascii
Corp., D-Link Systems, Inc., Multitech Inc., Inomedia, OKE LG, Cisco Systems, Veraz
Networks, Sonus Networks, Nuera, Tekelec, General Bandwidth, Telica and Commatch. In
addition we face competition in mid and high density gateways from internal development at
companies such as Nortel, Lucent, Alcatel, Siemens, Huawei, UTstarcom, ZTE and others.

We
also face significant and increasing competition in the market for products utilized in
the VoIP market. Our competitors in the market for VolP products include
telecommunications companies, data communication companies and companies specializing in
voice over IP products, some of which have greater name recognition, larger installed
customer bases and significantly greater financial, technical and marketing resources than
we do.

Many
of our competitors have the ability to offer vendor-sponsored financing programs to
prospective customers. Some of our competitors with broad product portfolios may also be
able to offer lower prices on products that compete with ours because of their ability to
recoup a loss of margin through sales of other products or services. Additionally, voice,
audio and other communications alternatives that compete with our products are being
continually introduced.

In
the future, we may also develop and introduce other products with new or additional
telecommunications capabilities or services. As a result, we may compete directly with
telephone companies and other telecommunications infrastructure providers. Additional
competitors may include companies that currently provide computer software products and
services, such as telephone, media, publishing and cable television. The ability of some
of ours competitors to bundle other enhanced services or other products, such as video
images, with VoIP products could give these competitors an advantage over us.

Offering
to sell system level products that compete with the products manufactured by our customers
could negatively affect our business.

We
have broadened our product offerings from chips to boards, subsystems and gateway level
products (systems). These products could compete with products offered by our customers.
These customers could decide to decrease purchases from us because of this competition.
This could result in a material adverse effect on our results of operations.

- 7 -

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We
rely on third-party subcontractors to assemble our products and therefore do not directly
control manufacturing costs, product delivery schedules or manufacturing quality.

Our
products are assembled and tested by third-party subcontractors. As a result of our
reliance on third-party subcontractors, we cannot directly control product delivery
schedules. We have in the past experienced delays in delivery schedules. Any problems that
occur and persist in connection with the delivery, quality or cost of the assembly and
testing of our products could have a material adverse effect on our business, financial
condition and results of operations. This reliance could also lead to product shortages or
quality assurance problems, which, in turn, could lead to an increase in the costs of
manufacturing or assembling our products.

We
may not be able to deliver our products to our customers, and substantial reengineering
costs may be incurred if a small number of third-party suppliers do not provide us with
key components on a timely basis.

Texas
Instruments Incorporated supplies all of the chips for our signal processor product line.
Our signal processor line is used both as a product line in its own right and as a key
component in our other product lines. Motorola manufactures all of the communications
processors currently used on our communications boards. These suppliers also supply many
of our competitors.

We
have not entered into any long-term supply agreements or alternate source agreements with
our suppliers and, while we maintain an inventory of critical components, our inventory of
chips would likely not be sufficient in the event that we had to engage an alternate
supplier for these components.

Texas
Instruments is also one of our major competitors in providing signal processing solutions.
An unexpected termination of the supply of the chips provided by Texas Instruments or
Motorola or disruption in their timely delivery, would require us to make a large
investment in capital and manpower resources to shift to using signal processors
manufactured by other companies and may cause a delay in introducing replacement products.
Customers may not accept an alternative product design. Supporting old products or
redesigning products may make it more difficult for us to support our products.

We
utilize other sole source suppliers upon whom we depend without having long term supply
agreements.

Some
of our sole source suppliers custom produce components for us based upon our
specifications and designs while other of our sole source suppliers are the only
manufacturers of certain components required by our products. We have not entered into any
long-term supply agreements or alternative source agreements with our suppliers and while
we maintain an inventory of components from single source providers, our inventory would
likely not be sufficient in the event that we had to engage an alternate supplier of these
single source components. In the event of any interruption in the supply of components
from any of our sole source suppliers, we may have to expend significant time, effort and
other resources in order to locate a suitable alternative manufacturer and secure
replacement components. If no replacement components are available, we may be forced to
redesign certain of our products. Any such new design may not be accepted by our
customers. A prolonged disruption in supply may force us to redesign and retest our
products. Any interruption in supply from any of these sources or an unexpected technical
failure or termination of the manufacture of components could disrupt production, thereby
adversely affecting our ability to deliver products and to support products previously
sold to our customers.

- 8 -

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In
addition, if demand for telecommunications equipment increases, we may face a shortage of
components from our suppliers. This could result in longer lead times, increases in the
price of components and a reduction in our margins, all of which could adversely affect
the results of our operations.

Our
customers may require us to produce products or systems to hold in inventory in order to
meet their just in time, or short lead time, delivery requirements. If we are
unable to sell this inventory on a timely basis, we could incur charges for excess and
obsolete inventory which would adversely affect our results of operations.

Our
customers expect us to maintain an inventory of products available for purchase off the
shelf subsequent to the initial sales cycle for these products. This may require us to
incur the costs of manufacturing inventory without having a purchase order for the
products. The VoP industry is subject to rapid technological change and volatile customer
demands, which result in a short product commercial life before a product becomes
obsolete. If we are unable to sell products that are produced to hold in inventory, we may
incur write offs and write downs as a result of slow moving items, technological
obsolescence, excess inventories, discontinued products and products with market prices
lower than cost. Write offs and write downs could adversely affect our operating results
and financial condition. We wrote off and wrote down inventory in the amount of $1.7
million in 2002, $835,000 in 2003 and $1.2 million in 2004.

Our products generally have long
sales cycles and implementation periods, which increase our costs in obtaining orders and
reduce the predictability of our revenues.

Our
products are technologically complex and are typically intended for use in applications
that may be critical to the business of our customers. Prospective customers generally
must make a significant commitment of resources to test and evaluate our products and to
integrate them into larger systems. As a result, our sales process is often subject to
delays associated with lengthy approval processes that typically accompany the design and
testing of new communications equipment. The sales cycles of our products to new customers
are approximately six to twelve months after a design win, depending on the type of
customer and complexity of the product. This time may be further extended because of
internal testing, field trials and requests for the addition or customization of features.
This delays the time until we realize revenue and results in our investing significant
resources in attempting to make sales.

Long
sales cycles also subject us to risks not usually encountered in a short sales span,
including customers budgetary constraints, internal acceptance reviews and
cancellation. In addition, orders expected in one quarter could shift to another because
of the timing of customers procurement decisions. The time required to implement our
products can vary significantly with the needs of our customers and generally exceeds
several months; larger implementations can take multiple calendar quarters. This
complicates our planning processes and reduces the predictability of our revenues.

- 9 -

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Our
proprietary technology is difficult to protect, and our products may infringe on the
intellectual property rights of third parties. Our business may suffer if we are unable to
protect our intellectual property or we are sued for infringing the intellectual property
rights of third parties.

Our
success and ability to compete depend in part upon protecting our proprietary technology.
We rely on a combination of patent, trade secret, copyright and trademark laws,
nondisclosure and other contractual agreements and technical measures to protect our
proprietary rights. These agreements and measures may not be sufficient to protect our
technology from third-party infringement, or to protect us from the claims of others.
Enforcement of intellectual property rights may be expensive and may divert attention of
management and of research and development personnel away from our business. Intellectual
property litigation could also call into question the ownership or scope of rights owned
by us. We believe that at least one of our patents may cover technology related to the ITU
G.723.1 standard. Because of our involvement in the standard setting process, we may be
required to license certain of our patents on a reasonable and non-discriminatory basis to
a current or future competitor, to the extent required to carry out the G.723.1 standard.
Additionally, our products may be manufactured, sold, or used in countries that provide
less protection to intellectual property than that provided under U.S. or Israeli laws or
where we do not hold relevant intellectual property rights.

Any
intellectual property claims against us, even without merit, could cost us a significant
amount of money to defend and divert managements attention away from our business.
We may not be able to get a license for technology that is used in our products and we may
face injunctive proceedings that prevent distribution and sale of our products even prior
to any dispute being concluded. These proceedings may also have a deterrent effect on
purchases by customers, who may be unsure about our ability to continue to supply their
requirements. We may be forced to repurchase our products and compensate customers that
have purchased such infringing products. We may be forced to redesign the product so that
it becomes non-infringing, which may have an adverse impact on the results of our
operations.

Multiple
patent holders in our industry may result in increased licensing costs.

There
are a number of companies besides us that hold patents for various aspects of the
technology incorporated in our industrys standards and our products. We expect that
patent enforcement will be given high priority by companies seeking to gain competitive
advantages or additional revenues. The holders of patents from which we have not obtained
licenses may take the position that we are required to obtain a license from them. We
cannot be certain that we would be able to negotiate a license agreement at an acceptable
price or at all. Our results of operations could be adversely affected by the payment of
any additional licensing costs or if we are prevented from manufacturing or selling a
product.

- 10 -

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Changes
in governmental regulations in the United States or other countries could slow the growth
of the VoIP telephony market and reduce the demand for our customers products,
which, in turn, could reduce the demand for our products.

In
the United States, changes in governmental regulation are being considered that may
negatively impact the VoIP telephony market. For example, the Federal Communications
Commission (FCC) has to date treated providers of telephone services over the public
Internet as enhanced service providers. Enhanced service providers are
currently exempt from federal and state regulations governing common carriers, including
the obligation to pay access charges and contribute to the universal service fund. The FCC
is examining the enactment of new regulations governing Internet telephony and the
question of whether certain forms of telephone services over the Internet should be
subject to the same FCC regulations as telecommunications services.

VoIP
equipment can be used as a way to provide telecommunication services while bypassing the
local service operator, in what is sometime referred to as toll bypass.
Telecommunications traffic is diverted from traditional telephone lines to the public
Internet, thus avoiding long distance call charges. As the use of VoIP to provide
telecommunication services increases, phone companies are seeking the adoption of
regulations that would require providers or users of such diverted calls to pay a charge
to local service providers.

On
March 10, 2004, the FCC released a Notice of Proposed Rule Making that seeks to establish
a regulatory framework for Internet Protocol-Enabled Services, including VoIP services.
The Notice of Proposed Rule Making seeks comments on how various IP-enabled services,
including VoIP, should be differentiated for regulatory purposes, and whether there are
technical or other characteristics of particular VoIP services that warrant differential
regulatory treatment. When the FCC enacts new regulations governing VoIP, or if it
determines that certain telephony providers over the public Internet, or the services they
provide, are subject to current FCC regulations governing common carriers, then some of
the service providers that buy equipment from our customers may be forced to pay access
charges and make universal service contributions, or may be subject to other taxes, fees
or restrictions under any such new regulations. The required payment of additional taxes,
fees or charges for VoIP services may impact the profitability of these services and the
use of VoIP services or technology.

On
May 19, 2005, the FCC issued an order that requires interconnected VoIP service providers
to be able to deliver all 911 calls to the customers local emergency operator.
Interconnected providers are those companies that enable VoIP customers to receive calls
from and make calls to the traditional public switched telephone network. The FCC also
indicated that it would adopt rules in the future that would require a method for
determining the location of a VoIP customer making a 911 call without the customer having
to report this information. VoIP service providers may have difficulties complying with
this order in the required time frame, as well as any future orders issued by the FCC.
Equipment and software manufacturers may have difficulty in complying with new technical
requirements. In addition, the cost of providing Internet phone service could increase
which could result in slower growth and decreased profitabilities for this industry. The
increase in regulation of VoIP services and the increase in the cost of these services
could adversely affect sales of our products and adversely affect our results of
operations.

- 11 -

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The
enactment of any additional regulation or taxation of communications over the public
Internet in the United States or elsewhere in the world could have a material adverse
effect on our customers (and their customers) businesses and could therefore
adversely affect sales of our products. We do not know what effect, if any, possible
legislation or regulatory actions in the United States or elsewhere in the world may have
on private telecommunication networks, the provision of VoIP services and purchases of our
products.

Use
of encryption technology in our products is regulated by governmental authorities and may
require special development, export or import licenses. Delays in the issuance of required
licenses, or the inability to secure these licenses, could adversely affect our revenues
and results of operations.

Growth
in the demand for security features may increase the use of encryption technology in our
products. The use ofencryption technology is generally regulated by governmental
authorities and may require specific development, export or import licenses. Encryption
standards may be based on proprietary technologies. We may be unable to incorporate
encryption standards into our products in a manner that will insure interoperability. We
also may be unable to secure licenses for proprietary technology on reasonable terms. If
we cannot meet encryption standards, or secure required licenses for proprietary
encryption technology, our revenues and results of operations could be adversely affected.

A
significant portion of our revenues is generated outside of the U.S. and Israel and we
intend to continue to expand our operations internationally and therefore our results of
operations could suffer if we are unable to manage our international operations
effectively.

We
generated 36% of our revenues in 2003 and 28% of our revenues in 2004 outside of the
United States and Israel. Part of our strategy is to expand our penetration in existing
foreign markets and to enter new foreign markets. Our ability to penetrate some
international markets may be limited due to different technical standards, protocols or
product requirements in different markets. Expansion of our international business will
require significant management attention and financial resources. Our international sales
and operations are subject to numerous risks inherent in international business
activities, including:

| |  | economic
and political instability in foreign countries;
| | - | --------------------------------------------------------

| |  | staffing
and managing foreign operations;
| | - | -----------------------------------------

| |  | increased
risk of collection; and
| | - | ---------------------------------

| |  | burdens
that may be imposed by tariffs and other trade barriers.
| | - | ----------------------------------------------------------------

If
we are unable to address these risks, our foreign operations may be unprofitable or the
value of our investment in our foreign operations may decrease.

Currently,
our international sales are denominated primarily in dollars.Therefore, any
devaluation in the local currencies of our customers relative to the dollar could cause
customers to decrease or cancel orders or default on payment.

- 12 -

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The
prices of our products may become less competitive due to foreign exchange fluctuations.

Foreign
currency fluctuations may affect the prices of our products. Our prices in all countries
are denominated primarily in dollars. If there is a significant devaluation in a specific
country, the prices of our products will increase relative to the local currency and may
be less competitive. We cannot be sure that our international customers will continue to
place orders denominated in dollars. The introduction into circulation of the Euro in 2002
placed pressure on us to sell to European customers in Euro rather than dollar prices.
Sales denominated in Euros could make our revenues subject to fluctuation in the
Euro/dollar exchange rate.

We
may be unable to attract sales representatives who will market our products effectively.

A
significant portion of our marketing and sales involves the aid of independent sales
representatives that are not under our direct control. We cannot be certain that our
current independent sales representatives will continue to distribute our products or
that, even if they continue to distribute our products, they will do so successfully.
These representatives are not subject to any minimum purchase requirements and can
discontinue marketing our products at any time. In addition, these representatives often
market products of our competitors. Accordingly, we must compete for the attention and
sales efforts of our independent sales representatives.

Our
products could contain defects, which would reduce sales of those products or result in
claims against us.

We
develop complex and evolving products. Despite testing by us and our customers, undetected
errors or defects may be found in existing or new products. The introduction of products
with reliability, quality or compatibility problems could result in reduced revenues,
additional costs, increased product returns and difficulty or delays in collecting
accounts receivable. The risk is higher with products still in the development stage,
where full testing or certification is not yet completed. This could result in, among
other things, a delay in recognition or loss of revenues, loss of market share or failure
to achieve market acceptance. We could also be subject to material claims by customers
that are not covered by our insurance.

Obtaining
certification of our products by national regulators may be time-consuming and expensive.
We may be unable to sell our products in markets in which we are unable to obtain
certification.

Our
customers may expect us to obtain certificates of compliance with safety and technical
standards set by national regulators, especially standards set by U.S. or European
regulators. There is no uniform set of standards, and each national regulator may impose
and change its own standards. National regulators may also prohibit us from importing
products that do not conform to their standards. If we make any change in the design of a
product, we are usually required to obtain recertification of the product. The process of
certification may be time-consuming and expensive and may affect the length of the sales
cycle for a product. If we are unable to obtain certification of a product in a market, we
may be unable to sell the product in that market.

- 13 -

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We
depend on a limited number of key personnel who would be difficult to replace.

Because
our products are complex and our market is evolving, the success of our business depends
in large part upon the continuing contributions of our management and key personnel.
Specifically, we rely heavily on the services of Shabtai Adlersberg, our Chief Executive
Officer. If Shabtai Adlersberg is unable or unwilling to continue with us, our results of
operations could be materially and adversely affected. We do not carry key person
insurance for Mr. Adlersberg.

The
success of our business also depends upon our continuing ability to attract and retain
other highly-qualified management, technical, sales and marketing personnel. We need
highly-qualified technical personnel who are capable of developing technologies and
products and providing the technical support required by our customers. Such personnel
were and may again be in great demand and we may not be successful in attracting,
integrating or retaining them when and as required.

We
intend to expand our business through acquisitions that could result in diversion of
resources and extra expenses. This could disrupt our business and adversely affect our
financial condition.

Part
of our strategy is to pursue acquisitions of, or investments in, businesses and
technologies or to establish joint ventures to expand our business. For example, in April
2003, we purchased a product group from Nortel Networks and in May 2004 we purchased
Ai-Logix Inc. We also increased our holdings in a privately held speech-recognition
company during 2003. We recognized losses from this investment in our results of
operations in each of the past three years.

The
negotiation of acquisitions, investments or joint ventures as well as the integration of
acquired or jointly developed businesses or technologies could divert our
managements time and resources. Acquired businesses, technologies or joint ventures
may not be successfully integrated with our products and operations. If any acquisition,
investment or joint venture were to occur, we may not realize the intended benefits of the
acquisition, investment or joint venture and we may incur future losses from such
acquisition, investment or joint venture.

Acquisitions
could result in:

| |  | substantial
cash expenditures;
| | - | ------------------------------

| |  | potentially
dilutive issuances of equity securities;
| | - | ----------------------------------------------------

| |  | the
incurrence of debt and contingent liabilities;
| | - | --------------------------------------------------

| |  | a
decrease in our profit margins;
| | - | ---------------------------------

| |  | amortization
of intangibles and potential impairment of goodwill; and
| | - | ---------------------------------------------------------------------

| |  | write-offs
of in-process research and development.
| | - | --------------------------------------------------

If
acquisitions disrupt our operations, our business may suffer.

- 14 -

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If
we do not manage our anticipated growth effectively, our results of operations could be
adversely affected.

We
have actively expanded our operations in the past and may continue to expand them in the
future. This expansion has required, and may continue to require, the application of
managerial, operational and financial resources. We cannot be sure that we will continue
to expand, or that we will be able to expand our operations successfully. In particular,
our business requires us to focus on multiple markets, including the VoIP, cable and
wireless markets. In addition, we work simultaneously with a number of large OEMs and
network equipment providers each of which may have different requirements for the products
that we sell to them. We may not have sufficient manpower, or may be unable to devote this
manpower when needed, to address the requirements of these markets and customers. If we
are unable to manage our expanding operations effectively, our revenues may not increase,
our cost of operations may rise and our results of operations may be adversely affected.

As
we grow we may need new or enhanced systems, procedures or controls. The transition to
such systems, procedures or controls, as well as any delay in transitioning to new or
enhanced systems, procedures or controls, may seriously harm our ability to accurately
forecast sales demand, manage our product inventory and record and report financial and
management information on a timely and accurate basis.

We
may not be able to raise additional financing for our future capital needs on favorable
terms, or at all, which could limit our ability to grow and to continue our longer term
expansion plans.

We
may need to raise additional capital in the future to continue our longer term expansion
plans. We cannot be certain that we will be able to obtain additional financing on
commercially reasonable terms, or at all. This could inhibit our growth and increase our
financing costs.

We
extend credit to customers for purchases of our products. We could incur charges in our
statement of operations if we are unable to collect these accounts receivable.

A
portion of our receivables result from credit extended to customers for purchases of our
products. We cannot be sure that we will be able to collect all of these accounts
receivable. The failure to collect accounts receivable could adversely affect our cash
flow position and results of operations.

Our
gross profit percentage could be negatively impacted by increased manufacturing costs and
other factors. This could adversely affect our results of operations.

Our
gross profit percentage has increased in each of the past three years. However, our gross
profit percentage is still lower than in 2000. The recent increase in our gross profit
percentage could be negatively affected by an increase in manufacturing costs, a shift in
our sales mix towards our less profitable products, increased customer demand for longer
product warranties and increased cost pressures as a result of increased competition.
Acquisitions of new businesses could also negatively affect our gross profit percentage,
which could cause an adverse effect on our results of operations.

- 15 -

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The
growth in our product portfolio means that we have to service and support more products.
This may result in an increase in our expenses and an adverse effect on our results of
operations.

The
size of our product portfolio has increased and continues to increase. As a result, we are
required to provide to our customers sales support and maintenance. Customers have
requested that we provide a contractual commitment to support a product for a specified
period of time. This period of time may exceed the working life of the product or extend
past the period of time that we may intend to manufacture or support a product. We are
dependent on our suppliers for the components (hardware and software) needed to provide
support and may be unable to secure the components necessary to satisfy our service
commitments. We do not have long term contracts with our suppliers, and they may not be
obligated to provide us with products or services for any specified period of time. We may
need to purchase an inventory of replacement components and parts in advance in order to
try to provide for their availability when needed. This could result in increased risk of
write offs with respect to our replacement component inventory to the extent that we
cannot accurately predict our future requirements under our customer service contracts. If
any of our component suppliers cease production, cease operations or refuse or fail to
make timely delivery of orders, we may not be able to meet our contractual commitments for
product support or maintenance. We may be required to supply upgraded components or parts
as substitutes if the original versions are no longer available. Product support may be
costly and any extra service revenues may not cover the hardware and software costs
associated with providing long-term support or maintenance.

Risks Relating to Operations in Israel

Conditions
in Israel affect our operations and may limit our ability to produce and sell our
products.

We
are incorporated under the laws of the State of Israel, and our principal offices are
located in the State of Israel. Political, economic and military conditions in Israel
directly affect our operations. Terrorist attacks against Israel have greatly intensified
since September 2000, which have led to ongoing hostilities between Israel, the
Palestinian Authority and other groups in the West Bank and Gaza Strip. We cannot predict
the effect on us of an increase in these hostilities or any future armed conflict,
political instability or violence in the region. Some of our officers and employees in
Israel are obligated to perform up to 36 days of military reserve duty annually and are
subject to being called for additional active duty under emergency circumstances. We
cannot predict the full impact of these conditions on us in the future, particularly if
emergency circumstances occur. If many of our employees are called for active duty, our
operations in Israel and our business may be adversely affected. Additionally, a number of
countries continue to restrict or ban business with Israel or Israeli companies, which may
limit our ability to make sales in those countries.

- 16 -

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The
Israeli rate of inflation may negatively impact our costs if it exceeds the rate of
devaluation of the New Israeli Shekel against the U.S. dollar.

A
substantial portion of the cost of our Israeli operations, mainly personnel and
facility-related, is incurred in New Israeli Shekels (NIS). In 2004, approximately 37% of
our costs were incurred in NIS. As a result, we bear the risk that the rate of inflation
in Israel will exceed the rate of devaluation of the New Israeli Shekel in relation to the
dollar or that the timing of such devaluations were to lag considerably behind inflation,
which will increase our costs as expressed in dollars.

To
protect against the changes in value of forecasted foreign currency cash flows resulting
from payments in NIS, we maintain a foreign currency cash flow hedging program. We hedge
portions of our forecasted expenses denominated in foreign currencies with forward
contracts. These measures may not adequately protect us from material adverse effects due
to the impact of inflation in Israel.

The
Israeli government programs and tax benefits that we currently participate in, or receive,
require us to meet several conditions and may be terminated or reduced in the future,
which would increase our costs.

We
benefit from certain government programs and tax benefits, particularly as a result of
exemptions and reductions resulting from the approved enterprise status of our
existing production facilities and programs in Israel. To be eligible for these programs
and tax benefits, we must continue to meet conditions, including making specified
investments in fixed assets and financing a percentage of investments with share capital.
If we fail to meet such conditions in the future, we will be subject to corporate tax at
the rate then in effect under Israeli law for such tax year. A comprehensive amendment to
the law prescribing these benefits has recently been approved by the Knesset. The
amendment imposes additional eligibility criteria for approved enterprise benefits. The
amendment also offers additional forms of alternative benefits. We do not believe that the
amendment would have a material effect on us.

In
2004, we recognized a grant of $765,000 from the Government of Israel, through the Office
of the Chief Scientist, or the OCS, for the financing of a portion of our research and
development expenditures in Israel. The OCS budget has been subject to reductions, which
may affect the availability of funds for these prospective grants and other grants in the
future. As a result, we cannot be certain that we will continue to receive grants at the
same rate, or at all. In addition, the terms of any future OCS grants may be less
favorable than our past grant.

The government grants we have
received for research and development expenditures limit ourability to
manufacture products and transfer technologies outside of Israel and require us to
satisfyspecified conditions. If we fail to satisfy these conditions, we may be
required to refund grants previouslyreceived together with interest and penalties.

In
connection with research and development grants received from the OCS, we must pay
royalties to the OCS on the revenue derived from the sale of products, technologies and
services developed with the grants from the OCS. The terms of the OCS grants and the law
pursuant to which grants are made restrict our ability to manufacture products or transfer
technologies developed outside of Israel if OCS grants funded the development of the
products or technology. This restriction may limit our ability to enter into agreements
for those products or technologies without OCS approval. We cannot be certain that any
approval of the OCS will be obtained on terms that are acceptable to us, or at all.

- 17 -

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In
order to meet specified conditions in connection with the grants and programs of the OCS,
we have made representations to the Government of Israel about our Israeli operations.
From time to time the conduct of our Israeli operations has deviated from our
representations. If we fail to meet the conditions related to the grants, including the maintenance of
a material presence in Israel, or if there is any material deviation from the
representations made by us to the Israeli government, we could be required to refund the
grants previously received (together with an adjustment based on the Israeli consumer
price index and an interest factor) and would likely be ineligible to receive OCS grants
in the future. The inability to receive these grants would result in an increase in our
research and development expenses.

It
may be difficult to enforce a U.S. judgment against us, our officers and directors
and our Israeli auditors or to assert U.S. securities law claims in Israel.

We
are incorporated in Israel. Substantially all of our executive officers and directors and
our Israeli auditors are nonresidents of the United States, and a majority of our assets
and the assets of these persons are located outside the United States. Therefore, it may
be difficult to enforce a judgment obtained in the United States against us or any such
persons. Israeli courts may refuse to hear a claim based on a violation of U.S. securities
laws because Israel is not the most appropriate forum to bring such a claim. In addition,
even if an Israeli court agrees to hear a claim, it may determine that Israeli law and not
U.S. law is applicable to the claim. If U.S. law is found to be applicable, the content of
applicable U.S. law must be proved as a fact which can be a time-consuming and costly
process. Certain matters of procedure will also be governed by Israeli law. There is
little binding case law in Israel addressing these matters. Additionally, there is doubt
as to the enforceability of civil liabilities under the Securities Act and the Securities
Exchange Act in original actions instituted in Israel.

Israeli
law may delay, prevent or make difficult a merger with or an acquisition of us, which
could prevent a change of control and therefore depress the price of our shares.

Provisions
of Israeli law may delay, prevent or make undesirable a merger or an acquisition of all or
a significant portion of our shares or assets. Israeli corporate law regulates
acquisitions of shares through tender offers and mergers, requires special approvals for
transactions involving significant shareholders and regulates other matters that may be
relevant to these types of transactions. These provisions of Israeli law could have the
effect of delaying or preventing a change in control and may make it more difficult for a
third party to acquire us, even if doing so would be beneficial to our shareholders. These
provisions may limit the price that investors may be willing to pay in the future for our
ordinary shares. In addition, our articles of association contain certain provisions that
may make it more difficult to acquire us, such as a staggered board and the ability of our
board of directors to issue preferred stock. Furthermore, Israel tax considerations may
make potential transactions undesirable to us or to some of our shareholders. See
Description of Share Capital  Possible Anti-Takeover Effects.

- 18 -

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Risks Relating to our Ordinary Shares and our Notes

# The price of our
ordinary shares may fluctuate significantly.

The
market price for our ordinary shares, as well as the prices of shares of other technology
companies, has been volatile. Between January 1, 2003 and May 20, 2005, our share price
has fluctuated from a low of $2.10 to a high of $17.00. The following factors may cause
significant fluctuations in the market price of our ordinary shares:

| |  | fluctuations
in our quarterly revenues and earnings or those of our competitors;
| | - | --------------------------------------------------------------------------------

| |  | shortfalls
in our operating results compared to levels forecast by securities analysts;
| | - | ---------------------------------------------------------------------------------------

| |  | announcements
concerning us, our competitors or telephone companies;
| | - | --------------------------------------------------------------------

| |  | announcements
of technological innovations;
| | - | -------------------------------------------

| |  | the
introduction of new products;
| | - | ---------------------------------

| |  | changes
in product price policies involving us or our competitors;
| | - | ------------------------------------------------------------------

| |  | market
conditions in the industry;
| | - | ----------------------------------

| |  | the
conditions of the securities markets, particularly in the technology and Israeli sectors;
and
| | - | -------------------------------------------------------------------------------------------------

| |  | political,
economic and other developments in the State of Israel and worldwide.
| | - | --------------------------------------------------------------------------------

In
addition, stock prices of many technology companies fluctuate significantly for reasons
that may be unrelated or disproportionate to operating results. The factors discussed
above may depress or cause volatility of our share price, regardless of our actual
operating results.

The
trading prices of our notes could be significantly affected by the market price of our
ordinary shares.

We
believe that the trading price of our notes is significantly affected by the market price
of our ordinary shares, which may be affected by a variety of factors as set forth in the
immediately preceding risk factor. This relationship may result in greater volatility in
the trading prices of our notes than would be expected for non-convertible debt
securities.

- 19 -

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Our
notes are effectively subordinated to our existing and future secured indebtedness and
structurally subordinated to existing and future indebtedness and other liabilities of our
subsidiaries.

Our
notes are our general, unsecured obligations and are effectively subordinated to any
existing and future secured indebtedness we may have. In addition, our notes are not
guaranteed by our subsidiaries or any future subsidiaries and, accordingly, our notes are
effectively subordinated to the existing and future indebtedness and other liabilities of
our subsidiaries. These liabilities may include indebtedness, trade payables, guarantees,
lease obligations and letter of credit obligations. Therefore, our rights and the rights
of our creditors, including the holders of the notes, to participate in the assets of any
subsidiary upon that subsidiarys liquidation or reorganization will be subject to
the prior claims of the subsidiarys creditors, except to the extent that we may
ourselves be a creditor with recognized claims against the subsidiary. However, even if we
are a creditor of one of our subsidiaries, our claims would still be effectively
subordinated to any security interests in, or mortgages or other liens on, the assets of
that subsidiary and would be subordinate to any indebtedness of the subsidiary senior to
that held by us. As of May 31, 2005, our existing subsidiaries had no outstanding
indebtedness (excluding intercompany debt and other liabilities).

There
are no restrictive covenants in the indenture for the notes relating to our ability to
incur future indebtedness or complete other transactions.

The
indenture governing our notes does not contain any financial covenants or restrictions on
the payment of dividends. The indenture does not restrict the issuance or repurchase of
securities by us or our subsidiaries. The indenture contains no covenants or other
provisions to afford holders of our notes protection in the event of a highly leveraged
transaction, such as a leveraged recapitalization, that would increase the level of our
indebtedness, or a change in control except for the ability of the holders to require us
to redeem the notes under certain circumstances. The indenture governing our notes does
not restrict us from incurring senior secured debt in the future or from guaranteeing our
indebtedness, nor does it limit the amount of indebtedness that we can issue that is equal
to our notes in right of payment. If we or our subsidiaries were to incur additional debt
or liabilities, our ability to pay our obligations on the notes could be adversely
affected.

Our
indebtedness and debt service obligations recently increased upon the issuance of our
notes, which may adversely affect our cash flow, cash position and stock price.

We
intend to fulfill our debt service obligations with respect to our notes from our existing
cash, investments and operations. In the future, if we are unable to generate cash or
raise additional cash financings sufficient to meet these obligations and need to use
existing cash or liquidate investments in order to fund these obligations, we may have to
delay or curtail research, development and commercialization programs.

Our
indebtedness could have significant additional negative consequences, including, without
limitation:

| |  | requiring
the dedication of a portion of our expected cash flow to service our indebtedness,
thereby reducing the amount of our expected cash flow available for other purposes,
including funding our research and development programs and other capital expenditures;
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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| |  | increasing
our vulnerability to general adverse economic conditions;
| | - | --------------------------------------------------------------------

| |  | limiting
our ability to obtain additional financing; and
| | - | --------------------------------------------------------

| |  | placing
us at a possible competitive disadvantage to less leveraged competitors and competitors
that have better access to capital resources.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------

Holders
of our notes are not be entitled to any rights with respect to our ordinary shares, but
they are subject to all changes made with respect to our ordinary shares.

Holders
of our notes are not entitled to any rights with respect to our ordinary shares
(including, without limitation, voting rights and rights to receive dividends, if any, or
other distributions on our ordinary shares), but such holders are subject to all changes
affecting our ordinary shares. Holders of our notes are entitled to rights on the ordinary
shares if and when we deliver ordinary shares to such holders in exchange for their notes.
For example, in the event that an amendment is proposed to our articles of association
requiring shareholder approval and the record date for determining the shareholders of
record entitled to vote on the amendment occurs prior to delivery to a converting holder
of our notes of our ordinary shares, such holders will not be entitled to vote on the
amendment, although that holder will nevertheless be subject to any changes in the powers,
preferences or special rights of our ordinary shares.

Our
ability to fulfill our obligations under our notes is dependent upon our future financial
and operating performance.

Our
ability to make interest and principal payments on our notes when due and to satisfy our
other debt obligations depends in part upon our future financial performance and upon our
ability to renew or refinance any debt obligations or to raise additional equity capital.
Prevailing economic conditions and financial, business and other factors, many of which
are beyond our control, will affect our ability to make these payments.

If
we are unable to generate sufficient cash flow to meet our debt services obligations, we
will have to pursue one or more alternatives, such as:

| |  | reducing
our operating expenses;
| | - | --------------------------------

| |  | reducing
or delaying capital expenditures;
| | - | ------------------------------------------

| |  | selling
assets; or
| | - | ------------------

| |  | raising
additional equity capital.
| | - | ----------------------------------

We
cannot be sure that any of these alternatives could be accomplished on satisfactory terms,
if at all, or that those actions would provide sufficient funds to retire the notes and
our other debt obligations.

- 21 -

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We
may not have the ability to purchase our notes for cash if required to do so by holders on
November 9, 2009, November 9, 2014 or November 9, 2019, or upon the occurrence of a
fundamental change.

On
November 9, 2009, November 9, 2014 or November 9, 2029, or upon specified fundamental
changes relating to us, each holder of the notes may require us to purchase for cash all
or a portion of such holders notes at a price equal to 100% of the principal amount,
plus accrued and unpaid interest, if any, on such notes to but excluding the date of
purchase. In addition, in the case of certain fundamental changes occurring before
November 9, 2009, we may be required to pay a make-whole premium to holders of the notes.
We cannot be sure that we will have sufficient financial resources to purchase the notes
for cash, or will be able to raise debt financing if we are required to purchase the notes
at the option of the holders of such notes or upon the occurrence of a fundamental change.
This repurchase requirement may also delay or make it harder for others to obtain control
of us.

We
do not anticipate declaring any cash dividends on our ordinary shares.

We
have never declared or paid cash dividends on our ordinary shares and do not plan to pay
any cash dividends in the near future. Our current policy is to retain all funds and
earnings for use in the operation and expansion of our business.

U.S.
          shareholders may be subject to adverse U.S. federal income tax consequences as a
          result of our possible status as a passive foreign investment company.

Based
on the composition of our gross income and the composition and value of our gross assets
during 2004, we do not believe that we would be treated as a passive foreign investment
company (PFIC) for U.S. federal income tax purposes for the 2004 tax year,
although it is possible that we would have been classified as a PFIC in 2001, 2002 and
2003, and there can be no assurance that we will not be treated as a PFIC for 2004 or any
subsequent tax year. If we are a PFIC for any tax year, U.S. shareholders who owned our
ordinary shares during such year may be subject to increased United States federal income
tax liabilities and reporting requirements for such year and succeeding years, even if we
are no longer a PFIC in such succeeding years. We urge U.S. holders of our notes or
ordinary shares to review Item 10E.  Taxation  United States Tax
Considerations  United States Federal Income Taxes  Passive Foreign Investment
Company Status in this Annual Report and to consult their own tax advisors with
respect to the U.S. federal income tax consequences of an investment in our ordinary
shares.

| | ITEM 4. | INFORMATION ON THE COMPANY
| | ------- | --------------------------

|A. | HISTORY
AND DEVELOPMENT OF THE COMPANY
|-- | --------------------------------------

AudioCodes
Ltd. was incorporated in 1992 under the laws of the State of Israel. Our principal
executive offices are located at 1 Hayarden Street, Airport City, Lod, 70151 Israel. Our
telephone number is 972-3-976-4000.

- 22 -

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Major Developments since
January 1, 2004

Acquisition of Ai-Logix

On
May 12, 2004, we acquired all of the outstanding shares of capital stock of Ai-Logix,
Inc., a leading provider of advanced voice recording hardware technology. Ai-Logix had
revenues of approximately $13 million in 2003. Its offices are located in Somerset, New
Jersey.

We
paid $10 million in cash at the closing and paid an additional $10 million in March 2005
based on the achievement of revenue milestones by the Ai-Logix business during 2004 and
2005.

This
acquisition was accounted for under the purchase method of accounting and, accordingly,
the purchase price has been allocated to the assets and liabilities acquired based on
their related fair values. We allocated $1.4 million of the purchase price to current
assets and liabilities (excluding cash and cash equivalents), $329,000 to property and
equipment, $3.1 million to technology and $3.8 million to goodwill. The results of
Ai-Logixs operations have been included in our consolidated financial statements
since the acquisition date.

Ai-Logix
is a strategic provider of voice and data hardware integration cards for the call
recording and voice/data logging industry. Ai-Logix provides a wide variety of voice
processing cards to its customers, which include contact centers, public safety agencies,
financial institutions, air traffic control and other government agencies. Its products
include proprietary public exchange integration products as well the SmartWORKS
family of products that are designed for all segments of the call recording industry.
Ai-Logix offers voice processing cards that support all three product segments in the call
recording industry, including passive analog trunk interface cards, passive digital trunk
interface cards and passive digital PBX telephone set integration cards.

Recent
trends evidence a growing momentum in the use of VoP technology in new network deployments
and an expected shift of communications budgets in the enterprise market towards IP-based
architectures. The call recording industry is experiencing similar trends. According to
Datamonitor, the contact center market and the call logging and recording industries are
rapidly adopting IP-based networking solutions. A significant portion of future voice
recording and call logging revenues are expected to be generated from deployments of VoIP
architectures. We believe that our acquisition of Ai-Logix will enhance our board line
business and provide an entry into the call recording market and computer telephony
integration (CTI) market by leveraging our VoP expertise with Ai-Logixs technology,
strategic partnerships and customer base.

Sale of Our 2.00% Senior Convertible Notes Due 2024

In
November 2004, we raised net proceeds of approximately $120.2 million in a private
placement of $125.0 million aggregate principal amount of our 2.00% Senior Convertible
Notes due 2024. These notes were issued pursuant to Rule 144A under the Securities Act of
1933. Holders of the notes are entitled to convert the notes into our ordinary shares at a
conversion rate of 53.4474 ordinary shares per $1,000 principal amount of notes, which is
the equivalent to a conversion price of approximately $18.71 per share. The conversion
rate is subject to adjustment in certain circumstances, such as changes in our capital
structure or upon the issuance by us of share dividends or certain cash distributions. The
notes may be redeemed by us, in whole or in part at any time on or after November 9, 2009.
The holders may require us to redeem the notes on November 9, 2009, November 9, 2014 or
November 9, 2019, or upon certain fundamental changes.

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Pursuant
to a registration rights agreement among us and the initial purchasers of the notes, we
agreed to file with the U.S. Securities and Exchange Commission within 150 days of
November 9, 2004, a shelf registration statement covering the notes and ordinary shares
issuable upon conversion of the notes and to maintain the effectiveness of the
registration statement until the earlier of the date on which all the shares have been
resold under the registration statement, the date of expiration of the holding period
under applicable law that would enable the resale of the shares without restriction or
registration under applicable law, or November 16, 2006. We filed this registration
statement on April 5, 2005 and expect that it will become effective shortly after we file
this Annual Report on Form 20-F.

Acquisition of UAS

In
April 2003, we purchased from Nortel Networks Limited selected assets of its Universal
Audio Server business, or UAS. As part of the transaction, Nortel Networks granted to us a
license to use its UAS technology. We have undertaken to act as an exclusive supplier to
Nortel Networks for its UAS products over a period of three years. In addition, the
parties have entered into a development agreement in relation to future platforms.

The
UAS products provides enhanced conferencing, multi-language announcement functionality,
and other regulatory media server applications for voice over packet networks. We are
seeking to leverage the UAS product and technology in order to further enhance our media
server products and increase related sales.

The
consideration for the transaction amounted to $5.5 million, of which $2.0 million was paid
at the closing, $2.0 million was paid nine months after the closing and $1.5 million was
paid in April 2004. Under the terms of the acquisition agreement, we also paid $1.0
million upon Nortel Networks completing product integration under the development
agreement. The acquisition was accounted for under the purchase method of accounting and,
accordingly, the purchase price has been allocated to the assets acquired based on their
related fair values. We allocated $380,000 of the purchase price to property and
equipment, $1.2 million to technology and $5.3 million to goodwill. The results of the UAS
operations have been included in our consolidated financial statements since the
acquisition date.

We
also made additional payments of $4.9 million in 2004 to Nortel Networks under the
acquisition agreement based on net orders for UAS products placed by Nortel. These
payments were not considered part of the acquisition cost and were offset against related
revenues earned by us from orders by Nortel Networks during 2004.

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|B. | BUSINESS
OVERVIEW
|-- | -----------------

# Introduction

We
design, develop and market enabling technologies and system products for the transmission
of voice, data and fax communications over packet networks, which we refer to as the new
voice infrastructure. Our products enable our customers to build high-quality packet
networking equipment and provide the building blocks to connect traditional telephone
networks to the new voice infrastructure. Our products are sold to leading original
equipment manufacturers, or OEMs, system integrators and network equipment providers in
the telecommunications and networking industries.

Packet
networks are data communications networks that transport information compressed into
packets over circuits shared simultaneously by several users. Equipment based
on advanced voice communications standards enables packet networks to carry voice and data
more efficiently than the traditional telephone networks, which were designed principally
to transmit high quality voice calls.

Our
voice compression technology permits the high quality transmission of voice over packet
networks using substantially less network capacity than used in traditional telephone
networks. Our products enable our customers to build highly-efficient, high capacity
gateways and access equipment that are used to connect traditional telephone networks to
packet networks. In addition, our gateway product offering provides our customers with a
substantial building block for voice over packet carrier-based solutions, as an
alternative to our customers developing or building their own gateways.

Our
products consist of:

| |  | Signal
processor chips, which process voice, data and fax signals and compress this information
into packets so that it can be sent between traditional telephone networks and packet
networks.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Communications
boards and modules for communication system products that are deployed on both access
networks and enterprise networks. The carrier network applications for these boards and
modules include media gateways, which terminate calls from the Public Switched Telephone
Network (PSTN), packetize and compress the call and then switch the call to the packet
network, and vice-versa. The enterprise applications for these products include Computer
Telephony Integration (CTI) deployments for contact centers, providing call logging and
recording utilizing either industry standard or proprietary protocols.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | System
products, including media servers and media gateways, for access networks, trunking
applications in carrier networks, and enterprise networks. These systems enable voice,
data and fax to be transmitted over Internet and other protocols, and interface with
third party equipment to facilitate the introduction of enhanced voice and data services.
Media servers provide enhanced conferencing, multi-language announcement functionality,
and other media server applications for voice over packet networks. Our media gateway
products include low density analog media gateways and low, mid and high density digital
media gateways.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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Our
products are based upon voice compression and fax detection technologies, which transform
voice and fax transmissions into small digital packets. We were involved in
the development of the voice coding standard that was adopted for use in packet networks
by the Voice over IP Forum, an industry group founded to ensure the interoperability and
high quality of telephone service over packet networks. We have also developed advanced
technologies for processing compressed voice transmissions and have significant voice
communication system design expertise.

We
sell our products to leading original equipment manufacturers, system integrators and
distributors in the telecommunications and networking industries for use in markets
providing:

| |  | telephony
over packet networks based on Internet protocols or networks based on asynchronous
transfer mode standards, known as ATM standards;
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------

| |  | telephony
over the wireless or cable television infrastructure; and
| | - | -------------------------------------------------------------------

| |  | telephone
service over high speed modems operating over wireless links or data modems, known as
digital subscriber line, or DSL, modems.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------

Customers
for our products consist of OEMs, network equipment providers and systems integrators. In
addition, our proprietary voice compression technology is licensed to a broad group of
companies that manufacture equipment for a variety of markets. As one of the original
developers of the standards for voice compression technology used in packet networks, we
are positioned to take advantage of the rapidly growing demand for advanced communications
components enabling high quality converged voice and data services.

# Industry Background

Market Trends

The
networking and telecommunications industries have experienced rapid change over the last
few years. The primary factors driving this change include the following:

| |  | Growth
in data communications traffic.The growth of the Internet has led to a surge in data
communications traffic. This growth has been fueled by the increasing number of users of
the Internet, as well as by the increased use of electronic mail and multimedia content
and the increased volume of information retrieved from the World Wide Web. In addition,
organizations are increasingly turning to the use of intranets and private networks to
increase productivity and create competitive advantages. This proliferation of intranets
and private networks has further contributed to the surge in data traffic.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Emergence
of packet networks and advances in networking technologies.Traditional voice
communications networks were not designed to handle the dramatic increase in data
traffic, the need for high-speed data communication and the need to serve a much larger
number of users. As data traffic becomes the dominant factor in communications and as
service providers begin to build and maintain converged networks for integrated voice and
data services, a new generation of data-centric networks is being developed. This
development has been enabled by a new generation of packet networking technologies. The
capabilities to effectively carry voice and fax and preserve the quality of
communications over these new networks have been made possible by the recent rapid
advances in voice compression technologies, the advent of digital signal processing chips
and new packet voice, fax and data networking technologies and protocols. The surge in
data traffic has led to the need for new packet-based infrastructures. As a result,
service providers are seeking to exploit the advances in high speed and packet voice
networking technologies to build networks that are more cost effective than the
traditional circuit-switched telephone networks.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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| |  | Competition
in the telecommunications industry.Competitive local exchange carriers and
alternative carriers are trying to penetrate the local telephone market with varying
degrees of success by bypassing the incumbent local telephone company network through the
use of emerging packet technologies in new functions like telephony transmission over
cable networks and digital subscriber line networks. In addition, there is a growth of
toll bypass service providers, who seek to use public or private networks in order to
bypass incumbent networks. Although these new and traditional service providers are not
our direct customers, they are creating market demand for equipment manufactured by our
customers. The surge in data traffic and the growth in overall volume and capacity of
infrastructures has also created a need for new infrastructure equipment that is capable
of more efficient utilization of the available networks.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | New
technologies. The expected extension of voice over packet technologies into wireless
networks alongside the introduction of new wireless standards (referred to often as
Second and Third Generations) and cable networks suggest a business opportunity for the
deployment of such technologies and products in these market segments. It is possible
that the introduction of Voice over Packet technologies into wireless and cable networks
will then place pressure on the traditional circuit switch service providers to modernize
their equipment so as to be able to compete with the new offerings, including price
reductions of these alternative networks.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Circuit-Switched
versus Packet Networks

Traditionally,
voice, data and fax communications have been transmitted and managed on separate networks,
each with its own distinct industry standards and protocols. Voice, data and fax have been
transmitted primarily over the traditional telephone network that is based on
circuit-switched technology. When a call is placed on a circuit-switched network, a
dedicated circuit is established between the two callers and is maintained for the
duration of the call. This dedicated channel, which requires bandwidth of 64 kilobits per
second, is unavailable for use by other callers on the network until the call is
terminated.

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Packet
networks differ fundamentally from circuit-switched networks in that the packet
networks resources and infrastructure can be shared simultaneously by several users
and bandwidth can be flexibly allocated. Packet-based communications systems format the
information to be transmitted, such as e-mail, voice, fax and data, into a series of
smaller digital packages of information called packets. Each of these packets
is then transmitted over the network and is reassembled as a complete communication at the
receiving end. The various packet networks employ different network protocols for
different applications, priority schemes and addressing formats to ensure reliable
communication.

Packet
networks offer a number of advantages over circuit-switched networks. Rather than
requiring a dedicated circuit for each individual call, packet networks commingle packets
of voice, fax and data from several communications sources on a single physical link. This
provides superior utilization of network resources, especially in dealing with information
sources with bursts of information followed by periods of silence. This superior
utilization means that the same amount of traffic can be carried using fewer network
resources. Additionally, the integration of voice and data communications makes possible
an enrichment of services and an entire range of new, value-added applications, such as
unified messaging and voice enabled web sites. In addition, voice traffic over packet
networks is usually compressed to provide a further reduction in the use of or demand for
bandwidth. For example, the rate at which information is transmitted over packet networks
is generally between 6.3 and 8 kilobits per second as compared to 64 kilobits per second
over circuit-switched telephone networks.

Convergence of Voice
and Data

The
proliferation of data-centric networks since the mid-1990s has made the transmission of
voice and fax over these networks a cost-effective alternative to existing
circuit-switched telephone networks. Most of the recent growth in packet networks has
taken place over networks based on Internet protocols, and, to a lesser extent, on packet
networks based on other protocols. Voice over IP, or VoIP, is the industry
terminology used to describe the transmission of voice over Internet protocol-based
networks.

The
need to re-route voice and fax traffic from the traditional circuit-switched networks onto
the new packet networks has led to the development of interface equipment between the two
networks, generally referred to as gateways or access equipment, depending on the type of
network. The processing of the voice and fax signals in gateway and access equipment is
done according to industry-wide standards. These standards are needed to ensure that all
traditional telephony traffic is seamlessly switched and routed over the packet network
and vice versa.

Gateway
equipment for Internet protocol-based packet networks has continued to experience
significant development and growth. The gateway equipment can be generally divided into
two key categories: open telecommunications architecture systems, built around
industry-standard PC and workstation platforms for which components are available from a
number of suppliers, and proprietary architecture-based gateways which are built around a
custom design of a telecommunications equipment manufacturer. Voice over IP gateway
equipment can be generally segmented into three classes: carrier class gateways for use in
central office facilities; enterprise gateways for use by corporations and in small
offices; and residential gateways for use at homes.

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The Challenges

Despite
the inherent advantages and the economic attractiveness of packet voice networking, the
transmission of packet voice and fax poses a variety of technological challenges. These
challenges relate to quality of service, reliability of equipment, functionality and
features, and ability to provide a good return on investment.

Quality
of Service. The most critical issues leading to poor quality of service in the
transmission of voice and fax over packet networks are packet loss, packet delay and
packet delay jitter. For real time signals like voice, the slightest delay in the arrival
of a packet may render that packet unusable and, in a voice transmission, the delayed
packet is considered a lost packet. Delay is usually caused by traffic hitting congestion
or a bottleneck in the network. The ability to address delay is compounded by the varying
arrival times of packets, called packet-jitter, which results from the different routes
taken by different packets. This jitter can be eliminated by holding the
faster arriving packets until the slower arriving packets can catch up, but this
introduces further delay. These idiosyncrasies of packet networks do not noticeably
detract from the quality of data transmission since data delivery is relatively
insensitive to time delay. However, even the slightest delay or packet loss in voice and
fax transmission can have severe ramifications such as voice quality degradation or, in
the case of a fax transmission, call interruption. Therefore, the need to compensate for
lost or delayed packets without degradation of voice and fax quality is a critical issue.

Gateway
Reliability. In order for a packet network to be efficient for voice or fax
transmission, the gateway equipment must be able to deliver an equivalent level of
performance to that of existing switching equipment located at central offices. The
telephony providers central offices contain circuit-switching equipment that
typically handles tens of thousands of lines and is built to meet severe performance
criteria relating to reliability, capacity, size, power consumption and cost. To date, the
gateways available for use in packet networks have not been able to cost-effectively
achieve these same levels of reliability in handling similar numbers of voice and fax
calls. As a result, new generation gateway equipment that meets the same performance level
as current circuit-switch technologies needs to be developed.

Functionality.          In
order to compete effectively with incumbent circuit-switching equipment,           packet
network equipment must be able to deliver equivalent and improved           functionality
and features for the service providers and network users.

Return
on Investment. With the reduction in profitability of service providers there is an
even greater need for them to achieve better returns on investment from capital
expenditures on new equipment. Given the evolving nature of packet technologies and
capabilities, there is greater pressure to provide cost effective technological solutions.

In
order to maximize the benefits of using packet networks for the transmission of voice data
and fax, products must be able to address and solve these inherent problems and
challenges. These products must also be standards-based to support interoperability among
different equipment manufacturers and to allow operation over various networks.

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# AudioCodes Solution

Using
our proprietary voice compression algorithms and industry standards, advanced digital
signal processing techniques and voice communications system design expertise, our
products address the quality of service problems posed by packet delay, packet delay
jitter and packet loss. As a result, we enable our customers to build packet networking
equipment that provides communication quality comparable to the traditional telephone
networks. In addition, our communications boards and modules improve gateway efficiency
and provide the building blocks for high performance, large capacity, open
telecommunications platform-based gateways. We work closely with our customers, tailor our
products to meet their specific needs, assist them in integrating our products within
their systems and help them bring their systems to market on a timely basis. We also work
with our customers in deploying their systems in various network environments.

We
believe that the following strengths have enabled us to develop our products and provide
services to our customers:

| |  | Leadership
in voice compression technology.We are a leader in voice compression technology.
Voice compression exploits redundancies within a voice signal to reduce the bit rate of
data required to digitally represent the voice signal while still maintaining acceptable
voice quality. Our key development personnel have significant experience in developing
voice compression technology. We were involved in the development of the ITU G.723.1
voice coding standard that was adopted by the Voice over IP Forum and the International
Telecommunications Union as the recommended standard for use in voice over IP gateways.
We implement industry voice compression standards and work directly with our customers to
design state-of-the-art proprietary voice compression algorithms that satisfy specific
network requirements. We believe that our significant knowledge of the basic technology
permits us to optimize its key elements and positions us to address further technological
advances in the industry. We also believe that our technological expertise has resulted
in us being sought out by leading equipment manufacturers to work with them in designing
their systems and provision of solutions to their customers.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Digital
signal processing design expertise.Our extensive experience and expertise in
designing advanced digital signal processing algorithms enables us to implement them
efficiently in real time systems. Digital signal algorithms are computerized methods used
to extract information out of signals. In designing our signal processors, we use minimal
digital signal processing memory and processing power resources. This allows us to
develop higher density solutions than our competitors. Our expertise is comprehensive and
extends to all of the functions required to perform voice compression, fax and modem
transmission over packet networks and telephone signaling processing.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Compressed
voice communications systems design expertise. We have the expertise to design and
develop the various building blocks and the complete gateways and media servers required
for complete voice over packet systems. In building these systems, we develop hardware
architectures, voice packetization software and signaling software, and integrate them
with our signal processors to develop a complete, high performance compressed voice
communications system. We assist our customers in integrating our signal processors into
their hardware and software systems to ensure high voice quality, high completion rate of
fax and data transmissions and telephone signaling processing accuracy. Further, we are
able to customize our off-the-shelf products to meet our customers specific needs,
thereby providing them with a complete, integrated solution and enabling them to market
their products with a reduced time to market.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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We believe that our products possess
the following advantages:

| |  | Voice
over Packet signal processors. Our multi-channel signal processors enable our
customers and us to create products that meet the reliability, capacity, size, power
consumption and cost requirements needed for building high capacity gateways.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Multiple
and comprehensive product lines.. We address both the
standards-based open telecommunications architecture market or the proprietary system
market, we are able to address both segments. We can do this because we enable our
customers to offer multiple applications and address different market segments. For
example, our voice over IP communications boards target the open telecommunications
architecture market, while our signal processors, modules and voice packetization
software target the proprietary system market. Our analog and digital media gateways
target access, trunking and enterprise applications and our digital media gateways target
wireless, wireline and cable networks.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Extensive
feature set. Our products incorporate an extensive set of signal processing functions
and features (such as protocols, coders), functionalities (such as H.323, Media Gateway
Control Protocol (MGCP), Media Gateway Control (Megaco) and Session Initiated Protocol
(SIP)) and implement a complete system. We offer the ability to manage multiple channels
of communications working independently of each other, with each channel capable of
performing all of the functions required for voice compression, fax and modem
transmission, telephone signaling processing and other functions. These functions include
voice, fax or data detection, echo cancellation, telephone tone signal detection and
generation and other telephony signaling processing.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Open
architecture. Our voice over packet communications boards target the open
architecture gateway market segment, which enables our customers to use hardware and
software products widely available for standards-based open telecommunications platforms.
We believe that this provides our customers with an improved time to market and the
benefits of scalability, upgradeability and enhanced functionality without the need to
completely redesign their systems for evolving applications.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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| |  | Various
entry level products. Our wide product range (chips to media gateways and media
servers) provides our customers with a range of entry level products. We believe that
these building blocks enable our customers to significantly shorten their time to market
by adding their value added solution.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | VoIPerfectTMarchitecture. Our
VoIPerfect architecture serves as the underlying technology platform common to all of our
products since 1998. VoIPerfectTM is regularly updated and upgraded with
features and functionalities required to comply with evolving standards and protocols.
VoIPerfectTM architecture comprises VoP digital signal processing, or DSP,
software and media streaming embedded software, integrated public telephone switched
network, or PTSN, signaling protocols and VoIP standard control protocols, provisioning
and management engines. Additional features enable carrier-grade quality and high
availability. VoIPerfectTM architecture components are available in AudioCodes products
at various levels of integration  from the chip level, through peripheral component
interconnect Mezzanine Card, or PMC, modules and PCI/compact PCI (cPCI) blades, to
high-availability and non-high-availability analog and digital media gateway platforms.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

# Business Strategy

Our
goal is to be the leading provider of enabling technologies and products for the
transmission of voice, data and fax over packet networks. The following are key elements
of our strategy:

| |  | Maintain
and extend technological leadership.We intend to capitalize on our expertise in
voice compression technology and proficiency in designing voice communications systems.
In 1995, we co-authored the ITU G.723.1 voice coding standard that was adopted by the
Voice over IP Forum as the recommended standard for use in voice over IP gateways. In
1998, we introduced NetCoder®, a new voice coder that was
designed specifically for IP networks. In 2001, we introduced TrunkPack®1610,
a cPCI Telephony board supporting PSTN, signaling, MGCP and MEGACO call controls. In
2002, we introduced the MediantTM2000 Media Gateway as part of our initiative
to provide complete media gateways to our network equipment provider. In 2002, we also
launched our media server product family to support IP-based local access and enhanced
services for wireless, cable, voice virtual private network and IP centrex markets. We
have invested heavily and are committed to continued investment in developing
technologies that are key to providing high performance voice, data and fax transmission
over packet networks and to be at the forefront of technological evolution in our
industry.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Strengthen
and expand strategic relationships with key customers.Our strategy has been to sell
our products to leading equipment manufacturers in the telecommunications and networking
industries and to establish and maintain long-term working relationships with them. We
work closely with our customers to engineer products and subsystems that meet each
customers particular needs. The long development cycles usually required to build
equipment incorporating our products frequently results in close working relationships
with our customers. By focusing on leading equipment manufacturers with large volume
potential, we believe that we reach a substantial segment of our potential customer base
while minimizing the cost and complexity of our marketing efforts.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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| |  | Expand
and enhance the development of highly-integrated products.We plan to continue
designing, developing and introducing new product lines and product features that address
the increasingly sophisticated needs of our customers. We believe that our knowledge of
core technologies and system design expertise enables us to offer better solutions that
are more complete and contain more features than competitive alternatives. We believe
that the greatest opportunities for our growth and profitability will come from the
development of even more highly-integrated product lines and product features such as our
recently announced digital media gateways.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Build
upon existing technologies to penetrate new markets.The technology we developed in
connection with the IP telephony market can be used to serve similar product requirements
in emerging markets utilizing similar packet networking technologies. These markets
include those providing telephony over digital subscriber lines, wireless networks and
the cable television infrastructure.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Develop
a network of strategic partners.Part of our strategy has been to sell our products
through customers that can offer our products as part of a full-service solution to their
customers. We expect to further develop our strategic partner relationships with system
integrators and other service providers in order to increase our customer base.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Acquire
complementary businesses and technologies.We expect to pursue the acquisition of
complementary businesses and technologies or the establishment of joint ventures to
broaden our product offerings, enhance the features and functionality of our systems,
increase our penetration in targeted markets and expand our marketing and distribution
capabilities. As part of this strategy, we acquired the UAS business from Nortel in April
2003 and Ai-Logix in May 2004.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

# Products

Our
products facilitate the transmission of voice, data and fax over packet networks. To date,
we have incorporated our algorithms, technologies and systems design expertise in nine
product lines:

| |  | voice
over packet processors;
| | - | -----------------------------

| |  | media
gateway modules;
| | - | ----------------------

| |  | VoIP
and VoATM communication boards;
| | - | ------------------------------------

| |  | enhanced
voice services and contact center solutions;
| | - | -----------------------------------------------------

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| |  | analog
media gateways for toll bypass access and enterprise applications;
| | - | -------------------------------------------------------------------------

| |  | digital
media gateways with various  capacities for wireless  (StrettoTM),  wireline  (MediantTM)
 and               cable (MediantTM Cable);
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------

| |  | IPmediaTM
 boards and servers for  enhanced  services and  functionalities  such as  conferencing
 and               messaging (IPmediaTM Platforms);
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------

| |  | universal
audio server (IP MediaTM Media Server);
| | - | -------------------------------------------------

| |  | Element
management system (EMS); and
| | - | ------------------------------------

| |  | Voice
and data logging hardware integration board products.
| | - | -----------------------------------------------------------

In
addition, we continue to offer customers our professional services, which usually involve
customization and development projects for customers.

Our
products are designed to build on our core technology and competence extending them both
vertically (chips inserted into boards, boards inserted into digital media gateways) and
horizontally into different applications for different market segments, such as
enterprise, wireline, cable and wireless.

Voice Over Packet
Processors

Our
signal processor chips compress and decompress voice, data and fax communications. This
enables these communications to be sent from circuit-switched telephone networks to packet
networks. Our chips are digital signal processors on which we have embedded our
algorithms. These signal processor chips are the basic building blocks used by our
customers and us to enable their products to transmit voice, fax and data over packet
networks. These chips may be incorporated into our communications boards, Media Gateway
Modules and Analog Media Gateways for access and enterprise applications or they may be
purchased separately and incorporated into other boards or customer products.

Our
signal processor chips implement a complete signal processing system, supporting voice
compression, echo cancellation, fax and modem processing and telephony signaling
processing. The signal processor chips also enhance gateway efficiency by supporting
multiple independently processed channels of communication.

We
provide a range of voice over packet processors of voice communications over different
types of packet networks, such as IP and ATM. Our processors are used by original
equipment manufacturers, known as OEMs, in their products enabling simple development and
a significant reduction in time-to-market. Each processor constitutes a full voice band
subsystem that includes standards-based low bit rate voice compression, echo cancellation,
in-band signaling detection and generation fax transmission and other signaling tones
handling.

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Media Gateway Modules

Our
media gateway modules are medium to high density, multi-protocol modules that allow OEM
gateway designers to take full advantage of the complete media gateway functionality
inherent in our TrunkPack®architecture, which is installed in millions of
lines worldwide. These modules connect as daughter cards onto proprietary OEM carrier
boards and convert content into low bit rate packetized voice over IP voice trunking.
Their comprehensive feature set and standard interfaces make them an integral building
block for high performance, carrier class media gateways by providing fast time to market
and a cost effective solution.

In
common with our TrunkPack® boards and compact peripheral component
interconnect, or PCI, solutions for open standards-based platforms. These modules bridge
the gap between our voice over packet processors, which offer developers maximum design
flexibility, and the communication boards that fit into standard peripheral component
interconnect, or PCI, or CompactPCI platforms.

The
module product family performs a variety of media gateway functions such as packetization,
compression, streaming and protocol processing. The module line also provides echo
cancellation functionality.

VoIP and VoATM
Communication Boards

Our
communications boards are designed to operate in gateways connecting the circuit-switched
telephone network to packet networks based on Internet protocols. Our boards comply with
voice over IP and voice over ATM (AAL2) industry standards and allow for interoperability
with other gateways. The boards also enable high capacity operations while fitting into a
single PCI or CompactPCI platforms. Just as our signal processor chips can handle multiple
channels on a single processor, our communications boards can support multiple telephony
trunk processing and differing modes of operations to provide manufacturers with greater
system flexibility.

Our
boards support standards-based open telecommunications architecture systems and combine
our signal processor chips with communications software, signaling software and
proprietary hardware architecture to provide a cost efficient interoperable solution for
high capacity gateways. We believe that using open architecture permits our customers to
bring their systems to market quickly and to integrate our products more easily within
their systems.

Our
boards represent a combined functionality of both media streaming processing (voice fax
and modem) and on-board telephony interfaces, along with their associated signaling
protocols.

Enhanced Voice
Services and Contact Center Solutions

Our
ArditoTM media gateway boards offer developers of enhanced voice services and
contact center solutions the capability to support PSTN infrastructure today and VoIP
foundations in the future.

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Analog Media
Gateways for Toll Bypass Access and Enterprise Applications

MediaPackTM,
our analog media gateways for toll bypass access and enterprise applications, empower the
next-generation network by providing cost-effective, cutting-edge technology solutions
that deliver voice and fax services to the corporate market, small businesses and home
offices. Our analog media gateways for access and enterprise applications provide media
streaming functionality while being either controlled by a centralized call agent or use
on-box VoIP control protocols (H.323, MGCP and SIP). Convergence of data, voice and fax is
achieved by a combination of the media gateway with any IP access technology, eliminating
the cost of multiple access circuits. This product family utilizes our experience and
digital signal processing, or DSP, technology for echo cancellation, voice compression,
silence suppression and comfort noise generation.

The
MediaPackTM family represents a feature rich product for streaming voice
quality with a powerful analog interface supporting all major control protocols such as
H323, SIP, MGCP and MEGACO.

Digital
Media Gateways with Various Capacities for Wireless (StrettoTM)
Wireline (MediantTM) and Cable (MediantTMCable.)

MediantTM
is our family of media gateways for wireline backbone and enterprise networks. The
MediantTM product family offers scalability and functionality, providing a full
suite of voice coders standard compliant control protocols and public switched telephone
network, or PSTN, signaling interfaces for a variety of wireline media gateway
applications in most softswitch control environments. The MediantTM family
provides carriers with a comprehensive line of different sized gateways. Small or
medium-sized gateways enable cost-effective solutions for enterprise or small points of
presence, as well as entry into fast growing new and emerging markets. The large gateway
scales to central office capacities and is designed to meet carriers operational
requirements. The entire MediantTM gateway family shares our same VoIP media
gateway boards, assuring mature, field-proven solutions.

The
MediantTM cable access gateway family is our line of packet telephony
standards-compliant cable access gateways designed for either hybrid or all IP cable
network architecture. The Mediant cable access gateway enables deployment of advanced
packet-based cable telephony at multiple service operators own pace, without costly
hardware changes. The MediantTM cable access gateway can be initially deployed
as a V5.2 IP access terminal and then easily migrated by software upgrade to a cable
telephony media gateway with external call management provided by a softswitch and an SS7
interface to the PSTN. Our StrettoTM product line is our family of media
gateways for the second and third generations of wireless networks. StrettoTM
is intended to enable packetization of legacy wireless networks, as well as serving as a
voice media gateway in third generation packet enabled architecture. The
StrettoTM product family is compatible with popular wireless voice coders and
protocols for wireless networks such as code-division multiple access (CDMA), global
system for mobile communications (GSM), CDMA2000 and universal mobile telecommunications
service (UMTS), and builds on our TrunkPack® architecture, which is installed in
millions of lines worldwide.

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0IPmediaTMBoards and Servers for Enhanced Services and Functionalities such as Conferencing and
Messaging (IPmediaTMPlatforms)

The
IPmediaTM product family is designed to allow OEMs to provide sophisticated
content and services that create revenue streams and customer loyalty through the ability
to provide additional services. The IPmediaTM platforms interface both packet
(IP or ATM) and switched-circuit telephony modules, while saving space. The
IPmediaTM platform provides voice and fax processing capabilities to enable,
together with our partners, an architecture for development and deployment of enhanced
services.

IPmediaTM
platforms are designed to answer the growing market demand for enhanced voice services
over packet networks, particularly network-based applications like unified communications,
call recording, and conferencing by carriers and application service providers.
IPmediaTM enables our customers to develop and market applications such as:
unified communications, interactive voice response, call-centers, conferencing and
voice-activated personal assistant. IPmediaTM products are currently offered on
our PCI and cCPI boards and on the 2000 series 1U media gateway box (IPmediaTM
2000) and will soon also be available in the recently announced 3000 series 2U gateway
platform, featuring IP and ATM interfaces and capabilities.

Universal Audio
Server (IPmediaTMMedia Server)

The
universal audio server is a product that we acquired from Nortel Networks in April 2003.
This product has been redesigned, upgraded and integrated into our IPmedia boards and
servers. The universal audio server provides enhanced conferencing, multi-language
announcement functionality, lawful intercept capabilities and other media server
applications for voice over packet networks.

Element Management
System (EMS)

Our
Element Management System (EMS), is an advanced solution for centralized, standard-based
management of our VoP gateways, covering all areas vital to the efficient operations,
administration, management and provisioning of our MediantTM,
StrettoTM and MediaPackTM VoP gateways.

Our
EMS offers network equipment providers and system integrators fast setup of medium and
large VoP networks with the advantage of a single centralized management system that
configures, provisions and monitors all of AudioCodes gateways deployed, either as
Customer Premises Equipment, access or core network platforms.

Voice and Data
Logging Hardware Integration Board Products

The
SmartWORKSTM family of products is our voice and data logging hardware
integration board product line. SmartWORKSTM boards for the call recording and
voice voice/data logging industry are compatible with a multitude of Private Branch
Exchange, or PBX, telephone system integrations.

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# Core Technologies

We
believe that one of our key competitive advantages is our broad base of core technologies
ranging from advanced voice compression algorithms to complex architecture system design.
We have developed and continue to build on a number of key technology areas.

Low Bit Rate Voice
Compression Algorithms

Voice
compression techniques are essential for the transmission of voice over packet networks.
Voice compression exploits redundancies within a voice signal to reduce the bit rate
required to digitally represent the voice signal, from 64 kilobits per second, or kbps,
down to low bit rates ranging from 5.3 kbps to 8 kbps, while still maintaining acceptable
voice quality. A bit is a unit of data. Different voice compression algorithms, or coders,
make certain tradeoffs between voice quality, bit rate, delay and complexity to satisfy
various network requirements. Use of voice activity detection techniques and silence
removal techniques further reduce the transmission rate by detecting the silence periods
embedded in the voice flow and discarding the information packets which do not contribute
to voice intelligibility.

We
are one of the innovators in developing low bit rate voice compression technologies. Our
patented MP-MLQTM coder was adopted in 1995 by the ITU as the basis for the
G.723.1 voice coding standard for audio/visual applications over the circuit-switched
telephone networks. By adhering to this standard, system manufacturers guarantee the
interoperability of their equipment with the equipment of other vendors.

Advanced Digital
Signal Processing Algorithms

To
provide a complete voice over packet communications solution, we have developed a library
of digital signal processing functions designed to complement voice compression coders
with additional functionality, including: echo cancellation; voice activity detection;
facsimile and data modem processing; and telephony signaling processing. Our extensive
experience and expertise in designing advanced digital signal processing solutions allows
us to implement algorithms using minimal processing memory and power resources. Our
algorithms include:

| |  | Echo
cancellation. Low bit rate voice compression techniques introduce considerable delay,
necessitating the use of echo cancellation algorithms. The key performance criterion of
an echo canceller is its ability to deal with large echo reflections, long echo delays,
fast changing echo characteristics, diverse telecommunications equipment and network
effects. Our technology achieves low residual echo and fast response time to render echo
effects virtually unnoticeable.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Fax
transmission. There are two widely used techniques for real time transmission of fax
over networks based on Internet protocols: fax relay and fax spoofing. Fax relay takes
place when a fax is sent from a fax machine through a gateway over networks based on
Internet protocols in real time to a fax machine at the other end of the network. At the
gateway, the analog fax signals are demodulated back into digital data, converted into
packets, routed over the packet network and reassembled at the receiving end. Fax relay
is used when the round trip network delay is small (typically below one second). When the
round trip network delay increases, one of the fax machines may time out while waiting
for a response from the other fax machine to arrive.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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| |  | Data
modem technology. We have developed data modem technologies that facilitate data
relay over packet networks. Our data modem relay software algorithms support all existing
data modem standards up to a bit rate of 14.4 kbps.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Telephony
signaling processing. Various telephony signaling standards and protocols are
employed to route calls over the traditional telephone network, some of which use in-band methods,
which means that the signaling tones are sent over the telephone line just like the voice
signal. As a result, in-band signaling tones may have to undergo the compression process
just like the voice signal. Most low bit-rate voice coders, however, are optimized for
speech signals and exhibit poor tone transfer performance. To overcome this, our
processors are equipped with tone detection and tone generation algorithms. To provide
seamless transparency between the traditional telephone network and packet networks for
signaling, we employ various digital signal processing techniques for efficient tone
processing.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Voice Communications
Software

To
transmit the compressed voice and fax over packet networks, voice packetization processes
are required to construct and deconstruct each packet of data for transmission. The
processing involves breaking up information into packets and adding address and control
fields information according to the specifications of the appropriate packet network
protocol. In addition, our software provides the interface with the signal processors and
addresses packet delay and packet loss issues.

Media Processing

Our
media processing products provide the enabling technology and platforms for developing
enhanced service applications for legacy and next generation networks. We have developed
media processing technologies such as message recording/playback, announcements, voice
coding and mixing and call progress tone detection that enable our customers to develop
and offer advanced revenue generating services such as conferencing, network
announcements, voice mail and interactive voice response. Our media processing technology
and products offer PSTN and packet interfaces to enable flexible deployment options.

Digital Cellular
Communications Technology

Convergence
of wireline and wireless networks is becoming a key driver for deployment of voice over
packet networks, enabling operators to use common equipment for both networks, thus
lowering capital expenditures and operating expenses, while offering enriched services.

Our
cellular voice over packet products provide a cost effective solution for these
convergence needs, complying with 2G and 3G cellular standards, for GSM/UMTS and
CDMA/CDMA2000 networks. These include support for cellular vocoders (concurrently with
wireline vocoders), interfaces and protocols. These interfaces and protocols are being
defined by special standardization groups (e.g., 3GPP and 3GPP2) and include capabilities
such as handling IP, ATM and TDM concurrently, mediation (mobile to mobile calls with no
transcoding), support for handoff and lawful intercept and various other cellular-specific
capabilities.

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VoIP for Telephony
over Cable Networks

Telephony
over cable networks is characterized by technical challenges due to the intrinsic nature
of the cable system which broadcasts across the subscriber network. The cable telephony
market is divided into two main standards: softswitch solutions and IP access terminal, or
IPAT, V5.2 solutions utilizing Class 5 switches. We have developed media gateway
technology that is capable of supporting both standards while migration from IPAT
solutions to softswitch solutions may be done by a software only upgrade, thus protecting
the end customers investment. Our technology complies with PacketCable standards
including security/encryption technology, support for quality of service, call control and
signaling.

Hardware
Architectures for High Density Multi-Trunk Voice over Packet Systems

Our
voice over packet product offerings include high density, multi-trunk voice over packet
systems for standards-based open telecommunications platforms in access equipment.
Multi-trunk processing is centered around a design encompassing two key processing
elements, signal processors performing voice, fax and data processing and a communications
processor. Overall system performance, reliability, capacity, size, cost and power
consumption are optimized, based on our hardware architecture, which supports high
throughput rates for multi-trunk processing. On-board efficient network and system
interfaces relieve the system controller from extensive real time data transfer and
processing of data streams.

Carrier Grade System
Expertise

To
provide state of the art carrier grade media gateways, we have developed a wide expertise
in a number of fields essential to such a product line. .We have developed or integrated
the various components required to implement a full digital media gateway solution that
behaves as a unified entity to the external world. This required a major investment in
adapting standard cPCI platforms to our needs. Such adaptation included optimizing power
supply and cooling requirements, adding centralized shelf controllers, fabric switches and
alarm cards to the chassis. Another aspect of the expertise developed to undertake this
task is related to High Availability software and hardware design. High Availability is a
required feature in any carrier grade media gateway platform. We have also developed a
sophisticated EMS (Element Management System) to complete our offering. This EMS enables
the user to provision and monitor a number of media gateways from a centralized location.

# Customers

Our
customers consist of OEMs, network equipment providers and systems integrators and
distributors. Historically, we have derived the majority of our revenues from sales to a
small number of customers. The identities of our principal customers have changed, and we
expect that they will continue to change, from year to year. We expect that a small number
of customers will continue to account for a large percentage of our sales. Our largest
customer in terms of our sales for the year ended December 31, 2004 was Nortel Networks.

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Sales
to Nortel Networks accounted for 14.3% of our revenues in 2003 and 18.6% of our revenues
in 2004. No other customer accounted for more than 8.0% of our revenues in 2003 or in
2004.

# Sales and Marketing

Our
sales and marketing strategy is to achieve design wins with industry leaders in our
targeted markets. Prospective customers generally must make a significant commitment of
resources to test and evaluate our products and to integrate them into larger systems. As
a result, our sales process is often subject to delays associated with lengthy approval
processes that typically accompany the design and testing of new communications equipment.
For these reasons, the sales cycles of our products to new customers are often lengthy,
averaging approximately six to twelve months after achieving a design win. This time may
be further extended because of internal testing, field trials and requests for the
addition or customization of features.

We
also provide our customers with reference platform designs, which enable them to achieve
easier and faster transitions from the initial prototype designs we use in the test trials
through final production releases. We believe this significantly enhances our
customers confidence that our products will meet their market requirements and
product introduction schedules.

We
market our products in the United States, Europe, Asia, Latin America and Israel primarily
through a direct sales force. Marketing managers are dedicated to principal customers to
promote close cooperation and communication. Additionally, we market our products in these
areas through independent sales representatives and system integrators. We select these
independent entities based on their ability to provide effective field sales, marketing
communications and technical support to our customers. We have generally entered into a
combination of exclusive and non-exclusive sales representation agreements with these
representatives in each of the major countries in which we do business. These agreements
are typically for renewable 12-month terms, are terminable at will by us upon 90 days
notice, and do not commit the sales representative to any minimum sales of our products to
third parties. Some of our representatives have the ability to return some of the products
they have previously purchased and purchase more up to date models.

# Manufacturing

Texas
Instruments Incorporated supplies all of the signal processor chips used for our signal
processors. The communications processor currently used on our communications boards is
manufactured by Motorola. We believe that similar communications processors are available
from other suppliers. Other components are generic in nature and we believe they can be
obtained from multiple suppliers.

We
have not entered into any long-term supply agreements. To date, we have been able to
obtain sufficient amounts of these components to meet our needs and do not foresee any
supply difficulty in obtaining timely delivery of any parts or components. However, an
interruption in supply from any of these sources, especially with regard to signal
processors from Texas Instruments Incorporated, or an unexpected termination of the
manufacture of certain electronic components could disrupt production, thereby adversely
affecting our results. We generally maintain an inventory of critical components used in
the manufacture and assembly of our products although our inventory of signal processor
chips would likely not be sufficient in the event that we had to engage an alternate
supplier for these components.

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We
utilize contract manufacturing for substantially all of our manufacturing processes. Until
the third quarter of 2002, all of our boards, modules and analog media gateways were
assembled by third-party subcontractors in Israel. Since the third quarter of 2002, we
have extended our manufacturing capabilities through third party subcontractors in the
United States and in China. Our subsidiary, Ai-Logix, utilizes third-party subcontractors
in the United States and Mexico to manufacture its products. Our internal manufacturing activities
consist primarily of the production of prototypes, test engineering, materials purchasing
and inspection, final product configuration and quality control and assurance.

# Competition

Competition
in our industry is intense and we expect competition to increase in the future. There has
been a significant amount of merger and acquisition activity and strategic alliances,
frequently involving major telecommunications equipment manufacturers acquiring smaller
companies, and we expect that this will result in an increasing concentration of market
share among these companies, many of whom are our customers.

Our
principal competitors in the sale of signal processing chips for voice over packet are
Texas Instruments, Broadcom, Infineon, Centillium, Mindspeed, Netergy and VoicePump, a
subsidiary of DSP Group. We expect that large manufacturers of generic signal processors,
such as Motorola, Agere Systems and Intel will market competing processors. Competition
for our module level products include semiconductor manufacturers such as Texas
Instruments, Mindspeed, Centillium Performance Technologies Inc. and Spectrum Signal
Processing Inc. Our principal competitors in the communications board market are NMS
Communications, Intel, Motorola, Brooktrout, Inc., Acculab and PIKA Technologies, Inc.

Our
principal competitors in the area of media gateways are Cisco Systems Inc., Mediatrix
Telecom, Inc., VegaStream Limited, Samsung, Innovaphone AG, Quintum Technologies, Tainet
Communication System Corp., Welltech, Ascii Corp, D-Link Systems, Inc., Multitec Inc.,
Innomedia, OKI, LG. Cisco Systems, Veraz Networks, Sonus Networks, Nuera, Tekelec, General
Bandwidth, Telica and Commatch. In addition we face competition in mid and high density
gateways from internal development at companies such as Nortel, Lucent, Alcatel, Siemens,
Huawei, UTstarcom, ZTE and others.

Some
of our competitors have greater name recognition, larger installed customer bases and
significantly greater financial, technical and marketing resources than we do. As a result
of the ongoing consolidation in our industry, several of our competitors have greater
financial, personnel and other resources, offer a broader range of products and services
than we do.

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# Intellectual Property
and Proprietary Rights

Our
success is dependent in part upon proprietary technology. We rely primarily on a
combination of patent, copyright and trade secret laws, as well as confidentiality
procedures and contractual provisions, to protect our proprietary rights. We also rely on
trademark protection concerning various names and marks that serve to identify it and our
products. While our ability to compete may be affected by our ability to protect our
intellectual property, we believe that, because of the rapid pace of technological change
in our industry, maintaining our technological leadership and our comprehensive
familiarity with all aspects of the technology contained in our signal processors and
communication boards is also of primary importance.

We
own U.S. patents that relate to our voice compression technology. We also actively pursue
patent protection in selected other countries of interest to us. In addition to patent
protection, we seek to protect our proprietary rights through copyright protection and
through restrictions on access to our trade secrets and other proprietary information
which we impose through confidentiality agreements with our customers, suppliers,
employees and consultants.

There
are a number of companies besides us who hold or may acquire patents for various aspects
of the technology incorporated in the ITUs standards or other industry standards or
proprietary standards, for example, in the fields of wireless and cable. While we have
obtained cross-licenses from some of the holders of these other patents, we have not
obtained a license from all of the holders. The holders of these other patents from whom
we have not obtained licenses may take the position that we are required to obtain a
license from them. Companies that have submitted their technology to the ITU (and
generally other industry standards making bodies) for adoption as an industry standard are
required by the ITU to undertake to agree to provide licenses to that technology on
reasonable terms. Accordingly, we believe that even if we were required to negotiate a
license for the use of such technology, we would be able to do so at an acceptable price.
Similarly, however, third parties who also participate with respect to the same
standards-setting organizations as do we may be able to negotiate a license for use of our
proprietary technology at a price acceptable to them, but which may be lower than the
price we would otherwise prefer to demand.

Under
a pooling agreement dated March 3, 1995, as amended, between AudioCodes and DSP Group,
Inc., on the one hand, and France Telecom, Universite de Sherbrooke and their agent, Sipro
Lab Telecom, on the other hand, we and DSP Group, Inc. granted to France Telecom and
Universite de Sherbrooke the right to use certain of our specified patents, and any other
of our and DSP Group, Inc. intellectual property rights incorporated in the ITU G.723.1
standard. Likewise France Telecom and Universite de Sherbrooke granted AudioCodes and DSP
Group, Inc. the right to use certain of their patents and any other intellectual property
rights incorporated in the G.723.1 standard. In each case, the rights granted are to
design, make and use products developed or manufactured for joint contribution to the
G.723.1 standard without any payment by any party to the other parties.

In
addition, each of the parties to the agreement granted to the other parties the right to
license to third parties the patents of any party included in the intellectual property
required to meet the G.723.1 standard, in accordance with each licensing partys
standard patent licensing agreement. The agreement provides for the fee structure for
licensing to third parties. The agreement provides that certain technical information be
shared among the parties, and each of the groups agreed not to assert any patent rights
against the other with respect of the authorized use of voice compression products based
upon the technical information transferred. Licensing by any of the parties of the
parties intellectual property incorporated in the G.723.1 standard to third parties
is subject to royalties that are specified under the agreement.

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Each
of the parties to the agreement is free to develop and sell products embodying the
intellectual property incorporated into the G.723.1 standard without payment of royalties
to other parties, so long as the G.723.1 standard is implemented as is, without
modification. The agreement expires upon the last expiration date of any of the
AudioCodes, DSP Group, Inc., France Telecom or Universite de Sherbrooke patents
incorporated in the G.723.1 standard. The parties to the agreement are not the only
claimants to technology underlying the G.723.1 standard.

We
are aware of parties who may be infringing our technology that is part of the G.723.1
standard. We evaluate these matters on a case by case basis, directly or through our
licensing partner. Although we have not yet determined whether to pursue legal action, we
may do so in the future. There can be no assurance that any legal action will be
successful.

Third
parties have claimed, and from time to time in the future may claim, that our past,
current or future products infringe their intellectual property rights. Intellectual
property litigation is complex and there can be no assurance of a favorable outcome of any
litigation. Any future intellectual property litigation, regardless of outcome, could
result in substantial expense to us and significant diversion of the efforts of our
technical and management personnel. Litigation could also disrupt or otherwise severely
impact our relationships with current and potential customers as well as our
manufacturing, distribution and sales operations in countries where relevant third party
rights are held and where we may be subject to jurisdiction. An adverse determination in
any proceeding could subject us to significant liabilities to third parties, require
disputed rights to be licensed from such parties, assuming licenses to such rights could
be obtained, or require us to cease using such technology and expend significant resources
to develop non-infringing technology. We may not be able to obtain a license at an
acceptable price.

We
have entered into technology licensing fee agreements with third parties. We expect that
in the ordinary course of business we may be required to enter into additional licensing
agreements. Under one agreement, we agreed to pay a third party royalty fees until 2008,
based on 0.75% of our revenues.

# Legal Proceedings

We
are not a party to any material legal proceedings.

|C. | ORGANIZATIONAL
STRUCTURE
|-- | ------------------------

# List of Significant
Subsidiaries

AudioCodes
Inc., our wholly-owned subsidiary, is a Delaware corporation.

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AudioCodes National
Inc., a wholly-owned subsidiary of AudioCodes Inc., is a Delaware corporation.

Ai-Logix
Inc., a wholly owned subsidiary of AudioCodes Inc., is a Delaware corporation

AudioCodes
Europe Limited, our wholly-owned subsidiary, is incorporated in England.

In
2005, we incorporated in Brazil AudioCodes Brasil Equipamentos de Voz sobre IP Ltda, a
wholly-owned subsidiary.

|D. | PROPERTY,
PLANTS AND EQUIPMENT
|-- | ------------------------------

We
lease our main facilities, located in Airport City, Lod, Israel, which currently occupy
approximately 111,000 square feet. We moved into these facilities in February 2004 which
enabled us to consolidate all of our operations in Israel into one location.

Our
U.S. subsidiary leases a 7,356 square foot facility in San Jose, California. Our
subsidiary has additional offices in Raleigh, Chicago, Boston and Dallas. We also have a
leased representative office in Beijing, China and in Tokyo, Japan.

Our
U.S. subsidiary, Ai-Logix, Inc., leases a 29,000 square foot facility in Somerset. New
Jersey.

We
believe that these properties are adequate to meet our current needs. We may need to
increase the size of our current facilities, seek new facilities, close certain facilities
or sublease portions of our existing facilities in order to address our needs in the
future.

Rent
expense was $1,713,000 in 2002, $1,829,000 in 2003, and $2,927,000 in 2004. We project
that our rent expense for 2005 will be approximately $2,705,000.

| | ITEM 5. | OPERATING AND FINANCIAL REVIEW AND PROSPECTS
| | ------- | --------------------------------------------

Statements
in this Annual Report concerning our business outlook or future economic performance;
anticipated revenues, expenses or other financial items; product introductions and plans
and objectives related thereto; and statements concerning assumptions made or expectations
as to any future events, conditions, performance or other matters, are
forward-looking statements as that term is defined under the United States
Federal securities laws. Forward-looking statements are subject to various risks,
uncertainties and other factors that could cause actual results to differ materially from
those stated in such statements. Factors that could cause or contribute to such
differences include, but are not limited to, those set forth under Risk
Factors in this Annual Report, as well as those discussed elsewhere in this Annual
Report and in our other filings with the Securities and Exchange Commission.

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# Critical Accounting
Estimates

Our
consolidated financial statements are prepared in accordance with generally accepted
accounting principles in the United States, or US GAAP. These accounting principles
require management to make certain estimates, judgments and assumptions based upon
information available at the time that they are made, historical experience and various
other factors that are believed to be reasonable under the circumstances. These estimates,
judgments and assumptions can affect the reported amounts of assets and liabilities as of
the date of the financial statements, as well as the reported amounts of revenues and
expenses during the periods presented.

On
an on-going basis, management evaluates its estimates and judgments, including those
related to revenue recognition and allowance for sales returns, allowance for doubtful
accounts, inventories, investment in an affiliated company and goodwill. Management bases
its estimates and judgments on historical experience and on various other factors that are
believed to be reasonable under the circumstances, the results of which form the basis for
making judgments about the carrying values of assets and liabilities that are not readily
apparent from other sources.

In
many cases, the accounting treatment of a particular transaction is specifically dictated
by US GAAP and does not require managements judgment in its application. There are
also areas in which managements judgment in selecting among available alternatives
would not produce a materially different result. Our management has reviewed these
critical accounting policies and related disclosures with our Audit Committee. See Note 2
to the Consolidated Financial Statements, which contain additional information regarding
our accounting policies and other disclosures required by US GAAP.

Management
believes the significant accounting policies that affect its more significant judgments
and estimates used in the preparation of its consolidated financial statements and are the
most critical to aid in fully understanding and evaluating AudioCodes reported
financial results include the following:

| |  | Revenue
recognition and allowance for sales returns;
| | - | ----------------------------------------------------

| |  | Allowance
for doubtful accounts;
| | - | --------------------------------

| |  | Inventories;
| | - | ------------

| |  | Investment
in an affiliated company; and
| | - | ----------------------------------------

| |  | Goodwill
| | - | --------

Revenue Recognition
and Allowance for Sales Returns

We
generate our revenues primarily from the sale of products. We sell our products through a
direct sales force and sales representatives. Our products are generally a bundled
hardware and software solution that is delivered together to our customers, which include
original equipment manufacturers (OEMs), network equipment providers, systems integrators
and distributors of a variety of telecommunications and networking products, all of whom
are considered end users.

Revenues
from products are recognized when the following criteria are met: (i) persuasive evidence
of an arrangement exists, (ii) delivery of the product has occurred, (iii) the fee is
fixed or determinable and (iv) collectability is probable. We have no obligation to
customers after the date on which products are delivered, other than pursuant to warranty
obligations and any applicable right of return. We generally grant our customers the right
of return or the ability to exchange a specific percentage of the total price paid for
products they have purchased over a period of three months for other products.

- 46 -

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We
maintain a provision for product returns and exchanges. This provision is based on
historical sales returns, analysis of credit memo data and other known factors.This provision is deducted from revenues, and amounted to $272,000 in 2002, $294,000
in 2003 and $619,000 in 2004.

Revenues
from the sale of products which were not yet determined to be final sales due to market
acceptance or technological compatibility were deferred and included in deferred revenues.

Allowance for
Doubtful Accounts

We
maintain an allowance for doubtful accounts. Management exercises its judgment as to our
ability to collect outstanding receivables. Provisions are made based upon a specific
review of all significant outstanding invoices. For those invoices not specifically
reviewed, provisions are made based upon the age of the receivable. In determining the
provision, we analyze our historical collection experience and current economic trends. If
the historical data used to calculate the allowance provided for doubtful accounts does
not reflect the future ability to collect outstanding receivables, additional provisions
for doubtful accounts may be needed and the future results of operations could be
materially affected.

Inventories

Inventories
are stated at the lower of cost or market value. Cost is determined using the moving
average cost method for raw materials and on the basis of direct manufacturing costs
for finished products. We periodically evaluate the quantities on hand relative to current
and historical selling prices and historical and projected sales volume and technological
obsolescence. Based on these evaluations, inventory write-offs and write-down provisions
are provided to cover risks arising from slow moving items, technological obsolescence,
excess inventories, discontinued products and for market prices lower than cost. We
wrote-off and wrote-down inventory in a total amount of $1.7 million in 2002, $835,000 in
2003 and $1.2 million in 2004.

Investment in an
Affiliated Company

Through
December 31, 2004, we had invested an aggregate of $2.5 million in a privately-held
company engaged in speech recognition. We currently own approximately 40% of the equity in
this company. This investment is accounted for by the equity method and is reviewed for
impairment whenever events or changes in circumstances indicate that the carrying amount
of the investment may not be recoverable. As of December 31, 2004, based on
managements most recent analyses, no impairment losses have been identified in
connection with this investment.

- 47 -

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---



Goodwill

SFAS
No.142 requires goodwill to be tested for impairment at least annually or between annual
tests in certain circumstances, and written down when impaired, rather than being
amortized as previous accounting standards required. Goodwill is tested for impairment at
the reporting unit level by comparing the fair value of the reporting unit with its
carrying value. In connection with our acquisition of selected assets of UAS, we
recognized $4.3 million of goodwill in 2003 and an additional $1.0 million of goodwill in
2004. We recognized $3.8 million of goodwill in 2004 in connection with our acquisition of
Ai-Logix. We paid an additional $10 million in March 2005 based on the achievement of
revenue milestones by the Ai-Logix business during 2004 and 2005. This contingent was
recorded as part of the acquisition cost as additional goodwill during 2005. Goodwill in
connection with the UAS and Ai-Logix acquisitions was reviewed for impairment during the
fourth quarter of 2004. No impairment losses have been identified in connection with these
acquisitions.

|A. | OPERATING
RESULTS
|-- | -----------------

You
should read this discussion with the consolidated financial statements and other financial
information included in this Annual Report.

# Overview

We
design, develop and market enabling technologies and products for the transmission of high
quality voice, data and fax over packet networks. Newly developed equipment based on
advanced voice communications standards enables packet networks to carry voice and data
more efficiently and at a lower cost than traditional telephone networks by using
substantially less network capacity. Our products are designed to enable our customers to
build packet voice networking equipment that provides comparable communication quality to
that of traditional telephone networks. Our communication boards are the building blocks
for connecting traditional telephone networks with packet voice networks and provide high
performance and large capacity on open telecommunications platform-based gateways. We have
continued to broaden our offerings as we have expanded in the last few years from selling
chips to boards, subsystems, media gateway systems and media servers.

Our
headquarters are in Airport City, Lod, Israel and we have eight additional offices
worldwide: in the United States in San Jose, Boston, Chicago, Dallas, Raleigh and
Somerset, New Jersey, as well as in Tokyo, Japan and Beijing, China.

In
2002, no customer accounted for more than 8.9% of our total revenues and our top five
customers accounted for 30.2% of our total revenues. Nortel Networks accounted for 14.3%
of our total revenues in 2003 and 18.6% of our total revenues in 2004 and our top five
customers accounted for 34.2% of our total revenues in 2003 and 35.7% of our total
revenues in 2004. Based on our experience, we expect that our largest customers may change
from period to period. If we lose a large customer and fail to add new customers to
replace lost revenue our operating results may be materially adversely affected.

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Revenues
based on the location of our customers for the last three fiscal years are as follows:

|         | 2002 | 2003 | 2004
|-------- | ---- | ---- | ----
|
|
|
|
|Americas |      |      |     
|Far East |      |      |     
|Europe   |      |      |     
|Israel   |      |      |     
|         |      |      |     
|Total    |      |      |     
|         |      |      |     

Part of
our strategy involves the acquisition of complementary businesses and technologies. Our
first strategic acquisition involved the purchase of the UAS product group from Nortel
Networks in April 2003. This acquisition added new media server technology and products
that we could offer to our customers and provided us with research and development
capability in the United States. As a result of our supply agreement with Nortel entered
into in connection with this transaction, we significantly increased our sales to Nortel,
with sales to Nortel accounting for 18.6% of our revenues in 2004 compared to 14.3% of our
revenues in 2003 and 1.4% of our revenues in 2002. We expect that sales to Nortel will
continue to account for a high percentage of our revenues in 2005.

We
completed a second acquisition in May 2004, acquiring Ai-Logix, a leading provider of
advanced voice recording hardware technology. We believe that this acquisition has
enhanced our board line business and provides an entry into the call recording market and
the computer telephony integration, or CTI, market by leveraging our VoP expertise with
the technology, strategic partnerships and customer base of Ai-Logix. We paid $10.0
million in cash at the closing of the transaction. We paid an additional $10 million in
March 2005 based on the achievement of revenue milestones by the Ai-Logix business during
2004 and 2005. The payment was recorded as part of the acquisition cost as additional
goodwill in accordance with the provisions of SFAS No. 141 in 2005.

The
increase in the percentage of our revenues from customers located in the Americas over the
past two years was primarily the result of our increased sales in the United States. The
increase in sales in the United States was primarily due to increased sales to Nortel as a
result of our acquisition of the UAS product group and our acquisition of Ai-Logix.

We
believe that prospective customers generally are required to make a significant commitment
of resources to test and evaluate our products and to integrate them into their larger
systems. As a result, our sales process is often subject to delays associated with lengthy
approval processes that typically accompany the design and testing of new communications
equipment. For these reasons, the sales cycles of our products to new customers are often
lengthy, averaging approximately six to twelve months. As a result, we may incur
significant selling and product development expenses prior to generating revenues from
sales.

The
currency of the primary economic environment in which our operations are conducted is the
U.S. dollar, and as such, we use the dollar as our functional currency. Transactions and
balances originally denominated in dollars are presented at their original amounts. All
transaction gains and losses from the remeasurement of monetary balance sheet items
denominated in non-dollar currencies are reflected in the statement of operations as
financial income or expenses, as appropriate.

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The
accelerated demand for Voice over IP, or VoIP, technology has impacted our business during
the last two years.. Over the past two years, the shift from traditional circuit-switched
networks to next generation packet-switched networks continued to gain momentum. As data
traffic becomes the dominant factor in communications, service providers are building and
maintaining converged networks for integrated voice and data services. In addition,
underdeveloped markets without basic wireline service in countries such as China and India
are beginning to use VoP technology to deliver voice and data services that were
previously unavailable. These trends are helping to overcome the downturn in the
telecommunications industry that affected us during previous years.

Unfavorable
economic conditions affected the communications sector during the period from 2000 to
2003. This caused a decrease in our revenues from 2000 to 2001 and from 2001 to 2002. It
also resulted in our net losses in 2001, 2002 and 2003. Sales of products, particularly
for applications in converged networks, to OEMs for use by large service providers
declined significantly during these periods. In response to our revenue decreases, we
implemented expense control programs to reduce operating expenses, while at the same time
we continued to invest in developing products that we believe our customers will need as
the market for telecommunications equipment improves. Many companies that had reduced
their capital expenditures during the recent economic downturn have begun to invest again
in their communications networks. The acceptance of next generation packet-switched
networks is contributing to these infrastructure investments as enterprises and service
providers begin to increase their use of IP networks for data traffic, such as fax
transmissions, and VoIP. These improving market conditions helped our revenues to increase
in 2003 and in 2004, and we expect our revenues in 2005 to exceed our revenues in 2004.

- 50 -

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# Results of Operations

The
following table sets forth the percentage relationships of certain items from our
consolidated statements of operations, as a percentage of total revenues for the periods
indicated:

|                                          | Year Ended December 31,
|----------------------------------------- | -----------------------
|
|
|
|
|Statement of Operations Data:             |                        
|                                          |                        
|Revenues                                  |                        
|Cost of revenues                          |                        
|                                          |                        
|Gross profit                              |                        
|Operating expenses:                       |                        
|Research and development, net             |                        
|Selling and marketing                     |                        
|General and administrative                |                        
|                                          |                        
|Total operating expenses                  |                        
|                                          |                        
|Operating income (loss)                   |                        
|Equity in losses of an affiliated company |                        
|Financial income, net                     |                        
|                                          |                        
|Income  (loss) before taxes on            |                        
|income                                    |                        
|Taxes on income                           |                        
|                                          |                        
|Net income (loss)                         |                        
|                                          |                        

# Year Ended December
31, 2004 Compared to Year Ended December 31, 2003

Revenues.
          Revenues increased 87.1% to $82.8 million in 2004 from $44.2 million in 2003.
          The increase in revenues was primarily due to an increase in sales in the United
          States, derived mainly from the inclusion of a full year of sales by our UAS
          product group, which was acquired in April 2003, and from sales generated as a
          result of our acquisition of Ai-Logix in May 2004. Our increase in revenues in
          2004 also reflected the increased interest and activity in the market for
          packet-based VoIP products.

Gross
Profit. Cost of revenues includes the manufacturing cost of hardware, quality
assurance, overhead related to manufacturing activity and technology licensing fees
payable to third parties. Gross profit increased to $48.4 million in 2004 from $24.2
million in 2003. Gross profit as a percentage of revenues increased to 58.5% in 2004 from
54.7% in 2003. The increase in our gross profit percentage was primarily a result of
higher sales volume that allowed us to leverage our operations as our manufacturing
overhead was spread over a larger sales base. In addition, gross profit percentage
increased because of higher sales of integrated systems which usually have higher margins
than sub-systems and chips. In the first quarter of 2004, we completed product integration
and started shipping UAS platforms based on our hardware which allowed us to achieve
better margins on these products. The increase in gross profit percentage was also due to
our ability to offset the continued decline in average selling prices of our products with
a reduction in manufacturing costs. The reduction in manufacturing costs was primarily due
to a reduction in our raw material costs.

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Research
and Development Expenses. Research and development expenses consist primarily of
compensation and related costs of employees engaged in ongoing research and development
activities, development-related raw materials and the cost of subcontractors. Research and
development expenses increased 29.3% to $20.0 million in 2004, from $15.5 million in 2003
and decreased as a percentage of revenues to 24.2% in 2004 from 35.0% in 2003. The
increase in net research and development expenses was primarily due to additions to our
research and development personnel resulting from the acquisition of the UAS product group
from Nortel Networks during the second quarter of 2003 and the acquisition of Ai-Logix
during the second quarter of 2004. We expect that research and development expenses will
continue to increase in absolute dollar terms as a result of our continued development of
new products.

Selling
and Marketing Expenses. Selling and marketing expenses consist primarily of
compensation for selling and marketing personnel, as well as exhibition, travel and
related expenses. Selling and marketing expenses increased 36.8% in 2004 to $19.9 million
from $14.5 million in 2003. As a percentage of revenues, selling and marketing expenses
decreased to 24.0% in 2004 from 32.9% in 2003. The increase in selling and marketing
expenses was primarily due to an increase in selling and marketing personnel and
associated expenses, as well as additional personnel as a result of the acquisition of
Ai-Logix. We expect that selling and marketing expenses will continue to increase in
absolute dollar terms as a result of an expected increase in our sales force and marketing
activities.

General
and Administrative Expenses. General and administrative expenses consist primarily of
compensation for finance, human resources, general management, rent, network and
information systems and bad debt reserve, as well as insurance and professional services
expenses. General and administrative expenses increased 19.3% to $4.9 million in 2004 from
$4.1 million in 2003. As a percentage of revenues, general and administrative expenses
decreased to 5.9% in 2004 from 9.2% in 2003. The increase in general and administrative
expenses in 2004 was primarily the result of consolidating the expenses of our Ai-Logix
subsidiary, which was acquired in May 2004. During 2003, we recorded $924,000 of expenses
in connection with our moving into our new premises in Israel. We did not have similar
expenses in 2004. We expect that general and administrative expenses will increase in
absolute dollar terms to support our expected growth.

Equity
in Losses of Affiliated Company. Equity in losses of an affiliated company were
$516,000 in 2004 compared to $429,000 in 2003. We believe that the products being
developed by the affiliated company may enable us to enter new markets and to offer new
products.

Financial
Income, Net. Financial income consists primarily of interest derived on cash and cash
equivalents and long term bank deposits and structured notes, net of interest accrued in
connection with our senior convertible notes and bank charges. Financial income, net, in
2004 was $2.2 million compared with financial income of $1.9 million in 2003. The increase
in financial income during 2004 was primarily due to higher interest rates and interest
income, net, on the $120.2 million of net proceeds from our sale of senior convertible
notes in November 2004.

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---



# Year Ended December
31, 2003 Compared to Year Ended December 31, 2002

Revenues.
          Revenues increased 62.7% to $44.2 million in 2003 from $27.2 million in 2002.
          This increase was primarily due to a growing momentum in the shift from
          traditional circuit-switched networks to next generation packet-switched
          networks, as well as an increase of $6.3 million in sales to Nortel Networks,
          primarily as a result of our acquisition of the UAS product group from Nortel.

Gross
Profit. Gross profit increased 70.6% to $24.2 million in 2003 from $14.2 million in
2002. Gross profit as a percentage of revenues increased to 54.7% in 2003 from 52.2% in
2002. The increase in gross profit percentage resulted primarily from a reduction in
inventory write-offs and write-downs which are included in the cost of revenues. These
write-offs and write-downs were $835,000 in 2003 compared to $1.7 million in 2002.
Inventory write-offs were higher in 2002 because of the effects of the slowdown in the
telecommunications market. In addition, gross profit percentage benefited from
manufacturing overhead being spread over a larger sales base.

Research
and Development Expenses. Research and development expenses increased 18.8% to $15.5
million in 2003, from $13.0 million in 2002 and decreased as a percentage of total
revenues to 35.0% in 2003 from 47.9% in 2002. The increase in research and development
expenses in 2003 was primarily due to additions to our research and development personnel
resulting from the acquisition of the UAS product group from Nortel Networks.

Selling
and Marketing Expenses. Selling and marketing expenses increased 1.7% in 2003 to $14.5
million from $14.3 million in 2002. As a percentage of total revenues, selling and
marketing expenses decreased to 32.9% in 2003 from 52.6% in 2002. The increase in selling
and marketing expenses was primarily due to an increase in selling and marketing personnel
and associated expenses.

General
and Administrative Expenses. General and administrative expenses increased 21.3% to
$4.1 million in 2003 from $3.4 million in 2002. As a percentage of total revenues, general
and administrative expenses decreased to 9.2% in 2003 from 12.3% in 2002. The increase in
general and administrative expenses was primarily due to expenses related to our moving
into our new premises in Israel.

Equity
in losses of Affiliated Company. Equity in losses of an affiliated company were
$429,000 in 2003 compared to $300,000 in 2002. We believe that the products being
developed by the affiliated company may enable us to enter new markets and to offer new
products. As a result, during 2003, we increased our ownership in this company to 40%. We
also adopted the equity method of accounting in 2003. Prior year results have been
adjusted to reflect this investment at equity.

Financial
Income, Net. Financial income consists primarily of interest derived on cash and cash
equivalents and long term bank deposits and structured notes, net of bank charges.
Financial income in 2003 was $1.9 million compared with financial income of $2.6 million
in 2002. The decrease in financial income was primarily due to lower interest rates on
cash and cash equivalents, and long term bank deposits and, to a lesser extent, a
reduction in cash reserves.

- 53 -

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# Impact of Inflation,
Devaluation and Fluctuation of Currencies on Results of Operations,Liabilities and
Assets

Since
the majority of our revenues are paid in or linked to the dollar, we believe that
inflation and fluctuations in the NIS/dollar exchange rate have no material effect on our
revenues. However, a portion of the cost of our Israeli operations, mainly personnel and
facility-related, is incurred in NIS. Inflation in Israel and dollar exchange rate
fluctuations, however, have some influence on our expenses and, as a result, on our net
income. Our NIS costs, as expressed in dollars, are influenced by the extent to which any
increase in the rate of inflation in Israel is not offset (or is offset on a lagging
basis) by a devaluation of the NIS in relation to the dollar.

To
protect against the changes in value of forecasted foreign currency cash flows resulting
from payments in NIS, we maintain a foreign currency cash flow hedging program. We hedge
portions of our forecasted expenses denominated in foreign currencies with forward
contracts. These measures may not adequately protect us from material adverse effects due
to the impact of inflation in Israel.

The
following table presents information about the rate of inflation in Israel, the rate of
devaluation of the NIS against the dollar, and the rate of inflation in Israel adjusted
for the devaluation:

|Year ended
December 31, | Israeli
inflation
rate
% | NIS
Devaluation
Rate
% | Israeli inflation
adjusted for
devaluation
%
|----------------------- | ------------------------ | ---------------------- | --------------------------------------------
|
|
|
|
|2002                    |                          |                        |                                             
|2003                    |                          |                        |                                             
|2004                    |                          |                        |                                             

# Effective Corporate
Tax Rate

Israeli
companies are generally subject to corporate tax on their taxable income at a rate of 35%
(in the 2004 tax year), 34% (in the 2005 tax year), 32% (in the 2006 tax year) and 30% (in
2007 and thereafter). However, the rate applicable to us is currently effectively reduced
as detailed below. Our production facilities have been granted approved enterprise status
in accordance with the Law for Encouragement of Capital Investments, 1959 under four
separate investment programs, and consequently the income derived from these facilities is
exempt from corporate tax in Israel for two or four years commencing in the year in which
the specific approved enterprise first generates taxable income, and to corporate tax at a
reduced rate of 10% to 25% for the following six or eight years (depending on the
percentage of foreign shareholdings). Income from sources other than the approved
enterprise during the benefit period will be subject to tax at the regular tax rate
prevailing at that time. Our effective tax rate will be a weighted combination of the
various applicable tax rates. See note 12 of the consolidated financial statements.

|B. | LIQUIDITY
AND CAPITAL RESOURCES
|-- | -------------------------------

We
have financed our operations for the last three years from the remaining proceeds from
prior public offerings of our Ordinary shares. In November 2004, we raised net proceeds of
approximately $120.2 million in a private placement of $125.0 million aggregate principal
amount of our 2.00% Senior Convertible Notes due 2024. As of December 31, 2004, we had
$166.8 million in cash and cash equivalents and $50.2 million in long-term bank deposits
and structured notes.

- 54 -

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---



In
connection with our acquisition of Ai-Logix, we paid an additional $10 million in March
2005 based on the achievement of revenue milestones by the Ai-Logix business during 2004
and 2005. This payment was recorded as part of the acquisition cost as additional goodwill
during 2005.

Our
operating activities provided cash in the amount of $3.5 million in 2004, primarily due to
our net income, depreciation and amortization expenses and an increase in trade payables
and other payables and accrued expenses, which were partially offset by an increase in
trade receivables and inventories and other receivables and prepaid expenses. Our
operating activities used cash in the amount of $6.5 million in 2003, primarily due to our
net loss and an increase in trade receivables, which were partially offset by depreciation
and amortization expenses and an increase in trade payables and other payables and accrued
expenses. Our operating activities used cash in the amount of $11.7 million in 2002,
primarily due to our net loss and a decrease in other payables and accrued expenses, which
were partially offset by depreciation and amortization expenses and a decrease in
inventories.

In
2004, our investing activities used cash in the amount of $15.9 million, primarily due to
the acquisition of Ai-Logix and UAS and the purchase of property and equipment. In 2003,
our investing activities provided cash in the amount of $6.1 million primarily due to
proceeds from short-term bank deposits, which were partially offset by investment in
long-term bank deposits and structured notes, payments of $4.4 million in connection with
the acquisition of UAS and the purchase of property and equipment. In 2002, our investing
activities provided cash in the amount of $13.3 million primarily due to proceeds from
short-term bank deposits which was offset in part by the purchase of property and
equipment. Our capital expenditures were $4.3 million in 2004, $2.0 million in 2003 and
$2.1 million in 2002. The majority of our capital investment has been for testing
equipment, an enterprise resources planning system, computers, peripheral equipment,
software, office furniture and leasehold improvements. We used working capital to finance
these expenditures.

In
2004, financing activities provided $130.4 million, due to the net proceeds of $120.2
million from our private placement of $125.0 million aggregate principal amount of our
2.00% Senior Convertible Notes due 2024 and $10.2 million from the issuance of shares upon
exercise of options and from purchases under our Employee Stock Purchase Plans. In 2003,
financing activities provided $1.4 million due to issuance of shares upon exercise of
options and from shares purchased under our Employee Stock Purchase Plans, partially
offset by $215,000 used to repurchase our ordinary shares. In 2002, financing activities
used $3.9 million to repurchase our ordinary shares, partially offset by $757,000 from
issuance of shares upon exercise of options and from shares purchased under our Employee
Stock Purchase Plans.

We
anticipate that our operating expenses will be a material use of our cash resources for
the foreseeable future. We believe that our current working capital is sufficient to meet
our present cash requirements. Part of our strategy is to pursue acquisition
opportunities. If we do not have available sufficient cash to finance our operations and
the completion of one or more acquisitions, we may be required to obtain additional debt
or equity financing. We cannot be certain that we will be able to obtain, if required,
additional financing on acceptable terms or at all.

- 55 -

---

---



# Repurchase of Shares

In
January 2001, our board of directors authorized us to repurchase up to 2,000,000 of our
ordinary shares, and in April 2002, our board authorized the repurchase of an additional
2,000,000 of our ordinary shares, all subject to the discretion of our management. In
2001, we purchased 1,774,800 of our ordinary shares for an aggregate purchase price of
approximately $6,401,000. In 2002, we purchased 2,079,139 of our ordinary shares for an
aggregate purchase price of $4,703,486. In 2003, we purchased 88,200 of our ordinary
shares for an aggregate purchase price of $215,321.

|C. | RESEARCH
AND DEVELOPMENT, PATENTS AND LICENSES, ETC.
|-- | ----------------------------------------------------

# Research and
Development

In
order to accommodate the rapidly changing needs of our markets, we place considerable
emphasis on research and development projects designed to improve our existing products
and to develop new ones. We are developing more advanced communications boards and analog
and digital media gateways for carrier and enterprise applications. Our platforms will
feature increased trunk capacity, new functionalities, enhanced signaling software and
compliance with new control protocols. As of December 31, 2004, 213 of our employees were
engaged primarily in research and development on a full-time basis. We also employed 9
persons on a part-time basis.

Our
research and development expenses were $20.0 million in 2004 compared to $15.5 million in
2003 and $13.0 million in 2002. From time to time we have received royalty-bearing grants
from the Office of the Chief Scientist of the Israeli Ministry of Industry, Trade and
Labor, or the OCS. As a recipient of grants from the OCS, we are obligated to perform all
manufacturing activities for projects subject to the grants in Israel unless we receive an
exemption. Know-how from the research and development which is used to produce products
may not be transferred to third parties without the approval of the OCS. This approval is
not required for the export of any products resulting from such research or development.
Through December 31, 2004, we had obtained grants from the OCS aggregating $1.2 million
for certain of our research and development projects. We are obligated to pay royalties to
the OCS, amounting to 3%-4% of the sales of the products and other related revenues
generated from such projects, up to 100% of the grants received, linked to the U.S. dollar
and bearing interest at the rate of LIBOR at the time of grant. The obligation to pay
these royalties is contingent on actual sales of the products and in the absence of such
sales no payment is required.

- 56 -

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Recent Accounting
Pronouncements

On
December 16, 2004, the Financial Accounting Standards Board issued SFAS No. 123(R)
(revised 2004), Share-Based Payment, which is a revision of SFAS No. 123.
Generally, the approach in SFAS No. 123(R) is similar to the approach described in SFAS
No. 123. However, SFAS No. 123 permitted, but not required, share-based payments to
employees to be recognized based on their fair values while SFAS No. 123(R) requires all
share-based payments to employees to be recognized based on their fair values. SFAS No.
123(R) also revises, clarifies and expands guidance in several areas, including measuring
fair value, classifying an award as equity or as a liability and attributing compensation
cost to reporting periods. Based on an amendment in April 2005, the new standard is
effective at the beginning of the first annual period commencing after June 15, 2005.
Accordingly, it will become effective for us on January 1, 2006. The adoption of SFAS
123(R) may have a significant effect on the Companys results of operations.

In
November 2004, the FASB issued SFAS No. 151, Inventory Costs, an amendment of ARB
No. 43, Chapter 4". SFAS No. 151 amends Accounting Research Bulletin
(ARB) No. 43, Restatement and Revision of Accounting Research
Bulletins, Chapter 4, to clarify that abnormal amounts of idle facility
expense, freight handling costs and wasted materials (spoilage) should be recognized as
current-period charges. In addition, SFAS No. 151 requires that allocation of fixed
production overheads to the costs of conversion be based on normal capacity of the
production facilities. SFAS No. 151 is effective for inventory costs incurred during
fiscal years beginning after June 15, 2005. We do not expect that the adoption of SFAS No.
151 will have a material effect on our financial position or results of operations.

TREND
INFORMATION

The
accelerated demand for VoIP technology has impacted our business during the last two
years. Over the past two years, the shift from traditional circuit-switched networks to
next generation packet-switched networks continued to gain momentum. As data traffic
becomes the dominant factor in communications, service providers are building and
maintaining converged networks for integrated voice and data services. In addition,
underdeveloped markets without basic wireline service in countries such as China and India
are beginning to use VoP technology to deliver voice and data services that were
previously unavailable. These trends are helping to overcome the downturn in the
telecommunications industry that affected us during the previous years.

In
2004, we continued to experience pressure to shorten our lead times in supplying products
to customers. Some of our customers are implementing demand pull programs by
which they only purchase our product very close to the time, if not simultaneously with
the time, they plan to sell their product. We are increasing our sales efforts in new
markets, such as Latin America, Eastern Europe and Far East. We have introduced system
level products, and new applications in our product lines. . We are still experiencing low
visibility into customer demand for our products and our ability to predict our level of
sales.

Unfavorable
economic conditions affected the communications sector during the period from 2000 to
2003. This caused a decrease in our revenues from 2000 to 2001 and from 2001 to 2002. It
also resulted in our net losses in 2001, 2002 and 2003. Sales of products, particularly
for applications in converged networks, to OEMs for use by large service providers
declined significantly during these periods. In response to our revenue decreases, we
implemented expense control programs to reduce operating expenses, while at the same time
we continued to invest in developing products that we believe our customers will need as
the market for telecommunications equipment improves. Many companies that had reduced
their capital expenditures during the recent economic downturn have begun to invest again
in their communications networks. The acceptance of next generation packet-switched
networks is contributing to these infrastructure investments as enterprises and service
providers begin to increase their use of IP networks for data traffic, such as fax
transmissions, and VoIP. These improving market conditions helped our revenues to increase
in 2003 and in 2004, and we expect our revenues in 2005 to exceed our revenues in 2004.

- 57 -

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|E. | OFF-BALANCE
SHEET ARRANGEMENTS
|-- | ------------------------------

We
do not have any off-balance sheet arrangements as this term is defined in Item
5E of Form 20-F.

|F. | TABULAR
DISCLOSURE OF CONTRACTUAL OBLIGATIONS
|-- | ---------------------------------------------

As
of December 31, 2004, our contractual obligations were as follows (in thousands):

|                             | PAYMENTS DUE BY PERIOD
|---------------------------- | ----------------------
|
|
|
|
|Rental and lease commitments |                       
|                             |                       
|Total cash obligations       |                       

Our
obligation for accrued severance pay under Israels Severance Pay Law as of December
31, 2004 was $5.0 million, of which $4.5 million was funded through deposits into
severance pay funds, leaving a net obligation of approximately $440,000.

| | ITEM 6. | DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES
| | ------- | ------------------------------------------

|A. | DIRECTORS
AND SENIOR MANAGEMENT
|-- | -------------------------------

The
following table sets forth certain information with respect to our directors, senior
executive officers and key employees at April 30, 2005:

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|Name               | Age | Position                                                    
|------------------ | --- | ------------------------------------------------------------
|
|
|
|
|Shabtai Adlersberg | 52  | Chairman of the Board, President and Chief Executive Officer
|Nachum Falek       | 34  | Vice President, and Chief Financial Officer                 
|Eyal Frishberg     | 46  | Vice President, Operations                                  
|Eli Nir            | 38  | Vice President, Research and Development                    
|Lior Aldema        | 39  | Vice President, Marketing and Product Management            
|Ben Rabinowitz     | 38  | Vice President, Marketing and Sales, North America          
|Yehuda Hershkowitz | 38  | Vice President, Systems                                     
|Tal Dor            | 36  | Vice President, Human Resources                             
|Gary Drutin        |     | Vice President, Channel Operations and Marketing            
|Moshe Tal          | 51  | President and Chief Executive Officer, Ai-Logix Inc.        
|Joseph Tenne       | 49  | Director                                                    
|Dana Gross         | 38  | Director                                                    
|Dr. Eyal Kishon    | 45  | Director                                                    
|Doron Nevo         | 49  | Director                                                    

Shabtai
Adlersberg co-founded AudioCodes in 1993, and has served as our Chairman of the Board
and Chief Executive Officer since inception. Mr. Adlersberg co-founded DSP Group, a
semiconductor company, in 1987. From 1987 to 1990, Mr. Adlersberg served as the Vice
President of Engineering of DSP Group, and from 1990 to 1992, he served as Vice President
of Advanced Technology. As Vice President of Engineering, Mr. Adlersberg established a
research and development team for digital cellular communication which was spun-off in
1992 as DSP Communications. Mr. Adlersberg also serves as Chairman of the Board of
Directors of Natural Speech Communication Ltd. Mr. Adlersberg holds an M.Sc. in
Electronics and Computer Engineering from Tel Aviv University and a B.Sc. in Electrical
Engineering from the Technion-Israel Institute of Technology, or the Technion.

Nachum
Falek joined AudioCodes in April 2000 and became our Vice President, and Chief
Financial Officer in November 2003. From 2000 to 2003, he served as Director of Finance.
Prior to joining AudioCodes, Mr. Falek served as Controller at ScanVec-Amiable Ltd. From
1998 to 1999, he was a Manager at Ernst & Young in Israel. Mr. Falek holds a B.A. in
Accounting and Economics from Haifa University, an M.B.A. from Tel Aviv University, and is
a licensed CPA in Israel.

Eyal
Frishberg has served as our Vice President, Operations since October 2000. From 1997
to 2000, Mr. Frishberg served as Associate Vice President, SDH Operations in ECI Telecom
Ltd., a major telecommunication company. From 1987 to 1997, Mr. Frishberg worked in
various operational positions in ECI Telecom including as manager of ECI production
facility and production control. Mr. Frishberg worked from 1994 until 1997 for ELTA
company, part of Israeli Aircraft Industries in the planning and control department. Mr.
Frishberg holds a B.Sc. in Industrial Engineering from Tel Aviv University and an M.B.A.
from Ben-Gurion University of the Negev.

Eli
Nir has served as our Vice President, Research and Development since April 2001. He
has been employed by us since 1996, when he founded and headed our System Software Group
in our research and development department. Prior to 1996, Mr. Nir served as an officer in
the Technical Unit of the Intelligence Corps of the Israeli Defense Forces (Major),
heading both operational units and large development groups mostly related to digital
processing. Mr. Nir holds an M.B.A. and an M.Sc. from Tel Aviv University in Digital
Speech Processing and a B.Sc. from the Technion.

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Lior
Aldema has served as our Vice President, Product Management since January 2002. Mr.
Aldema has also served as our Vice President Marketing since February 2003. He has been
employed by us since 1998, when he was team leader and later headed our System Software
Group in our research and development department. Prior to 1998, Mr. Aldema served as an
officer in the Technical Unit of the Intelligence Corps of the Israeli Defense Forces
(Major), heading both operational units and large development groups related to various
technologies and headed one of the largest projects conducted in the IDF and executed by
the Israeli Defense industry corporations. Mr. Aldema holds an M.B.A. from Tel Aviv
University and a B.Sc. from the Technion.

Ben
Rabinowitz joined us in December, 1999 and became our Vice President of Marketing and
Sales for North America in October 2004. Previously, Mr. Rabinowitz served as Vice
President of our Systems Group. From 1998 to 1999, Mr. Rabinowitz served as Director for
Product Marketing at Westell Inc., a broadband access company. From 1997 to 1998, Mr.
Rabinowitz served as Senior Director within the strategy practice of Technology Solutions
Company, a technology consulting firm. Mr. Rabinowitz also previously served in Ernst
& Youngs consulting practice from 1994 to 1997, and provided consulting services
to telecommunications companies. Mr. Rabinowitz holds an M.B.A. from Georgetown
University.

Yehuda
Hershkovits has served as our Vice President, Systems Group since 2003. From 2001 to
2003, Mr. Hershkovits served as our Vice President, Advanced Products. From 2000 to 2001,
Mr. Hershkovits served as our Director of Advanced Technologies. From 1994 to 1998 and
during 1999, Mr. Hershkovits held a variety of research and development positions at
Advanced Recognition Technologies, Ltd., a voice and handwriting recognition company,
heading its research and development from 1999 to 2000 as Vice President, Research and
Development. From 1998 to 1999, Mr. Hershkovits developed various wireless communication
algorithms at Comsys, a telecommunications company. Mr. Hershkovits holds an M.Sc. and a
B.Sc., from the Technion both in the area of telecommunications.

Tal
Dor has served as our Vice President of Human Resources since March 2000. For more
than three years prior to March 2000, Ms. Dor acted as a consultant in Israel to, among
others, telephone and cable businesses, as well as health and social service
organizations. Ms. Dor holds a B.A. in psychology, from Ben-Gurion University of the Negev
and an M.A. in psychology from Tel Aviv University.

Moshe
Tal joined us in May 2004 in connection with the acquisition of Ai-Logix, Inc. and
serves as the President and CEO of our Ai-Logix subsidiary. Mr. Tal co-founded Ai-Logix,
Inc. in 1991, and has served as its President and CEO since 1998. Mr. Tal has more than
twenty-five years of product design and engineering experience, principally associated
with analog and digital signal processing technologies. Mr. Tal holds a B.Sc. in
Electronic Engineering from Tel Aviv University. He also served in the Israeli Navy as a
Submarine Communication System Technician.

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Gary
Drutin joined us in 2004 as Vice President of Channel Operations and Marketing. From
2001 until 2004 Mr. Drutin was Country Manager and General Manager for Cisco Israel,
Cyprus and Malta and from 1997 until 2001 served as regional sales manager for service
providers and enterprises for Cisco Israel. From 1990 until 1997, he served in sales
management roles at Digital Equipment Corporation Israel. Mr. Drutin holds an M.B.A degree
from Tel-Aviv University in Information Systems and Marketing and a B.Sc. degree in
Computer Engineering from the Technion.

Joseph
Tenne has served as one of our directors since June 2003. Mr. Tenne is currently the
Chief Financial Officer of Ormat Technologies, Inc., a company listed on the New York
Stock Exchange, which is engaged in the geothermal and recovered energy business. From
2003 to 2004 Mr. Tenne was the Chief Financial Officer of Treofan Germany GmbH & Co.
KG, a German company, which is engaged in the development, production and marketing of
oriented polypropylene films, which are mainly used in the food packaging industry. From
1997 until 2003, Mr. Tenne was a partner in Kesselman & Kesselman, Certified Public
Accountants in Israel and a member of PricewaterhouseCoopers International Limited. Mr.
Tenne holds a B.A. in Accounting and Economics and an M.B.A. from Tel Aviv University. Mr.
Tenne is also a Certified Public Accountant in Israel.

Dana
Gross has served as one of our directors since June 2000. Ms. Gross has served as
Chief Marketing Officer of M-Systems Flash Disk Ltd. since April 2000, and as a director
of M-Systems since September 2000. Prior to that, Ms. Gross served as Executive Vice
President of the DiskOnChip business unit of M-Systems from 2000 and as Vice President of
Worldwide Sales of M-Systems from 1998 until April 2000. Ms. Gross joined M-Systems in
July 1992 as Vice President of Operations and became Chief Financial Officer in 1994,
President of M-Systems Inc. in 1995 and Executive Vice President of Business Development
in 1997. Ms. Gross also serves as a director of PowerDsine Ltd., a Power over Ethernet
technology company that is traded on Nasdaq. . Ms. Gross holds a B.Sc. in Industrial
Management Engineering from Tel Aviv University and an M.B.A. from San Jose State
University.

Dr.
          Eyal Kishon has served as one of our directors since 1997. Since 1996, Dr.
          Kishon has been Managing Partner of Genesis Partners, an Israel based venture
          capital fund. From 1993 to 1996, Dr. Kishon served as Associate Director of
          Dovrat-Shrem/Yozma-Polaris Fund Limited Partnership. In his capacity as Managing
          Partner of Genesis, Dr. Kishon serves as a director of VCON Telecommunications
          Ltd., a video conferencing technology company. From 1991 to 1992, Dr. Kishon was
          a Research Fellow in the Multimedia Department of IBM Science & Technology.
          From 1989 to 1991, Dr. Kishon worked in the Robotics Research Department of
          AT&T Bell Laboratories. Dr. Kishon holds a B.A. in Computer Science from the
          Technion and an M.Sc. and a Ph.D. in Computer Science from New York University.

Doron
Nevo has served as one of our directors since 2000. From 1996 to 1999, Mr. Nevo served
as President and CEO of NKO, Inc. Mr. Nevo established NKO in early 1995 as a startup
subsidiary of Clalcom, Ltd. NKO designed and developed a full scale carrier grade IP
Telephony system platform and established its own IP network. From 1992 to 1996, Mr. Nevo
was President and CEO of Clalcom Ltd. Mr. Nevo established Clalcom in 1992 as a fax
service provider in Israel. Mr. Nevo is President and CEO of KiloLambda Technologies Ltd.
an optical subsystems company. He also serves on the board of a number of companies such
as: Utility Wireless Corp. (a manufacturer of radio frequency sub-systems), Elcom
Technologies (manufacturer of Satcom and Digital Radio synthesizers), Notox, Ltd. (a
biotech company) and Cellaris, Ltd. (a new materials company). Mr. Nevo holds a B.Sc. in
Electrical Engineering from the Technion and an M.Sc. in Telecommunications Management
from Brooklyn Polytechnic.

- 61 -

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|B. | COMPENSATION
|-- | ------------

The
aggregate direct remuneration paid to all 14 persons who served in the capacity of
director or senior executive officer during the year ended December 31, 2004 was
approximately $1.3 million, including $168,000 which was set aside for pension and
retirement benefits. This does not include amounts expended by us for automobiles made
available to our officers, expenses (including business, travel, professional and business
association dues and expenses) reimbursed to officers and other fringe benefits commonly
reimbursed or paid by companies in Israel.

Stock
options to purchase our ordinary shares granted to persons who served in the capacity of
director or executive officer under our 1997 and 1999 Stock Option Plans are generally
exercisable at the fair market value at the date of grant, and expire ten years (under the
1997 Plan) and seven years (under the 1999 Plan), respectively, from the date of grant.
The options are generally exercisable in four or five equal annual payments, commencing
one year from the date of grant.

A
summary of our stock option activity and related information for the years ended December
31, 2002, 2003 and 2004 for all 14 persons who served in the capacity of director or
senior executive officer during the year ended December 31, 2004 is as follows:

|                                    | 2002 | 2003 | 2004
|----------------------------------- | ---- | ---- | ----
|
|
|
|
|Outstanding  at  the  beginning  of |      |      |     
|the year                            |      |      |     
|Adjustments to opening balance      |      |      |     
|                                    |      |      |     
|Granted                             |      |      |     
|Cancelled                           |      |      |     
|Exercised                           |      |      |     
|                                    |      |      |     
|                                    |      |      |     
|                                    |      |      |     
|Outstanding at the end of the year  |      |      |     
|                                    |      |      |     

As
of December 31, 2004, options to purchase 902,644 ordinary shares were exercisable at an
average exercise price of $9.67 per share.

|C. | BOARD
PRACTICES
|-- | ---------------

# Independent Directors;
Audit Committee; Internal Auditor

Under
the Israeli Companies Law, Israeli companies that have offered securities to the public in
or outside of Israel are required to appoint at least two outside directors.
Doron Nevo and Dr. Eyal Kishon are our outside directors. Under the requirements for
listing on The Nasdaq National Market, we will be required by July 31, 2005 to have a
majority of our directors be independent as defined by Nasdaq rules. Doron Nevo, Dr. Eyal
Kishon, Dana Gross and Joeseph Tenne are independent directors for purposes of the Nasdaq
rules.

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To
qualify as an outside director under Israeli law, an individual or his affiliates may not
have, and may not have had at any time during the previous two years, any affiliation with
the company or its affiliates, as such terms are defined in the Companies Law. In
addition, no individual may serve as an outside director if the individuals position
or other activities create or may create a conflict of interest with his or her role as an
outside director or are likely to interfere with his or her ability to serve as a
director. For a period of two years from termination from office, a former outside
director may not serve as a director or employee of the company or provide professional
services to the company for consideration.

The
outside directors must be elected by the shareholders, including at least one-third of the
shares of non-controlling shareholders voted on the matter. However, the outside directors
can be elected by shareholders without this one-third approval if the total shares of
non-controlling shareholders voted against the election do not represent more than one
percent of the voting rights in the company. The term of an outside director is three
years and may be extended for one additional three-year term. An outside director can be
removed from office only under very limited circumstances. Each committee of a
companys board of directors is required to include at least one outside director.
If, at the time outside directors are elected, all current members of the board of
directors are of the same gender, then at least one outside director must be of the other
gender.

Under
the Companies Law and the requirements for listing on The Nasdaq National Market, our
board of directors is required to appoint an audit committee. The audit committee must be
comprised of at least three directors, including all of the outside directors. The audit
committee consists of three members: Dr. Eyal Kishon, Doron Nevo and Joseph Tenne. The
audit committee may not include the chairman of the board, a controlling shareholder and
the members of his immediate family, or any director who is employed by the company or
provides services to the company on a regular basis. Under Israeli law, the role of the
audit committee is to examine flaws in our business management, in consultation with the
internal auditor and the independent accountants, and to propose remedial measures to the
board. The audit committee also reviews for approval transactions between the company and
office holders or interested parties, as described below.

Under
the Companies Law, our board of directors is also required to appoint an internal auditor
proposed by the audit committee. The internal auditor may be our employee, but may not be
an interested party or office holder, or a relative of any interested party or office
holder, and may not be a member of our independent accounting firm. The role of the
internal auditor is to examine, among other things, whether our activities comply with the
law and orderly business procedure. Eitan Hashachar CPA has been our internal auditor
since January 2001.

Our
board of directors appointed Dr. Eyal Kishon and Dana Gross to serve on the compensation
committee of the board of directors.

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Pursuant
to our articles of association, our directors were classified into three classes (classes
I, II and III). The members of each class of directors and the expiration of the term of
office is as follows:

|                   |           |     
|------------------ | --------- | ----
|
|
|
|
|Dana Gross         | Class I   | 2007
|Joseph Tenne       | Class II  | 2005
|Shabtai Adlersberg | Class III | 2006

Our
outside directors under the Companies Law, Doron Nevo and Dr. Eyal Kishon, are not members
of any class and serve in accordance with the provisions of the Companies Law. Mr.
Nevos term ends in 2006 and Dr. Kishons term ends in 2005.

|D. | EMPLOYEES
|-- | ---------

As
of December 31, 2004, we employed a total of 445 persons worldwide, including 213 in
research and development, 144 in selling and marketing, technical service and support, 25
in management and administration and 63 in operations. 105 of our employees are based in
the United States, primarily in Somerset, New Jersey, 2 in Latin America, 3 in Europe, 13
in China one in India and one in Japan. In addition, as of December 31, 2004, we employed
an additional 24 part-time employees. The growth in the number of employees during 2004
was attributable mainly to additions to our personnel resulting from the acquisition of
Ai-Logix and to growth in our research and development and sales personnel.

As
of December 31, 2003, we employed a total of 328 persons worldwide, including 145 in
research and development, 119 in sales and marketing, technical service and support, 19 in
management and administration and 45 in operations. Fifty of our employees are based in
the United States, primarily in Raleigh, North Carolina, one in Japan, one in the United
Kingdom, one in France and 10 in Beijing, China. In addition, as of December 31, 2003, we
employed an additional 24 part-time employees. The growth in the number of employees
during 2003 was attributable mainly to growth in our research and development team, and
sales personnel.

As
of December 31, 2002, we employed a total of 278 persons worldwide, including 137 in
research and development, 84 in sales and marketing, technical service and support, 18 in
management and administration and 39 in operations. 32 of our employees are based in the
United States, primarily in San Jose, California, one in Japan and 8 in Beijing, China. In
addition, as of December 31, 2002, we employed an additional 22 part-time employees. The
growth in the number of employees during 2002 was attributable mainly to growth in our
research and development teams, sales and sales support personnel.

Israeli
labor laws and regulations are applicable to our employees in Israel. These laws
principally concern matters such as paid annual vacation, paid sick days, length of the
workday, pay for overtime, insurance for work-related accidents, severance pay and other
conditions of employment. Israeli law generally requires severance pay, which may be
funded by Managers Insurance, described below, upon the retirement or death of an
employee or termination of employment without cause (as defined under Israeli law).
Furthermore, Israeli employees and employers are required to pay predetermined sums to the
National Insurance Institute. Since January 1, 1995, such amounts also include payments
for national health insurance. The payments to the National Insurance Institute are
approximately 16.3% of wages, of which the employee contributes approximately 64% and the
employer contributes approximately 36%.

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Although
not legally required, we regularly contribute to a Managers Insurance
fund or to a privately managed pension fund on behalf of our employees located in Israel.
These funds provide employees with a lump sum payment upon retirement (or a pension, in
case of a pension fund) and severance pay, if legally entitled thereto, upon termination
of employment. We provide for payments to a Managers Insurance Fund and pension fund
contributions in the amount of 13.3% of an employees salary on account of severance
pay and provident payment or pension, with the employee contributing 5.0% of his salary.
We also pay an additional amount of up to 2.5% of certain of our employees salaries
in connection with disability payments. In addition, we administer an Education Fund for
our Israeli employees and pay 7.5% of these employees salaries thereto, with the
employees contributing 2.5% of their salary.

Furthermore,
our employees are subject to certain provisions of the collective bargaining agreements
between the Histadrut (General Federation of Labor in Israel) and the Coordination Bureau
of Economic Organizations (including the Industrialists Associations) by order of the
Israeli Ministry of Labor and Welfare. These provisions principally concern cost of living
increases, recreation pay and other conditions of employment. We generally provide our
employees with benefits and working conditions above the required minimums. Our employees,
as a group, are not currently represented by a labor union. To date, we have not
experienced any work stoppages.

|E. | SHARE
OWNERSHIP
|-- | ---------------

The
following table sets forth the share ownership and outstanding number of options of our
directors and officers as of March 31, 2005:

|Name               | Total Shares Beneficially
Owned | Percentage of Ordinary Shares | Number of Options
|------------------ | ------------------------------- | ----------------------------- | -----------------
|
|
|
|
|Shabtai Adlersberg | 5,033,102                       | 12.6                          | 633,718          
|Nachum Falek       | *                               |                               | *                
|Eyal Frishberg     | *                               |                               | *                
|                  
|Eli Nir            | *                               |                               | *                
|Lior Aldema        | *                               |                               | *                
|                  
|Ben Rabinowitz     | *                               |                               | *                
|Yehuda Hershkowitz | *                               |                               | *                
|Tal Dor            | *                               |                               | *                
|Gary Drutin        | *                               |                               | *                
|Moshe Tal          | *                               |                               | *                
|Joseph Tenne       | *                               |                               | *                
|Dana Gross         | *                               |                               | *                
|Dr. Eyal Kishon    | *                               |                               | *                
|Doron Nevo         | *                               |                               | *                

*Less than one percent.

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The
officers and directors have the same voting rights as the other shareholders.

The
following table sets forth information with respect to the options to purchase our
ordinary shares held by Mr. Adlersberg as of March 31, 2005.

Shabtai Adlersberg

|Number of
Options | Grant Date         | Exercise
Price | Exercised | Cancelled | Vesting | Expiration Date   
|----------------- | ------------------ | -------------- | --------- | --------- | ------- | ------------------
|96,000            | July 1, 1996       | $  0.61        | (96,000)  | -         | 4 years | July 1, 2006      
|96,000            | July 1, 1998       | $  1.10        | (72,000)  | -         | 4 years | July 1, 2008      
|100,000           | May 23, 2000       | $29.16         | -         | -         | 4 years | May 23, 2007      
|225,000           | December 19, 2001  | $  4.18        | -         | -         | 4 years | December 19, 2008 
|9,718             | August 9, 2002     | $  2.04        | -         | -         | 2 years | August 9, 2009    
|275,000           | September 23, 2004 | $12.84         | -         | -         | 4 years | September 23, 2011

Employee
Share Plans

We
have an Employee Share Purchase Plan and Employee Share Option Plans for the granting of
options to our employees, officers, directors and consultants and adopted the 2001 U.S.
Employee Stock Purchase Plans during 2001. Most of these plans are pursuant to the Israeli
Income Tax Ordinance, entitling the beneficiaries who are our employees to tax benefits
under Israeli law. There are various conditions that must be met in order to qualify for
these benefits, including registration of the options in the name of a trustee for each of
the beneficiaries who is granted options. Each option, and any ordinary shares acquired
upon the exercise of the option, must be held by the trustee for a period commencing on
the date of grant and ending no earlier than 24 months after the end of the tax year in
which the option was granted and deposited in trust with the trustee. . There are similar
plans for our U.S. employees, which are designed to comply with the corresponding
provisions of the Internal Revenue Code of 1986, as amended.

Employee Share
Purchase Plans

We
implemented two Employee Share Purchase Plans in May 2001. One plan is for our U.S. and
Mexico employees and the other for all our Israeli and other employees. Under these Plans
an aggregate of 2,000,000 of our ordinary shares were reserved for sale to our employees
at a price equal to 85% of the lesser of fair market value on the first day or last day of
each offering period under the Plans. As of December 31, 2004, we had issued 708,964 of
our ordinary shares pursuant to purchases under these plans.

Employee Share
Option Plans

In
1999, our board restated three 1997 Employee Share Option Plans for our Israeli employees,
officers, directors and consultants and two 1997 Share Option Plans for our U.S.
employees, officers, directors and consultants. Additionally, in 1999 our board adopted an
Employee Share Option Plan for our Israeli employees, officers, directors and consultants,
and an Employee Share Option Plan for our U.S. employees, officers, directors and
consultants. The terms of the 1999 Plans are substantially the same as those of the 1997
Plans, but have reduced the exercise period from 10 to 7 years. The board has the ability
to grant options with longer or shorter terms. The terms of the 1999 Plans have been
modified slightly since they were adopted and in 2003, the Israeli Plan was changed to
conform to amendments to the Israeli income tax law.

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As
of December 31, 2004, options to purchase a total of 6,534,669 shares are outstanding
under the 1997 and 1999 Israeli Plans and options to purchase a total of 1,359,631 shares
are outstanding under the 1997 U.S. Plan. In addition, a reserve of 561,000 shares has
been made available for grant under the 1999 Israeli Plan and a reserve of 627,500 shares
has been made available for grant under the 1999 U.S. Plan. However, subject to our board
deciding otherwise, each year on July 1, starting with July 1999, the number of shares
that will be made available for grant under both of the 1999 Plans, will be automatically
increased to that number of shares that is equal to 5% of our outstanding share capital on
such a date.

The
holders of options under all of the plans are responsible for all personal tax
consequences relating to the options. The exercise prices of the options are based on the
fair value of the ordinary shares at the time of grant as determined by our board of
directors. The board considers many factors in establishing such prices, including our
financial condition and operating results, investors valuations and the market for
the securities of comparable industry group companies.

| | ITEM 7. | MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS
| | ------- | -------------------------------------------------

|A. | MAJOR
SHAREHOLDERS
|-- | ------------------

To
our knowledge, (A) we are not directly or indirectly owned or controlled (i) by another
corporation or (ii) by any foreign government and (B) there are no arrangements, the
operation of which may at a subsequent date result in a change in control of AudioCodes.
The following table sets forth, as of December 31, 2004, the number of our ordinary
shares, which constitute our only voting securities, beneficially owned by (i) all
shareholders known to us to own more than 5% of our outstanding ordinary shares, and (ii)
all of our directors and senior executive officers as a group.

|Identity of Person or Group                                            | Amount Owned | Percent of Class
|---------------------------------------------------------------------- | ------------ | ----------------
|Shabtai Adlersberg (1)                                                 | 5,334,328    | 13.4%           
|Leon Bialik (2)                                                        | 3,928,222    | 9.9%            
|FMR Corp. (3)                                                          | 3,275,764    | 8.2%            
|Kern Capital (4)                                                       | 2,674,100    | 6.7%            
|All directors and senior executive officers as a group (14 persons)(5) | 831,775      | 2.1%            

---

|(1) | Includes
options to purchase 302,468 shares, which may be purchased pursuant to
               options exercisable within sixty days following December 31, 2004.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | The
information is derived from a statement on Schedule 13G/A, dated February
               14, 2005of Leon Bialik filed with the Securities and Exchange
               Commission.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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|(3) | The
information is derived from the joint statement on Schedule 13G/A, dated
               February 14, 2005, of FMR Corp., Edward C. Johnson 3d, Abigail P. Johnson,
and                Fidelity Management & Research Company filed with the Securities
and                Exchange Commission. The address of FMR Corp. is 82 Devonshire Street,
Boston,                Massachusetts 02109.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(4) | The
information is derived from a statement on Schedule 13G, dated February 14,
               2005of Kern Capital Management, Robert E. Kern Jr. and David G.
Kern                filed with the Securities and Exchange Commission.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(5) | Includes
621,209 ordinary shares, which may be purchased pursuant to options
               exercisable within sixty days following December 31, 2004.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------

During
2004, Mr. Adlersberg acquired 93,421 of our ordinary shares and Mr. Bialik sold 421,500 of
our ordinary shares. During 2003, Mr. Adlersberg acquired 285,130 of our ordinary shares
and Mr. Bialik sold 208,000 of our ordinary shares. During 2002, Mr. Adlersberg acquired
10,265 of our ordinary shares and Mr. Bialik did not sell or acquire any of our ordinary
shares.

FMR
Corp. held 8.2% of our ordinary shares as of December 31, 2004, as compared to 7.3% of our
ordinary shares as of December 31, 2003 and 10.2% of our ordinary shares as of December
31, 2002. Kern Capital held 6.7% of our ordinary shares as of December 31, 2004, as
compared to less than 5% of our ordinary shares as of December 31, 2003.

As
of March 31, 2005, there were approximately 25 holders of record of our ordinary shares in
the United States, although we believe that the number of beneficial owners of the
ordinary shares is significantly greater. The number of record holders in the United
States is not representative of the number of beneficial holders nor is it representative
of where such beneficial holders are resident since many of these ordinary shares were
held of record by brokers or other nominees.

The
major shareholders have the same voting rights as the other shareholders.

|B. | RELATED
PARTY TRANSACTIONS
|-- | --------------------------

In
October 1999, we entered into a development agreement with DSP Group Ltd., a company
affiliated with DSP Group, Inc., and a third party. According to the agreement, DSP Group
Ltd. will pay royalties for every chip actually sold by DSP Group Ltd. to third parties.
During 2004, DSP Group, Inc. sold all its holdings in our shares.

We
recorded revenues related to this agreement in a total amount of $209,000 in 2002,
$261,000 in 2003 and $47,000 in 2004. In addition, we purchased from DSP Group Ltd. raw
material in a total amount of $19,000 in 2002 and $15,000 in 2003.

|C. | INTERESTS
OF EXPERTS AND COUNSEL
|-- | --------------------------------

| | Not
applicable.
| | ---------------

| | ITEM 8. | FINANCIAL INFORMATION
| | ------- | ---------------------

| | See
Item 18.
| | ------------

- 68 -

---

---



| | ITEM 9. | THE OFFER AND LISTING
| | ------- | ---------------------

|A. | OFFER
AND LISTING DETAILS
|-- | -------------------------

Our
ordinary shares are listed on the Nasdaq National Market and The Tel Aviv Stock Exchange
under the symbol AUDC.

In
accordance with Rule 4350(a)(1) of the Rules of Corporate Governance of The Nasdaq Stock
Market, Inc., we have received an exemption from the requirement to distribute an annual
report to our shareholders prior to our annual meeting of shareholders.  The basis
for the exemption is that the generally accepted business practice in Israel, where
we are incorporated, is not to distribute an annual report to shareholders.  We post
our Annual Report on Form 20-F on our web site (www.audiocodes.com) as soon as
practical following the filing of the Annual Report on Form 20-F with the Securities and
Exchange Commission.

The
following table sets forth, for the periods indicated, the high and low sales prices of
our ordinary shares as reported by the Nasdaq National Market. All per share prices for
periods prior to or including October 6, 2000 have been retroactively adjusted to reflect
the two-for-one stock split effected on that date.

- 69 -

---

---



|Calendar Year | Price Per Share
|------------- | ---------------
|
|
|
|
|2004          |                
|2003          |                
|2002          |                
|2001          |                
|2000          |                
|              |                
|
|
|              |                
|2005          |                
|              |                
|              |                
|2004          |                
|              |                
|              |                
|              |                
|              |                
|2003          |                
|              |                
|              |                
|              |                
|              |                
|              |                
|
|
|              |                
|2005          |                
|              |                
|              |                
|              |                
|              |                
|              |                
|2004          |                
|              |                

The
following table sets forth, for the periods indicated, the high and low sales prices of
our ordinary shares as reported by The Tel Aviv Stock Exchange. Our shares commenced
trading on The Tel Aviv Stock Exchange on October 21, 2001. All share prices shown in the
following table are in NIS. As of December 31, 2004, the exchange rate was equal to
approximately 4.308 NIS per U.S. $1.00.

|Calendar Year                      | Price Per Share
|---------------------------------- | ---------------
|
|
|
|
|2004                               |                
|2003                               |                
|2002                               |                
|2001 (commencing October 21, 2001) |                

- 70 -

---

---



|Calendar Period | Price Per Share
|--------------- | ---------------
|
|
|
|
|2005            |                
|                |                
|                |                
|2004            |                
|                |                
|                |                
|                |                
|                |                
|2003            |                
|                |                
|                |                
|                |                
|                |                
|                |                
|
|
|                |                
|2005            |                
|                |                
|                |                
|                |                
|                |                
|                |                
|2004            |                
|                |                
|                |                

|B. | PLAN
OF DISTRIBUTION
|-- | --------------------

| | Not
applicable.
| | ---------------

|C. | MARKETS
|-- | -------

Our
ordinary shares are listed for trading on the Nasdaq National Market under the symbol
AUDC. Our ordinary shares are also listed for trading on The Tel-Aviv Stock
Exchange under the symbol AUDC. In addition, we are aware of our ordinary
shares being traded on the following markets: Frankfurt Stock Exchange, Berlin Stock
Exchange, Munich Stock Exchange and XETRA.

|D. | SELLING
SHAREHOLDERS
|-- | --------------------

| | Not
applicable.
| | ---------------

|E. | DILUTION
|-- | --------

| | Not
applicable.
| | ---------------

- 71 -

---

---



|F. | EXPENSES
OF THE ISSUE
|-- | ---------------------

| | Not
applicable.
| | ---------------

| | ITEM 10. | ADDITIONAL INFORMATION
| | -------- | ----------------------

|A. | SHARE
CAPITAL
|-- | -------------

| | Not
applicable.
| | ---------------

|B. | MEMORANDUM
AND ARTICLES OF ASSOCIATION
|-- | --------------------------------------

# Objects and Purposes

Our
registration number with the Israeli Registrar of Companies is 520044132. Our objects and
purposes, set forth in Section 2 of our memorandum of association, are:

| |  | to
plan, develop and market voice signal systems;
| | - | -------------------------------------------------

| |  | to
purchase,  import,  market and wholesale and retail distribute,  in Israel and abroad,
 consumption               goods and accompanying products;
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------

| |  | to
serve as  representatives  of bodies,  entrepreneurs  and  companies  from  Israel and
abroad  with               respect to their activities in Israel and abroad; and
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | to
carry out any activity as determined by the lawful management.
| | - | -----------------------------------------------------------------

# Borrowing Powers

The
board of directors has the power to cause us to borrow money and to secure the payment of
borrowed money. The board of directors specifically has the power to issue bonds or
debentures, and to impose mortgages or other security interests on all or any part of our
property.

# Amendment of Articles
of Association

Shareholders
may amend our articles of association by a resolution adopted at a shareholders meeting by
the holders of 50% of voting power represented at the meeting in person or by proxy and
voting thereon.

# Dividends

We
may pay dividends only out of our profits. The amount of any dividend to be distributed
among shareholders is based on the nominal value of their shares. Our board of directors
has determined that any tax-exempt income attributable to the approved enterprise will not
be distributed as dividends.

- 72 -

---

---



# Voting Rights and
Powers

Unless
any shares have special rights as to voting, every shareholder has one vote for each share
held of record. A shareholder is not entitled to vote at any shareholders meeting unless
all calls then payable by him in respect of his shares have been paid (this does not apply
to separate meetings of the holders of a particular class of shares with respect to the
modification or abrogation of their rights).

Under
our articles of association, wemay issue preferred shares from time to time, in
one or more series. However, in connection with our listing on The Tel-Aviv Stock Exchange
in 2001, we agreed that for such time as our ordinary shares are traded on The Tel-Aviv
Stock Exchange, we will not issue any of the 2,500,000 preferred shares, nominal value NIS
0.01, authorized in our articles of association. Notwithstanding the foregoing, we may
issue preferred shares if the preference of those shares is limited to a preference in the
distribution of dividends and such preferred shares have no voting rights.

# Business Combinations

Our
articles of association impose restrictions on our ability to engage in any merger, asset
or share sale or other similar transaction with a shareholder holding 15% or more of our
voting shares.

# Winding Up

Upon
our liquidation, our assets available for distribution to shareholders will be distributed
to them in proportion to the nominal value of their shares.

# Redeemable Shares

Wemay issue and redeem redeemable shares.

# Modification of Rights

Subject
to the provisions of our memorandum of association, and without prejudice to any special
rights previously conferred upon the holders of our existing shares, we may, from time to
time, by a resolution approved by the holders of 50% voting power represented at the
meeting in person or by proxy and voting thereon, provide for shares with such preferred
or deferred rights or rights of redemption, or other special rights and/or such
restrictions, whether in regard to dividends, voting repayment of share capital or
otherwise, as may be stipulated in such resolution.

If
at any time our share capital is divided into different classes of shares, we may modify
or abrogate the rights attached to any class, unless otherwise provided by the articles of
association, by a resolution approved by the holders of 50% voting power represented at
the meeting in person or by proxy and voting thereon, subject to the consent in writing of
the holders of 75% of the issued shares of that class.

- 73 -

---

---



The
provisions of our articles of association relating to general meetings also apply to any
separate general meeting of the holders of the shares of a particular class, except that
two or more members holding not less than 75% of the issued shares of that class must be
present in person or by proxy at that separate general meeting for a quorum to exist.

Unless
otherwise provided by our articles of association, the increase of an authorized class of
shares, or the issuance of additional shares thereof out of the authorized and unissued
share capital, shall not be deemed to modify or abrogate the rights attached to previously
issued shares of that class or of any other class.

# Shareholders Meetings

An
annual meeting of shareholders is to be held once a year, within 15 months after the
previous annual meeting. The annual meeting may be held in Israel or outside of Israel, as
determined by the board of directors.

The
board of directors may, whenever it thinks fit, convene a special shareholders meeting.
The board must convene a special shareholders meeting at the request of:

| |  | at
least two directors;
| | - | -----------------------

| |  | at
least one-quarter of the directors in office; or
| | - | ---------------------------------------------------

| |  | shareholders
who hold at least 5% of the outstanding equity and at least 1% of the voting rights, or
at least 5% of the outstanding voting rights.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------

A
special shareholders meeting may be held in Israel or outside of Israel, as determined by
the board of directors.

# Notice of General
Meetings; Omission to Give Notice

The
provisions of the Companies Law and the related regulations override the provisions of our
articles of association, and provide for notice of a meeting of shareholders to be sent to
each registered shareholder at least 21 days in advance of the meeting. Notice of a
meeting of shareholders must also be published in two Israeli newspapers prior to the
record date for the meeting.

Notice
of a meeting of shareholders must specify the type of meeting, the place and time of the
meeting, the agenda, a summary of the proposed resolutions, the majority required to adopt
the proposed resolutions, and the record date for the meeting. The notice must also
include the address and telephone number of our registered office, and a list of times at
which the full text of the proposed resolutions may be examined at the registered office.

The
accidental omission to give notice of a meeting to any shareholder, or the non-receipt of
notice sent to such shareholder, does not invalidate the proceedings at the meeting.

- 74 -

---

---



# Limitations on Foreign
Shareholders to Hold or Exercise Voting Rights

There
are no limitations on foreign shareholders in our articles of association. Israeli law
restricts the ability of citizens of countries that are in a state of war with Israel to
hold shares of Israeli companies.

# Approval of
Transactions under Israeli Law

The
Companies Law imposes fiduciary duties that office holders, including
directors and executive officers, owe to their company. An office holders fiduciary
duties consist of a duty of care and a duty of loyalty. The duty of care generally
requires an office holder to act with the level of care which a reasonable office holder
in the same position would have acted under the same circumstances. The duty of loyalty
generally requires an office holder to act in good faith and for the good of the company.
Specifically, an office holder must avoid any conflict of interest between the office
holders position in the company and his or her other positions or personal affairs.
In addition, an office holder must avoid competing against the company or exploiting any
business opportunity of the company for his or her own benefit or the benefit of others.
An office holder must also disclose to the company any information or documents relating
to the companys affairs that the office holder has received due to his or her
position in the company. The term office holder includes any person who,
either formally or in substance, serves as a director, general manager or chief executive
officer, or who reports directly to the general manager or chief executive officer. Each
person listed in the table under Item 6. Directors, Senior Management and
EmployeesA. Directors and Senior Management above is an office
holder of AudioCodes.

Under
the Companies Law, all arrangements as to compensation of office holders who are not
directors require approval of the board of directors and, in certain cases, the prior
approval of the audit committee. Arrangements as to compensation of directors also require
audit committee and shareholder approval.

The
Companies Law requires that an office holder promptly disclose any personal interest that
he or she may have, and all related material information known to him or her, in
connection with any existing or proposed transaction by the company. A personal interest
of an office holder includes a personal interest of the office holders relative or a
corporation in which the office holder or the office holders relative is a 5% or
greater shareholder, director or general manager or has the right to appoint at least one
director or the general manager. The office holders duty to disclose shall not apply
in the event that the personal interest only results from a personal interest of the
office holders relative in a transaction that is not an extraordinary transaction.
An extraordinary transaction is a transaction not in the ordinary course of business, not
on market terms, or likely to have a material impact on the companys profitability,
assets or liabilities.

For
a transaction that is not an extraordinary transaction, under the Companies Law, once the
office holder complies with the above disclosure requirement, the board of directors is
authorized to approve the transaction, unless the articles of association provide
otherwise. A transaction that is adverse to the companys interest may not be
approved. If the transaction is an extraordinary transaction, then it also must be
approved by the companys audit committee and board of directors, and, under certain
circumstances, by the shareholders of the company. Generally, when an extraordinary
transaction is considered by the audit committee and board of directors, the interested
directors may not be present or vote.

- 75 -

---

---



# Duties of Shareholders

Under
the Companies Law, the disclosure requirements that apply to an office holder also apply
to a controlling shareholder of a public company. A controlling shareholder is a
shareholder who has the ability to direct the activities of a company, including a
shareholder that owns 25% or more of the voting rights if no other shareholder owns more
than 50% of the voting rights, but excluding a shareholder whose power derives solely from
his or her position on the board of directors or any other position with the company.
Extraordinary transactions with a controlling shareholder or in which a controlling
shareholder has a personal interest, and the engagement of a controlling shareholder as an
office holder or employee, generally require the approval of the audit committee, the
board of directors and the shareholders. The shareholder approval must include at least
one-third of the shares of non-interested shareholders voted on the matter. However, the
transaction can be approved by shareholders without this one-third approval if the total
shares of non-interested shareholders voted against the transaction do not represent more
than one percent of the voting rights in the company.

In
addition, under the Companies Law, each shareholder has a duty to act in good faith toward
the company and other shareholders and to refrain from abusing his or her power in the
company, such as in shareholder votes. In addition, specified shareholders have a duty of
fairness toward the company. These shareholders include any controlling shareholder, any
shareholder who knows that it possesses the power to determine the outcome of a
shareholder vote and any shareholder who, pursuant to the provisions of the articles of
association, has the power to appoint an office holder or any other power with respect to
the company. A recent amendment to the Companies Law provides that a breach of the duty of
fairness will be governed by the laws governing breach of contract. However, the Companies
Law does not define the substance of this duty of fairness.

Israeli
law permits a company to insure an office holder in respect of liabilities incurred by the
office holder as a result of:

| |  | the
breach of his or her duty of care to the company or to another person, or
| | - | -----------------------------------------------------------------------------

| |  | as
a result of the breach of his or her fiduciary duty to the company,
| | - | ----------------------------------------------------------------------

to the extent that the office holder
acted in good faith and had reasonable cause to believe that the act would not prejudice
the company. A company can also insure an office holder against monetary liabilities as a
result of an act or omission that the office holder committed in connection with his or
her serving as an office holder.

- 76 -

---

---



Moreover,
a company can indemnify an office holder for any of the following obligations or expenses
incurred in connection with his or her acts or omissions as an office holder:

| |  | monetary
liability imposed upon the office holder in favor of other persons pursuant to a court
judgment, including a compromise judgment or an arbitrators decision approved by a
court;
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | reasonable
litigation expenses, including attorneys fees, incurred by the office holder as a
result of an investigation or proceeding instituted against the office holder by a
competent authority, provided that such investigation or proceeding concluded without the
filing of an indictment against the office holder or the imposition of any financial
liability in lieu of criminal proceedings, or concluded without the filing of an
indictment against the office holder and a financial liability was imposed on the office
holder in lieu of criminal proceedings with respect to a criminal offense that does not
require proof of criminal intent; and
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | reasonable
litigation expenses, including attorneys fees, actually incurred by the office
holder or imposed upon the office holder by a court, in an action, suit or proceeding
brought against the office holder by or on behalf of the company or other persons; in a
criminal action in which the office holder was acquitted; or in a criminal action which
does not require criminal intent in which the office holder was convicted. A company may
also exculpate an office holder in advance, in whole or in part, from liability for
damages sustained by a breach of duty of care to the company.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Furthermore,
a company can, with one limited exception, exculpate an office holder in advance, in whole
or in part, from liability for damages sustained by a breach of duty of care to the
company.

Our
articles of association allow us to insure, indemnify and exculpate office holders to the
fullest extent permitted by law, provided such insurance or indemnification is approved in
accordance with law.

We
have entered into an undertaking to indemnify our office holders in specified limited
categories of events and in specified amounts, subject to certain limitations. This
undertaking has been ratified by our audit committee, board of directors and shareholders.
We have acquired directors and officers liability insurance covering our
officers and directors and the officers and directors of our subsidiaries against certain
claims.

|C. | MATERIAL
CONTRACTS
|-- | ------------------

On
November 3, 2004, we entered into a purchase agreement with Merrill Lynch & Co.,
Merrill Lynch, Pierce, Fenner & Smith Incorporated, Lehman Brothers Inc. and CIBC
World Markets Corp., with respect to the issue and sale of $100.0 million aggregate
principal amount of our 2.00% Senior Convertible Notes due 2024 and the grant of an option
for the purchase of an additional $25.0 million aggregate principal amount of our notes,
which was exercised in full on November 16, 2004.

- 77 -

---

---



On
November 9, 2004, we entered into an indenture with U.S. Bank National Association in
connection with the issuance of our 2.00% Senior Convertible Notes due 2024. The indenture
provides that the notes are senior, unsecured obligations of AudioCodes Ltd. Pursuant to
the indenture, the notes accrue interest at a rate of 2.00% per annum, payable
semi-annually on May 9 and November 9 of each year, with a final maturity on November 9,
2024. The indenture provides that the notes may be redeemed by us, in whole or in part, at
any time after November 9, 2009, and that the holders of the notes may require us to
redeem the notes on November 9, 2009, November 9, 2014 or November 9, 2019, or upon
certain fundamental changes. If any notes are redeemed prior to November 9, 2009 based on
certain fundamental changes, we will also be required to make a make-whole
premium payment to the redeeming note holders. Under the terms of the indenture and the
notes, holders of the notes are entitled to convert the notes into our ordinary shares at
a conversion rate of 53.4474 ordinary shares per $1,000 principal amount of notes, which
is the equivalent to a conversion price of approximately $18.71 per share. The conversion
rate is subject to adjustment in certain circumstances, such as changes in our capital
structure or upon the issuance by us of share dividends or certain cash distributions.

On
November 9, 2004, we also entered into a registration rights agreement with Merrill Lynch
& Co., Merrill Lynch, Pierce, Fenner & Smith Incorporated, Lehman Brothers Inc.
and CIBC World Markets Corp., pursuant to which we agreed to file with the U.S. Securities
and Exchange Commission within 150 days of November 9, 2004, a shelf registration
statement covering our 2.00% Senior Convertible Notes due 2024 and shares issuable upon
conversion of the notes, and to maintain the effectiveness of the registration statement
until the earlier of the date on which all the shares have been resold under the
registration statement, the date of expiration of the holding period under applicable law
that would enable the resale of the shares without restriction or registration under
applicable law, or November 16, 2006. Under the terms of the registration rights
agreement, if either (i) on the day following the filing deadline, the shelf registration
statement has not been filed with the SEC; (ii) on the 211th day following the
earliest date of original issuance of any of the notes, the shelf registration statement
is not declared effective, (iii) the registration statement ceases to be effective or
fails to be usable without being succeeded within five business days by a post-effective
amendment or a report filed with the SEC pursuant to the Exchange Act that cures the
failure of the registration statement to be effective or usable or (iv) the prospectus has
been suspended for more than 60 days (or more than 90 days in any twelve month period),
then additional interest will accrue on our notes beginning on the day following such
triggering event through the day on which the triggering event has been cured. The
additional interest will accrue at a rate of 0.25% for the first ninety days of the
triggering event, and 0.5% thereafter.

On
May 12, 2004, we acquired the outstanding shares of capital stock of Ai-Logix, Inc. See
Item 4A for a summary of material terms of the Stock Purchase Agreement between us,
AudioCodes Inc., Ai-Logix and AI Technologies N.V.

On
April 7, 2003, we purchased selected assets of Nortel Networks Universal Audio Server
business. See Item 4A for a summary of material terms of our Asset Purchase Agreement with
Nortel Networks.

In
connection with our acquisition of Nortel Networks Universal Audio Server business, we
also entered into an OEM Purchase and Sale Agreement with Nortel Networks on April 28,
2003, under which we agreed to supply Nortel Networks with certain Universal Audio Server
products at specified prices for a duration of at least three years.

- 78 -

---

---



|D. | EXCHANGE
CONTROLS
|-- | -----------------

Since
January 1, 2003, all exchange control restrictions imposed by the State of Israel have
been removed, although there are still reporting requirements for foreign currency
transactions. However, legislation remains in effect pursuant to which currency controls
can be imposed by administrative action at any time. Nonresidents of Israel who purchase
our ordinary shares are able to receive any dividends thereon (and any amounts payable
upon the dissolution, liquidation and winding up of our affairs) freely repatriable in
non-Israeli currency, provided that Israeli income tax has been paid or withheld on such
amounts (see Item 10. Additional InformationE. TaxationIsraeli Tax
ConsiderationsTax on Dividends).

Non-residents
of Israel may freely hold and trade our ordinary shares, and the proceeds of sale thereof
are not subject to Israeli currency control restrictions. Our memorandum of association
and articles of association do not restrict in any way the ownership of ordinary shares by
non-residents of Israel and neither our memorandum of association and articles of
association nor Israeli law restricts the voting rights of non-residents, except with
respect to citizens of countries that are in a state of war with Israel.

|E. | TAXATION
|-- | --------

The
following is a summary of the material Israeli and United States tax consequences, Israeli
foreign exchange regulations and certain Israeli government programs affecting us. To the
extent that the discussion is based on new tax or other legislation that has not been
subject to judicial or administrative interpretation, there can be no assurance that the
views expressed in the discussion will be accepted by the tax or other authorities in
question. The discussion is not intended, and should not be construed, as legal or
professional tax advice, is not exhaustive of all possible tax considerations and should
not be relied upon for tax planning purposes.

Israeli Tax Considerations

# Tax Reform in Israel

On
January 1, 2003, the Law for Amendment of the Income Tax Ordinance (Amendment No.132),
2002, or the Tax Reform, came into effect, following its enactment by the Israeli
Parliament on July 24, 2002. On December 17, 2002, the Israeli Parliament approved a
number of amendments to the Tax Reform, which came into effect on January 1, 2003. Other
regulations and decrees relating to the Tax Reform were executed as well.

The
Tax Reform, aimed at broadening the categories of taxable income and reducing the tax
rates imposed on employment income, introduced the following, among other things:

| |  | Reduction
of the tax rate levied on capital gains (other than gains deriving from the sale of
listed securities) derived after January 1, 2003, to a general rate of 25% for both
individuals and corporations. Regarding assets acquired prior to January 1, 2003, the
reduced tax rate will apply to a proportionate part of the gain, in accordance with the
holding periods of the asset, before or after January 1, 2003, on a linear basis;
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

- 79 -

---

---



| |  | Imposition
of Israeli tax on all income of Israeli residents, individuals and corporations,
regardless of the territorial source of income, including income derived from passive
sources such as interest, dividends and royalties;
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Introduction
of controlled foreign corporation (CFC) rules into the Israeli tax structure. Generally
under such rules, an Israeli resident who holds, directly or indirectly, 10% or more of
the rights in a foreign corporation whose shares are not publicly traded, in which more
than 50% of rights are held directly or indirectly by Israeli residents, which has
undistributed profits and a majority of whose income in a tax year is considered passive
income, will be liable for tax on the portion of such income attributed to his holdings
in such corporation, as if such income were distributed to him as a dividend;
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Imposition
of capital gains tax on capital gains realized by individuals as of January 1, 2003, from
the sale of shares of publicly traded companies (which was previously exempt from capital
gains tax in Israel). For information with respect to the applicability of Israeli
capital gains taxes on the sale of ordinary shares, see Capital Gains Tax
Applicable to Resident and Non-Resident Shareholders below;
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Introduction
of a new regime for the taxation of shares and options issued to employees and
officers (including directors).
| | - | ---------------------------------------------------------------------------------------------------------------------------

# General Corporate Tax
Structure

Israeli
companies are generally subject to corporate tax on their taxable income at a rate of 35%
(in the 2004 tax year), 34% (in the 2005 tax year), 32% (in the 2006 tax year) and 30% (in
and after the 2007 tax year). However in our case, the rate is currently effectively
reduced, as described below.

# Tax Benefits Under the
Law for the Encouragement of Capital Investments, 1959

Our
facilities have been granted approved enterprise status pursuant to the Law for the
Encouragement of Capital Investments, 1959 or the Investment Law, which provides certain
tax and financial benefits to investment programs that have been granted such status.

The
Investment Law provides that a proposed capital investment in eligible facilities may be
designated as an approved enterprise. Each certificate of approval for an
approved enterprise relates to a specific investment program delineated both by its
financial scope, including its capital sources, and by its physical characteristics, such
as the equipment to be purchased and utilized pursuant to the program. The tax benefits
under the Investment Law are not available for income derived from products manufactured
outside of Israel.

- 80 -

---

---



A
company owning an approved enterprise may elect to receive either governmental grants or
an alternative package of tax benefits. Under the alternative package, a companys
undistributed income derived from an approved enterprise will be exempt from corporate tax
for a period of two to ten years (depending on the geographic location of the approved
enterprise within Israel). The exemption commences in the first year of taxable income,
and the company is taxed at a reduced corporate rate of 10% to 25% for the following five
to eight years, depending on the extent of foreign shareholders ownership of the
companys ordinary shares. The benefits period is limited to twelve years from
completion of the investment under the approved plan or fourteen years from the date of
approval, whichever is earlier. A Foreign Investors Company, or FIC, defined in the
Investment Law as a company of which more than 25% of its shareholders are non-Israeli
residents, may enjoy benefits for a period of up to ten years, or twelve years if it
complies with certain export criteria stipulated in the Investment Law (the actual length
of the benefits period is graduated based on the percentage of foreign ownership).

The
tax benefits derived from any certificate of approval relate only to taxable income
attributable to the specific approved enterprise. If a company has more than one approval
or only a portion of its capital investments are approved, its effective tax rate is the
result of a weighted combination of the applicable rates.

Our
production facilities have been granted the status of approved enterprise. Income arising
from our approved enterprise facilities is tax-free under the alternative package of
benefits described above and entitled to reduced tax rates based on the level of foreign
ownership for specified periods. We have derived, and expect to continue to derive, a
substantial portion of our operating income from our approved enterprise facilities. The
tax benefits attributable to our current approved enterprises are scheduled to expire
gradually from 2007 to 2014.

Distribution
of earnings derived from approved enterprise which were previously taxed at reduced tax
rates, would not result in additional tax consequences to us. However, if retained
tax-exempt income is distributed in a manner, we would be taxed at the reduced corporate
tax rate applicable to such profits (between 10%-25%). We are not obliged to distribute
exempt retained earnings under the alternative package of benefits, and may generally
decide from which source of income to declare dividends. We currently intend to reinvest
the amount of our tax-exempt income and not to distribute such income as a dividend.
Dividends from approved enterprises are generally taxed at a rate of 15% (which is
withheld and paid by the company paying the dividend) if such dividend is distributed
during the benefits period or within twelve years thereafter. The twelve-year limitation
does not apply to an FIC.

Future
approved enterprises will be reviewed separately, and the decisions whether to approve or
reject a designation as an approved enterprise will be based, among other things, on the
criteria set forth in the Investment Law and related regulations, the then prevailing
policy of the Investment Center, and the specific objectives and financial criteria of the
company. Accordingly, there can be no assurance that any new investment programs will be
approved as approved enterprises. In addition, the benefits available to an approved
enterprise are conditional upon the fulfillment of conditions stipulated in the Investment
Law and related regulations and the criteria set forth in the specific certificate of
approval. In the event that a company does not meet these conditions, it will be subject
to corporate tax at the rate then in effect under Israeli law for such tax year. As of
December 31, 2004, management believes that we meet all of the aforementioned conditions.
A comprehensive amendment of the Investment Law has recently been approved by the Knesset.
The amendment imposes additional eligibility criteria for approved enterprise benefits.
The amendment also offers additional forms of alternative benefits. We do not believe that
the amendment would have a material effect on us.

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# Law for the
Encouragement of Industrial Research and Development, 1984

Under
the Law for the Encouragement of Industrial Research and Development, 1984 and the related
regulations, or the Research Law, research, development and pre-manufacturing programs
that meet specified criteria and are approved by a governmental committee (the Research
Committee) of the Office of Chief Scientist (OCS) are eligible for grants of up to 50% of
the expenditures on the program. Each application to the OCS is reviewed separately, and
grants are based on the program approved by the Research Committee. Expenditures supported
under other incentive programs of the State of Israel are not eligible for OCS grants. As
a result, we cannot be sure that applications to the OCS will be approved or, if approved,
that we will receive the amounts for which we apply.

Recipients
of these grants are required to pay royalties on the revenues derived from the sale of
product developed in accordance with the program. The royalties are payable at the rate of
3% of revenues during the first three years, 4% of revenues during the following three
years, and 5% of revenues in the seventh year and thereafter, with the total royalties not
to exceed 100% of the dollar value of the OCS grant.

The
terms of the Israeli government participation require that products developed with OCS
grants must generally be manufactured in Israel. If we receive OCS approval for any
portion of this manufacturing to be performed outside of Israel, the royalty rate would be
increased and the repayment schedule would be accelerated, based on the extent of the
manufacturing conducted outside of Israel. Depending upon the extent of the manufacturing
volume that is performed outside of Israel, the ceiling on royalties would increase to
120%, 150% or 300% of the grant. Under an amendment to the Research Law effective June 7,
2005, the authority of the Research Committee to approve the transfer of manufacture
outside of Israel was expanded.

The
technology developed pursuant to the terms of these grants may not be transferred to third
parties without the prior approval of the Research Committee. This approval is required
only for the export of the technology, and not for the export of any products that
incorporate the sponsored technology. Approval of the transfer of technology may be
granted only if the recipient agrees to abide by all the provisions of the Research Law,
including the restrictions on the transfer of know-how and the obligation to pay royalties
in an amount that may be increased. The amendment to the Research Law effective June 7,
2005 granted authority to the Research Committee to approve the transfer of sponsored
technology outside of Israel, subject to various conditions.

We
have received grants from the OCS, and therefore we are subject to various restrictions
under the Research Law on the transfer of technology or manufacturing. These restrictions
do not terminate upon the full payment of royalties.

In
order to meet specified conditions in connection with the grants and programs of the OCS,
we have made representations to the Government of Israel about our Israeli operations.
From time to time the conduct of our Israeli operations has deviated from our
representations. If we fail to meet the conditions to grants, including the maintenance of
a material presence in Israel, or if there is any material deviation from the
representations made by us to the Israeli government, we could be required to refund the
grants previously received (together with an adjustment based on the Israeli consumer
price index and an interest factor) and would likely be ineligible to receive OCS grants
in the future.

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# Tax Benefits Under the
Law for the Encouragement of Industry (Taxation), 1969

According
to the Law for the Encouragement of Industry (Taxation), 1969, or the Industry
Encouragement Law, an industrial company is a company resident in Israel, that
at least 90% of its income, in any tax year (determined in Israeli currency, exclusive of
income from certain government loans, capital gains, interest and dividends) is derived
from an industrial enterprise owned by it. An industrial enterprise is defined as an
enterprise whose major activity in a given tax year is industrial production activity. We
currently believe that we qualify as an industrial company within the definition of the
Industry Encouragement Law. Under the Industry Encouragement Law, industrial companies are
entitled to the following preferred corporate tax benefits:

| |  | deduction
of purchases of know-how and patents over an eight-year period for tax purposes;
| | - | ------------------------------------------------------------------------------------------

| |  | the
right to elect,  under  specified  conditions,  to file a  consolidated  tax return  with
 related               Israeli industrial companies; and
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | accelerated
depreciation rates on equipment and buildings.
| | - | ----------------------------------------------------------

Eligibility
for the benefits under the Industry Encouragement Law is not subject to receipt of prior
approval from any governmental authority. The Israeli tax authorities may determine that
we do not qualify as an industrial company, which would entail our loss of the benefits
that relate to this status. In addition, no assurance can be given that we will continue
to qualify as an industrial company, in which case the benefits described above will not
be available in the future.

# Stamp Tax

Under
Israels Stamp Tax on Documents Law, certain documents are subject to stamp tax.
Recently promulgated regulations provide for a gradual phase-out of the stamp tax by 2008.
In 2004, however, the tax authorities began an enforcement campaign involving
extensive audits of companies compliance with the stamp tax obligation with respect
to all agreements that had been signed since June 2003. We have recently received from the
tax authorities a request for a list of all agreements signed since June 2003.

We
have received legal advice that there are a variety of defenses relating to the obligation
to pay stamp tax or to the amount to be paid. In addition, the Israeli Forum of CFOs has
filed a petition with the Israeli Supreme Court against enforcement of the law, and this
petition is currently pending. If the Forum of CFOs petition is rejected and the tax
authorities do not accept our defenses, we may be liable to pay stamp tax with respect to
the period beginning June 1, 2003. Our management believes that applicable provision in
the financial statements as of December 31, 2004, is adequate to cover probable costs
arising from this matter.

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# Special Provisions
Relating to Measurement of Taxable Income

Until
December 31, 2002, we measured our taxable income in accordance with the Income Tax Law
(Inflationary Adjustments), 1985 or the Inflationary Adjustments Law, which represents an
attempt to overcome the problems presented to a traditional tax system by an economy
undergoing rapid inflation. The Inflationary Adjustments Law is highly complex. Since
January 1, 2003, we elected to measure our taxable income based on the changes in the
exchange rate of the U.S. dollar rather than on the basis of inflation, based on our
status as an FIC.

# Capital Gains Tax
Applicable to Resident and Non-Resident Shareholders

Israeli
law generally imposes a capital gains tax on the sale of capital assets located in Israel,
including shares in Israeli resident companies, by both residents and non-residents of
Israel, unless a specific exemption is available or unless a treaty between Israel and the
country of the non-resident provides otherwise. Regulations promulgated under the Israeli
Income Tax Ordinance provided for an exemption from Israeli capital gains tax for gains
accrued before January 1, 2003 and derived from the sale of shares of an industrial
company, as defined by the Industry Encouragement Law, that are traded on specified
non-Israeli markets, including The Nasdaq National Market, provided that the sellers
purchased their shares either in the companys initial public offering or in public
market transactions thereafter. This exemption does not apply to shareholders who are in
the business of trading securities, or to shareholders that are Israeli resident companies
subject to the Inflationary Adjustments Law. We believe that we are currently an
industrial company, as defined by the Industry Encouragement Law. The status of a company
as an industrial company may be reviewed by the tax authorities from time to time. There
can be no assurance that the Israeli tax authorities will not deny our status as an
industrial company, possibly with retroactive effect.

On
January 1, 2003, the Tax Reform came into effect thus imposing capital gains tax at a rate
of 15% on gains derived on or after January 1, 2003 from the sale of shares in Israeli
companies:

| |  | publicly
traded on The Tel Aviv Stock Exchange, or the TASE;
| | - | ------------------------------------------------------------

| |  | publicly
traded on Nasdaq or a recognized stock exchange or regulated market in a country that has
a treaty for the prevention of double taxation with Israel; or
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | companies
dually traded on both the TASE and on Nasdaq or a recognized stock exchange or a
regulated market outside of Israel.
| | - | ------------------------------------------------------------------------------------------------------------------------------

This
tax rate does not apply to the sale of shares:

| |  | to
a relative (as defined in the tax reform);
| | - | ---------------------------------------------

| |  | by
dealers in securities;
| | - | -------------------------

| |  | by
shareholders that report in accordance with the Inflationary Adjustments Law; or
| | - | -----------------------------------------------------------------------------------

| |  | by
shareholders who acquired their shares prior to an initial public offering (that are
subject to a different tax arrangement).
| | - | --------------------------------------------------------------------------------------------------------------------------------

This
tax rate is contingent upon the shareholder not claiming a deduction for financing
expenses in connection with such shares.

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Regulations
adopted in connection with the Tax Reform deal with the taxation of the gain on securities
acquired prior to the effectiveness of the Tax Reform and sold subsequent to the
effectiveness of the Tax Reform (allocation of the gain as between the exempt period and
the taxable period).

Non-Israeli
residents are exempt from Israeli capital gains tax on any gains derived from the sale of
shares publicly traded on the TASE, provided such gains do not derive from a permanent
establishment of such shareholders in Israel. Non-Israeli residents are also exempt from
Israeli capital gains tax on any gains derived from the sale of shares of Israeli
companies publicly traded on a recognized stock exchange or regulated market outside of
Israel, provided that such capital gains are not derived from a permanent establishment in
Israel and that such shareholders did not acquire their shares prior to the issuers
initial public offering. However, non-Israeli corporations will not be entitled to the
exemption with respect to gains derived from the sale of shares of Israeli companies
publicly traded on the TASE, if an Israeli resident (i) has a controlling interest of 25%
or more in such non-Israeli corporation, or (ii) is the beneficiary or is entitled to 25%
or more of the revenues or profits of such non-Israeli corporation, whether directly or
indirectly.

In
some instances where our shareholders may be subject to Israeli tax on the sale of their
ordinary shares, the payment of the consideration may be subject to the withholding of
Israeli tax at the source.

# United States-Israel
Tax Treaty

Pursuant
to the Convention Between the Government of the United States of America and the
Government of Israel with respect to Taxes on Income, as amended, or the United
States-Israel Tax Treaty, the sale, exchange or disposition of ordinary shares by a person
who holds the ordinary shares as a capital asset and who qualifies as a resident of the
United States within the meaning of the United States- Israel Tax Treaty and who is
entitled to claim the benefits afforded to such person by the United States-Israel Tax
Treaty, or a Treaty United States Resident, generally will not be subject to the Israeli
capital gains tax unless such Treaty United States Resident holds, directly or indirectly,
shares representing 10% or more of the voting power of our company during any part of the
twelve-month period preceding such sale, exchange or disposition, subject to certain
conditions. A sale, exchange or disposition of shares by a Treaty United States Resident
who holds, directly or indirectly, shares representing 10% or more of the voting power of
our company at any time during such preceding twelve-month period would be subject to such
Israeli tax, to the extent applicable; however, under the United States-Israel Tax Treaty,
such Treaty United States Resident would be permitted to claim a credit for such taxes
against the United States federal income tax imposed with respect to such sale, exchange
or disposition, subject to the limitations in United States laws applicable to foreign tax
credits. The United States-Israel Tax Treaty does not relate to state or local taxes.

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# Tax on Dividends

Non-residents
of Israel are subject to Israeli income tax on income accrued or derived from sources in
Israel or received in Israel. These sources of income include passive income such as
dividends, royalties and interest, as well as non-passive income from services rendered in
Israel. On distributions of dividends, other than bonus shares and stock dividends, income
tax at the rate of 25% is withheld at the source, unless a different rate is provided in a
treaty between Israel and the shareholders country of residence. If the dividends
are distributed out of approved enterprise earnings, the applicable tax rate would be 15%.
Under the U.S.-Israel Tax Treaty, the maximum tax on dividends paid to a holder of
ordinary shares who is a Treaty United States Resident will be 25%, however that tax rate
is reduced to 12.5% for dividends not generated by an approved enterprise to a corporation
which holds 10% or more of the voting power of our company during a certain period
preceding distribution of the dividend. Dividends derived from an approved enterprise will
still be subject to 15% tax withholding.

# Foreign Exchange
Regulations

Dividends,
if any, paid to the holders of the ordinary shares, and any amounts payable upon
dissolution, liquidation or winding up, as well as the proceeds of any sale in Israel of
the ordinary shares to an Israeli resident, may be paid in non-Israeli currency or, if
paid in Israeli currency, may be converted into freely repatriable dollars at the rate of
exchange prevailing at the time of conversion, provided that Israeli income tax has been
paid or withheld on such amounts.

United States Tax Considerations

# United States Federal
Income Taxes

The
following summary describes the material U.S. federal income tax consequences to
U.S. holders (as defined below) arising from the purchase, ownership and
disposition of our ordinary shares. This summary is based on current provisions of the
Internal Revenue Code of 1986, as amended, or the Code, the final, temporary
and proposed U.S. Treasury Regulations promulgated thereunder and administrative and
judicial interpretations thereof, all of which are subject to change, possibly with
retroactive effect. For purposes of this summary, a U.S. holder will be deemed
to refer only to any of the following holders of our ordinary shares:

| |  | an
 individual  who is either a U.S.  citizen or a resident of the U.S.  for U.S.  federal
 income tax               purposes;
| | - | ------------------------------------------------------------------------------------------------------------------------------

| |  | a
 corporation  (or an entity  taxable as a  corporation)  created or organized  under the
laws of the               U.S. or any political subdivision thereof;
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | an
estate,  the income of which is subject to U.S.  federal income tax regardless of the
source of its               income; and
| | - | --------------------------------------------------------------------------------------------------------------------------------

| |  | a
trust, if either (a) a U.S. court is able to exercise primary  supervision  over the
 administration               of the trust and one or more U.S.  persons  have the
 authority  to control  all the  substantial               decisions of the trust,  or
(b) the trust has a valid  election in effect under  applicable  U.S.
              Treasury regulations to be treated as a U.S. person.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

This
summary does not consider all aspects of U.S. federal income taxation that may be relevant
to particular U.S. holders by reason of their particular circumstances, including
potential application of the alternative minimum tax, or any aspect of state, local or
non-U.S. federal tax laws. In addition, this summary is directed only to U.S. holders that
hold our ordinary shares as capital assets and does not address the considerations that
may be applicable to particular classes of U.S. holders, including financial institutions,
insurance companies, broker-dealers, tax-exempt organizations, holders whose functional
currency is not the U.S. dollar, holders of our ordinary shares as part of a
straddle, hedge or conversion transaction, holders,
directly, indirectly or through attribution, of 10% or more of our outstanding ordinary
shares and persons who own our ordinary shares through a partnership or other pass-through
entity.

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Each
U.S. holder should consult with its own tax advisor as to the particular tax consequences
to it of the purchase, ownership and sale of our ordinary shares, including the effects of
applicable state, local, foreign or other tax laws and possible changes in the tax laws.

# Distributions With
Respect to Our Ordinary Shares

The
amount of a distribution with respect to our ordinary shares will equal the amount of cash
and the fair market value of any property distributed and will also include the amount of
any Israeli taxes withheld, as described below under Israeli Tax Considerations
 Tax on Dividends. Other than distributors in liquidation and distributions in
redemption of stock that are treated as exchanges, a distribution paid by us with respect
to our ordinary shares to a U.S. holder generally will be treated as a dividend to the
extent that the distribution does not exceed our current and accumulated earnings and
profits, as determined for U.S. federal income tax purposes. The amount of any
distribution that exceeds these earnings and profits will be treated first as a
non-taxable return of capital, reducing the U.S. holders tax basis in its ordinary
shares, and then generally as capital gain. Currently, an individual U.S. holders
qualified dividend income is subject to tax at a reduced rate of 15%. For this
purpose, qualified dividend income generally includes dividends paid by a
foreign corporation if either (a) the stock of such corporation with respect to which the
dividends are paid is readily tradable on an established securities market in the U.S.,
including the Nasdaq National Market, or (b) such corporation is eligible for the benefits
of a comprehensive income tax treaty with the U.S. which includes an information exchange
program and is determined to be satisfactory by the U.S. Secretary of the Treasury. The
U.S. Secretary of the Treasury has indicated that the income tax treaty between the U.S.
and Israel is satisfactory for this purpose. Dividends paid by a foreign corporation will
not qualify for the 15% U.S. federal income tax rate, however, if such corporation is
treated, for the tax year in which the dividends are paid or the preceding tax year, as a
foreign investment company, a foreign personal holding company or
a passive foreign investment company for U.S. federal income tax purposes.
Based on the nature of our operations and the ownership of our ordinary shares, we do not
believe that we would be treated as either a foreign investment company or a
foreign personal holding company, and as discussed in more detail below under
Passive Foreign Investment Company Status, we do not currently believe that we
would be classified as a passive foreign investment company for U.S. federal
income tax purposes. Accordingly, dividend distributions with respect to our ordinary
shares should be treated as qualified dividend income and, subject to U.S.
holders satisfaction of certain holding period requirements, should be eligible for
the reduced 15% U.S. federal income tax rate. Corporate holders of our ordinary shares
generally will not be allowed a deduction for dividends received on our ordinary shares.

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A
dividend paid by us in NIS will be included in the income of U.S. holders at the dollar
amount of the dividend, based on the spot rate of exchange in effect on the
date the distribution is includable in the U.S. holders income, regardless of
whether the payment is in fact converted into dollars. The spot rate generally
refers to a rate that reflects a fair market rate of exchange available to the public for
currency under a spot contract in a free market and involving representative
amounts. A spot contract is a contract to buy or sell a currency no more than
two business days following the date of the execution of the contract. If a spot rate
cannot be demonstrated, the U.S. Internal Revenue Service has the authority to determine
the spot rate. U.S. holders will have a tax basis in the NIS for U.S. federal income tax
purposes equal to that dollar value. Any subsequent gain or loss on NIS arising from
exchange rate fluctuations during the period from the date a U.S. holder includes the
dividend payment in income to the date such U.S. holder converts the payment to dollars
will be taxable as ordinary income or loss and will be U.S.-source income or loss for U.S.
foreign tax credit purposes.

Dividend
income derived with respect to our ordinary shares will constitute portfolio
income for purposes of the limitation on the use of passive activity losses and,
therefore, generally may not be offset by passive activity losses, and generally will be
treated as investment income for purposes of the limitation on the deduction
of investment interest expense. Dividends paid by us generally will be foreign-source
passive income for U.S. foreign tax credit purposes or, in the case of a U.S. holder that
is a financial services entity, financial services income. Subject to certain limitations,
U.S. holders may elect to claim as a foreign tax credit against their U.S. federal income
tax liability any Israeli income tax withheld from dividends received on our ordinary
shares. U.S. holders that do not elect to claim a foreign tax credit may instead claim a
deduction for Israeli income tax withheld. In addition, special rules may apply to the
computation of foreign tax credits relating to qualified dividend income. The calculation
of foreign tax credits and, in the case of a U.S. holder that elects to deduct foreign
income taxes, the availability of deductions is complex and involves the application of
rules that depend on a U.S. holders particular circumstances. U.S. holders are urged
to consult their own tax advisors regarding the availability to them of foreign tax
credits or deductions in respect of any Israeli tax withheld or paid.

# Disposition of Our
Ordinary Shares

Subject
to the discussion below under Passive Foreign Investment Company Status, a
U.S. holders sale or exchange of our ordinary shares generally will result in the
recognition by such U.S. holder of capital gain or loss in an amount equal to the
difference between the United States dollar value of the amount realized and the U.S.
holders tax basis in the ordinary shares sold. This gain or loss will be long-term
capital gain or loss if the ordinary shares sold have been held for more than one year at
the time of the sale or exchange. If the U.S. holders holding period on the date of
the sale or exchange is one year or less, such gain or loss will be a short-term capital
gain or loss. Individual U.S. holders currently are subject to a maximum tax rate of 15%
on long-term capital gains for tax years beginning on or before December 31, 2008.
Short-term capital gains generally are taxed at the same rates applicable to ordinary
income. See Israeli Tax Considerations  Capital Gains Tax Applicable to
Resident and Non-Resident Shareholders for a discussion of taxation by Israel of
capital gains realized on sales of capital assets. Any capital loss realized upon the
sale, exchange or other disposition of our ordinary shares generally will be deductible
only against capital gains and not against ordinary income, except that in the case of
non-corporate U.S. holders, a capital loss is deductible in any year to the extent of
capital gains plus ordinary income up to $3,000. In general, any capital gain recognized
by a U.S. holder upon the sale or exchange of our ordinary shares will be treated as
U.S.-source income for U.S. foreign tax credit purposes. Under the tax treaty between the
United States and Israel, gain derived from the sale, exchange or other disposition of
ordinary shares by a holder who is a resident of the United States for purposes of the
treaty and who sells the ordinary shares within Israel may be treated as foreign-source
income for U.S. foreign tax credit purposes.

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A
U.S. holders tax basis in its ordinary shares generally will be equal to the
purchase price paid therefor by such U.S. holder. The holding period of each ordinary
share owned by a U.S. holder will begin on the day following the date of the U.S.
holders purchase of such ordinary share and will include the day on which the
ordinary share is sold by such U.S. holder.

In
the case of a U.S. holder who uses the cash basis method of accounting and who receives
NIS in connection with the sale or taxable disposition of ordinary shares, the amount
realized will be based on the spot rate as determined on the settlement date of such
exchange. If such U.S. holder subsequently converts NIS into dollars at a conversion rate
other than the spot rate in effect on the settlement date, he, she or it may have a
foreign currency exchange gain or loss that would be treated as ordinary income or loss. A
U.S. holder who uses the accrual method of accounting may elect the same treatment
required of cash basis taxpayers with respect to a sale or taxable disposition of ordinary
shares, provided that the election is applied consistently from year to year. Such
election may not be changed without the consent of the U.S. Internal Revenue Service. If
an accrual basis U.S. holder does not elect to be treated as a cash basis taxpayer
(pursuant to the Treasury regulations applicable to foreign currency transactions), such
U.S. holder may be deemed to have realized an immediate foreign currency gain or loss for
U.S. federal income tax purposes because of differences between the dollar value of the
NIS on the date of sale or other taxable disposition and on the settlement date. Any such
currency gain or loss would be treated as ordinary income or loss and would be in addition
to gain or loss, if any, recognized by such U.S. holder on the sale or taxable disposition
of ordinary shares.

# Passive Foreign
Investment Company Status

Generally,
a foreign corporation is treated as a passive foreign investment company
(PFIC) for U.S. federal income tax purposes for any tax year if, in such tax
year, either (i) 75% or more of its gross income, including its pro rata share of the
gross income of any company in which it is considered to own 25% or more of the shares by
value, is passive in nature (the Income Test), or (ii) the average percentage
of its assets during such tax year, including its pro rata share of the assets of any
company in which it is considered to own 25% or more of the shares by value, which
produce, or are held for the production of, passive income (determined by averaging the
percentage of the fair market value of its total assets which are passive assets as of the
end of each quarter of such year) is 50% or more (the Asset Test).

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Based
on the composition of our gross income and the composition and value of our gross assets
during 2004, we do not believe that we were a PFIC in 2004, although it is possible that
we would have been classified as a PFIC under the Asset Test in 2001, 2002 and 2003
principally because a significant portion of our assets continued to consist of the cash
raised in connection with the two public offerings of our ordinary shares in 1999, and the
public market value of our ordinary shares declined significantly during 2001, 2002 and
the first half of 2003. The tests for determining whether we are a PFIC for any tax year
are applied annually, and it is difficult to make accurate predictions regarding the
composition of our future income and assets, the factors which are relevant to this
determination. In addition, there is no definitive method prescribed in the Code, United
States Treasury Regulations or administrative or judicial interpretations thereof for
determining the value of a foreign corporations assets for purposes of the Asset
Test. While the legislative history of the United States Taxpayer Relief Act of 1997
indicates that the total value of a publicly-traded foreign corporations
assets generally will be treated as equal to the sum of the aggregate value of its
outstanding stock plus its liabilities, there remains substantial uncertainty
regarding the valuation of a publicly-traded foreign corporations assets for
purposes of the Asset Test. Moreover, certain factors relevant to the PFIC determination,
such as declines in the market value of our stock, are not within our control and can
cause us to become a PFIC if, for example, we do not apply the net proceeds realized from
our sale of notes in November 2004 to the acquisition of assets which generate active
income. Accordingly, there can be no assurance that we will not be deemed a PFIC for 2004
or any future tax year.

In
view of the uncertainty regarding our use of the net proceeds realized from our sale of
notes in November 2004, the valuation of our assets for purposes of the Asset Test and the
complexity of the issues regarding our treatment as a PFIC, U.S. holders are urged to
consult their own tax advisors for guidance as to our status as a PFIC. For those U.S.
holders who determine that we were a PFIC in 2004 or are a PFIC in any subsequent tax year
and notify us in writing of their request for the information required in order to
effectuate the QEF Election described below, we will promptly make such information
available to them.

If
we are treated as a PFIC for U.S. federal income tax purposes for any year during a U.S.
holders holding period of our ordinary shares and the U.S. holder does not make a
QEF Election or a mark-to-market election (both as described below):

| |  | "Excess
  distributions"  by  us  to  a  U.S.  holder  would  be  taxed  in  a  special  way.
 "Excess          distributions"  with respect to any U.S. holder are amounts received by
such U.S. holder with          respect  to  our  ordinary   shares  in  any  tax  year
 that  exceed  125%  of  the  average          distributions  received  by such U.S.
 holder  from us during  the  shorter  of (i) the three          previous years, or (ii)
such U.S.  holder's  holding period of our ordinary shares before the
         then-current  tax year.  Excess  distributions  must be allocated  ratably to
each day that a          U.S. holder has held our ordinary  shares.  A U.S.  holder must
include amounts  allocated to          the current  tax year in its gross  income as
ordinary  income for that year.  A U.S.  holder          must  pay tax on  amounts
 allocated  to each  prior  tax year in which we were a PFIC at the          highest
 rate in effect for such prior year on  ordinary  income and the tax is subject to an
         interest charge at the rate applicable to deficiencies for income tax.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | The
entire amount of any gain realized by a U.S. holder upon the sale or other disposition of
our ordinary shares also would be treated as an excess distribution subject to tax as
described above.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

- 90 -

---

---



| |  | The
tax basis in ordinary shares acquired from a decedent who was a U.S. holder would not
receive a step-up to fair market value as of the date of the decedents death but
would instead be equal to the decedents basis, if lower.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Although
we generally will be treated as a PFIC as to any U.S. holder if we are a PFIC for any year
during the U.S. holders holding period, if we cease to satisfy the requirements for
PFIC classification, the U.S. holder may avoid the consequences of PFIC classification for
subsequent years by electing to recognize gain based on the unrealized appreciation in the
notes or ordinary shares through the close of the tax year in which we cease to be a PFIC.
Additionally, if we are treated as a PFIC, a U.S. holder who acquires ordinary shares from
a decedent would be denied the normally available step-up in tax basis for these ordinary
shares to fair market value at the date of death and instead would have a tax basis equal
to the decedents tax basis.

A
U.S. holder who beneficially owns shares of a PFIC must file Form 8621 (Return by a
Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund) with the
IRS for each tax year in which the U.S. holder holds shares in a PFIC. This form describes
any distributions received with respect to these shares and any gain realized upon the
disposition of these shares.

For
any tax year in which we are treated as a PFIC, a U.S. holder may elect to treat its
ordinary shares as an interest in a qualified electing fund (a QEF Election),
in which case, the U.S. holder would be required to include in income currently such U.S.
holders proportionate share of our earnings and profits in years in which we are a
PFIC regardless of whether distributions of our earnings and profits are actually
distributed to the U.S. holder. Any gain subsequently recognized upon the sale or other
disposition by the U.S. holder of the ordinary shares, however, generally would be taxed
as capital gain and the denial of the basis step-up at death described above would not
apply.

A
U.S. holder may make a QEF Election with respect to a PFIC for any tax year of the U.S.
holder. A QEF Election is effective for the year in which the election is made and all
subsequent tax years of the U.S. holder. Procedures exist for both retroactive elections
and the filing of protective statements. An additional election is available to defer the
payment of taxes that may result from a QEF Election, although interest must be paid on
any deferred taxes. A U.S. holder making the QEF Election must make the election on or
before the due date, as extended, for the filing of the U.S. holders income tax
return for the first tax year to which the election will apply. A U.S. holder must make a
QEF Election by completing Form 8621 and attaching it to its U.S. federal income tax
return, and must satisfy additional filing requirements each year the election remains in
effect.

As
an alternative to a QEF Election, a U.S. holder generally may elect to mark its ordinary
shares to market annually, recognizing ordinary income or loss (subject to certain
limitations) equal to the difference, as of the close of the taxable year, between the
fair market value of the ordinary shares and their adjusted tax basis. Losses would be
allowed only to the extent of net mark-to-market gain accrued under the election. If a
mark-to-market election with respect to ordinary shares is in effect on the date of a U.S.
holders death, the normally available step-up in tax basis to fair market value will
not be available. Rather, the tax basis of the ordinary shares in the hands of a U.S.
holder who acquired them from a decedent will be the lesser of the decedents tax
basis or the fair market value of the ordinary shares. Once made, a mark-to-market
election generally continues, unless revoked with the consent of the IRS.

- 91 -

---

---



The
implementation of many aspects of the Codes PFIC rules requires the issuance of
regulations which in many instances have yet to be promulgated and which may have
retroactive effect. We cannot be sure that any of these regulations will be promulgated
or, if so, what form they will take or what effect they will have on the foregoing
discussion. Accordingly, and due to the complexity of the PFIC rules, U.S. holders should
consult their own tax advisors regarding our status as a PFIC and the eligibility, manner
and advisability of making a QEF Election or a mark-to-market election.

# Information Reporting
And Backup Withholding

Any
dividends paid on our ordinary shares to U.S. holders may be subject to U.S. federal tax
information reporting requirements and the U.S. backup withholding tax (the backup
withholding rate currently is 28%). In addition, the proceeds of a U.S. holders sale
of ordinary shares may be subject to tax information reporting and the U.S. backup
withholding tax. Backup withholding will not apply if the U.S. holder (i) is a corporation
or other exempt recipient, and demonstrates the fact when so required, or (ii) the U.S.
holder provides a U.S. taxpayer identification number, certifies as to no loss of
exemption from backup withholding and complies with any other applicable backup
withholding requirements. Any amounts withheld under the U.S. backup withholding tax rules
will be allowed as a refund or a credit against the U.S. holders U.S. federal income
tax liability, provided the required information is furnished to the U.S. Internal Revenue
Service.

The
foregoing discussion of certain U.S. federal income tax considerations is for general
information only and is not tax advice. Accordingly, each U.S. holder should consult with
his, her or its own tax adviser regarding U.S. federal, state, local and non-U.S. income
and other tax consequences of the acquisition, ownership and disposition of ordinary
shares.

|F. | DIVIDENDS
AND PAYING AGENTS
|-- | ---------------------------

| | Not
applicable.
| | ---------------

|G. | STATEMENT
BY EXPERTS
|-- | --------------------

| | Not
applicable.
| | ---------------

|H. | DOCUMENTS
ON DISPLAY
|-- | --------------------

You
may request a copy of our U.S. Securities and Exchange Commission filings, at no cost, by
writing or calling us at AudioCodes Ltd., 1 Hayarden Street, Airport City, Lod, 701514,
Israel, Attention: Itamar Rosen, General Counsel, telephone: 972-3-539-4000. A copy of
each report submitted in accordance with applicable United States law is available for
public review at our principal executive offices.

- 92 -

---

---



A
copy of each document (or a translation thereof to the extent not in English) concerning
AudioCodes that is referred to in this Annual Report on Form 20-F, is available for public
view at our principal executive offices at AudioCodes Ltd., 1 Hayarden Street, Airport
City, Lod, 701514, Israel.

|I. | SUBSIDIARY
INFORMATION
|-- | ----------------------

| | Not
applicable.
| | ---------------

| | ITEM 11. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
| | -------- | ----------------------------------------------------------

At
December 31, 2004, we did not own any market risk sensitive instruments. We have
contracted several long-term structured note deals that are sensitive to changes in
interest rates. Due to the nature of our long-term investment, we do not believe that
there is any material market risk exposure. Therefore, no quantitative tabular disclosures
are required. However, we may in the future undertake hedging or other similar
transactions or invest in market risk sensitive instruments if management determines that
it is necessary to offset these risks. See Item 3. Key InformationD. Risk
FactorsRisks Relating to Operations in Israel.

To
protect against the changes in value of forecasted foreign currency cash flows resulting
from salary payments, we have instituted a foreign currency cash flow hedging program. We
hedge portions of our forecasted expenses denominated in foreign currencies with forward
contracts.

During
2002, we entered into forward contracts to hedge a portion of the anticipated NIS payroll
payments for periods of one to six months. These forward contracts are designated as cash
flows hedges, as defined by SFAS No. 133, as amended, and are all highly effective as
hedges of these expenses when the salary is recorded. The effective portion of the hedged
instruments is included in payroll expenses in the statement of operations. During the
year ended December 31, 2002, we recognized a net loss of $18,000 related to the forward
contracts hedging salary payments. At December 31, 2002, we expected to reclassify $72,000
of net profit on derivative instruments from accumulated other comprehensive income to
earnings during the next twelve months.

During
the year ended December 31, 2003, we recognized net income of $426,000 related to the
forward contracts hedging salary payments. At December 31, 2003, we expected to reclassify
$145,000 of net profit on derivative instruments from accumulated other comprehensive
income to earnings during the next twelve months.

During
the year ended December 31, 2004, we recognized net income of $87,000 related to the
forward contracts hedging salary payments. At December 31, 2004, we expected to reclassify
$353,000 of net profit on derivative instruments from accumulated other comprehensive
income to earnings during the next twelve months.

- 93 -

---

---



| | ITEM 12. | DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES
| | -------- | ------------------------------------------------------

| | Not
applicable.
| | ---------------

# PART II

| | ITEM 13. | DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES
| | -------- | -----------------------------------------------

| | Not
applicable.
| | ---------------

| | ITEM 14. | MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS
| | -------- | ----------------------------------------------------------------------------

| | Not
applicable
| | --------------

| | ITEM 15. | CONTROLS AND PROCEDURES
| | -------- | -----------------------

As
of the end of the period covered by this Annual Report, we performed an evaluation of the
effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) and
15d-15(e) of the Securities Exchange Act of 1934). The evaluation was performed with the
participation of our key corporate senior management and under the supervision of our
Chairman of the Board, President and Chief Executive Officer, Shabtai Adlersberg, and our
Chief Financial Officer, Nachum Falek. Our management, including Messrs. Adlersberg and
Falek, concluded that our disclosure controls and procedures were effective in alerting
them to material information, on a timely basis, required to be included in our periodic
filings with the U.S. Securities and Exchange Commission. No change in our internal
control over financial reporting has occurred during the period covered by this annual
report that has materially affected, or is reasonably likely to materially affect, our
internal control over financial reporting.

| | ITEM 16. | [RESERVED]
| | -------- | ----------

| | ITEM 16A. | AUDIT COMMITTEE FINANCIAL EXPERT
| | --------- | --------------------------------

Our
Board of Directors has determined that Joseph Tenne is an audit committee financial
expert as defined in Item 16A of Form 20-F.

| | ITEM 16B. | CODE OF ETHICS
| | --------- | --------------

In
2004, we adopted a Code of Conduct and Business Ethics that applies to our chief executive
officer, chief financial officer and other senior financial officers. This Code has been
posted on our website, www.audiocodes.com.

- 94 -

---

---



| | ITEM 16C. | PRINCIPAL ACCOUNTANT FEES AND SERVICES
| | --------- | --------------------------------------

Kost
Forer Gabbay & Kasierer, a member of Ernst & Young Global, has served as our
independent public accountants for each of the years in the three-year period ended
December 31, 2004. The following table presents the aggregate fees for professional audit
services and other services rendered by Kost Forer Gabbay & Kasierer in 2003 and 2004.

|                   | Year ended December 31,(Amounts in thousands)
|------------------ | ---------------------------------------------
|
|
|
|
|Audit Fees         |                                              
|Audit Related Fees |                                              
|Tax Fees           |                                              
|All Other Fees     |                                              
|                   |                                              
|Total              |                                              
|                   |                                              

Audit
Fees consist of fees billed for the annual audit of the companys consolidated
financial statements and the statutory financial statements of the company. They also
include fees billed for other audit services, which are those services that only the
external auditor reasonably can provide, and include the provision of consents and the
review of documents filed with the SEC.

Audit
Related Fees consist of fees billed for assurance and related services that are reasonably
related to the performance of the audit or review of the companys financial
statements and include operational effectiveness of systems. They also include fees billed
for other services in connection with merger and acquisition due diligence, as well as our
offering of convertible notes and our filing of a registration statement on Form F-3 with
respect to the convertible notes.

Tax
Fees include fees billed for tax compliance services, including the preparation of tax
returns and claims for refund; tax consultations, such as assistance and representation in
connection with tax audits and appeals, transfer pricing, and requests for rulings or
technical advice from taxing authorities; tax planning services; and expatriate tax
compliance, consultation and planning services.

# Audit Committee
Pre-approval Policies and Procedures

The
Audit Committee of AudioCodes Board of Directors is responsible, among other
matters, for the oversight of the external auditor subject to the requirements of Israeli
law. The Audit Committee has adopted a policy regarding pre-approval of audit and
permissible non-audit services provided by our independent auditors (the
Policy).

Under
the Policy, proposed services either (i) may be pre-approved by the Audit Committee
without consideration of specific case-by-case services as general
pre-approval; or (ii) require the specific pre-approval of the Audit Committee as
specific pre-approval. The Audit Committee may delegate either type of
pre-approval authority to one or more of its members. The appendices to the Policy set out
the audit, audit-related, tax and other services that have received the general
pre-approval of the Audit Committee, including those described in the footnotes to the
table, above; these services are subject to annual review by the Audit Committee. All
other audit, audit-related, tax and other services must receive a specific pre-approval
from the Audit Committee.

- 95 -

---

---



The
Audit Committee establishes budgeted fee levels annually for each of the four categories
of audit and non-audit services that are pre-approved under the Policy, namely, audit,
audit-related, tax and other services. Requests or applications to provide services that
require specific approval by the Audit Committee are submitted to the Audit Committee by
both the external auditor and the chief financial officer. At each regular meeting of the
Audit Committee, the external auditor provides a report in order for the Audit Committee
to review the services that the external auditor is providing, as well as the status and
cost of those services.

During
2004, no services provided to AudioCodes by Kost Forer Gabbay & Kasierer were approved
by the Audit Committee pursuant to the de minimis exception to the pre-approval
requirement provided by paragraph (c)(7)(i)(C) of Rule 2-01 of Regulation S-X.

| | ITEM 16D. | EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES
| | --------- | ----------------------------------------------------------

| | Not
applicable.
| | ---------------

| | ITEM 16E. | PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS
| | --------- | ----------------------------------------------------------------------

| | Not
applicable.
| | ---------------

# PART III

| | ITEM 17. | FINANCIAL STATEMENTS
| | -------- | --------------------

| | Not
applicable.
| | ---------------

| | ITEM 18. | FINANCIAL STATEMENTS
| | -------- | --------------------

The
following consolidated financial statements and related auditors reports are filed
as part of this Annual Report.

|                                              |               
|--------------------------------------------- | --------------
|
|
|
|
|Report of Independent Auditors                | F - 2         
|Consolidated Balance Sheets                   | F - 3         
|Consolidated Statements of Operations         | F - 4         
|Statements of Changes in Shareholders' Equity | F - 5         
|Consolidated Statements of Cash Flows         | F - 6 - F - 7 
|Notes to Consolidated Financial Statements    | F - 8 - F - 33

- 96 -

---

---



Schedule II
                      SCHEDULE OF VALUATION AND QUALIFYING ACCOUNTS AT DECEMBER 31, 2004
                                                (in thousands)

|Description                     | Balance at
Beginning of
Period | Provision for
doubtful
accounts | Write-off of
previously
provided
accounts | Ai-Logix
acquisition | Balance at end
of period
|------------------------------- | ------------------------------ | ------------------------------- | ----------------------------------------- | -------------------- | ------------------------
|Year ended December 31, 2002:   |                                |                                 |                                           |                      |                         
|Allowance for doubtful accounts | 1,233                          | 71                              | (173)                                     | -                    | 1,131                   
|Year ended December 31, 2003:   |                                |                                 |                                           |                      |                         
|Allowance for doubtful accounts | 1,131                          | 293                             | (975)                                     | -                    | 449                     
|Year ended December 31, 2004:   |                                |                                 |                                           |                      |                         
|Allowance for doubtful accounts | 449                            | 187                             | (7)                                       | 56                   | 685                     

Other schedules are omitted because
they are not required or the required information is shown in the financial statements or
notes thereto.

- 97 -

---

---



| | ITEM 19. | EXHIBITS
| | -------- | --------

The
following exhibits are filed as part of this Annual Report:

|Exhibit No. |  | Exhibit
|----------- |  | -------

|1.1 |  | Memorandum
of Association of Registrant.*
|--- |  | ------------------------------------------

|1.2 |  | Articles
of Association of Registrant, as amended.**
|--- |  | ----------------------------------------------------

|2.1 |  | Indenture,
 dated  November 9, 2004,  between  AudioCodes  Ltd. and U.S. Bank National  Association,
 as            Trustee, with respect to the 2.))% Senior Convertible Notes due 2024.****
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.1 |  | AudioCodes
Ltd. 1997 Key Employee Option Plan (C).*
|--- |  | ---------------------------------------------------

|4.2 |  | AudioCodes
Ltd. 1997 Key Employee Option Plan, Qualified Stock Option Plan--U.S. Employees (D).*
|--- |  | ------------------------------------------------------------------------------------------------

|4.3 |  | Founder's
Agreement between Shabtai Adlersberg and Leon Bialik, dated January 1, 1993.*
|--- |  | ----------------------------------------------------------------------------------------

|4.4 |  | Share
Purchase  Agreement by and among  AudioCodes Ltd., The Israel Private Equity Fund L.P.,
DS Polaris            Ltd., Chase Capital Partners L.P. and Additional Investors, dated
as of June 22, 1997.*
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.5 |  | Investment
Agreement between AudioCodes Ltd. and DSP Semiconductor, Inc., dated April 5, 1993.*
|--- |  | -----------------------------------------------------------------------------------------------

|4.6 |  | Investment
Agreement between AudioCodes Ltd. and DSP Group, Inc., dated June 16, 1994.*
|--- |  | ---------------------------------------------------------------------------------------

|4.7 |  | License
Agreement between AudioCodes Ltd. and DSP Group, Inc., dated as of May 6, 1999.*
|--- |  | -----------------------------------------------------------------------------------------

|4.8 |  | Lease
Agreement between AudioCodes Inc. and Spieker Properties, L.P., dated January 26, 2000.**
|--- |  | -----------------------------------------------------------------------------------------------

|4.9 |  | Agreement
between AudioCodes Ltd. and DSP Group, Inc. dated as of May 6, 1999.*
|--- |  | -------------------------------------------------------------------------------

|4.10 |  | OEM
Purchase Agreement between AudioCodes Ltd. and Clarent Corporation, dated as of December
1, 1998.*
|---- |  | ------------------------------------------------------------------------------------------------------

- 98 -

---

---



|Exhibit No. |  | Exhibit
|----------- |  | -------

|4.11 |  | Shareholders
 Agreement by and among DSP Group, Inc., Shabtai Adlersberg,  Leon Bialik, Genesis
Partners            I, L.P., Genesis Partners I (Cayman) L.P.,  Polaris Fund II (Tax
Exempt Investors) L.L.C.,  Polaris Fund            II L.L.C.,  Polaris Fund II L.P., DS
Polaris Trust Company (Foreign  Residents)  (1997) Ltd., DS Polaris            Ltd.,
 Dovrat,  Shrem Trust Company  (Foreign  Funds) Ltd.,  Dovrat  Shrem-Skies  92 Fund L.P.
and Chase            Equity Securities CEA, dated as of May 6, 1999.*
|---- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.12 |  | Agreement
 between  AudioCodes Ltd. and DSP Group, Inc. and France Telecom and Universite de
Sherbrooke,            dated March 3, 1995.*
|---- |  | -----------------------------------------------------------------------------------------------------------------------------------------

|4.13 |  | AudioCodes
Ltd. 1997 Key Employee Option Plan (D).*
|---- |  | ---------------------------------------------------

|4.14 |  | AudioCodes
Ltd. 1997 Key Employee Option Plan (E).*
|---- |  | ---------------------------------------------------

|4.15 |  | AudioCodes
Ltd. 1999 Key Employee Option Plan (F), as amended.***
|---- |  | -----------------------------------------------------------------

|4.16 |  | AudioCodes
Ltd. 1997 Key Employee Option Plan, Qualified Stock Option Plan  U.S. Employees (E).*
|---- |  | -------------------------------------------------------------------------------------------------

|4.17 |  | AudioCodes
Ltd. 1999 Key Employee Option Plan, Qualified Stock Option Plan  U.S. Employees (F).***
|---- |  | ---------------------------------------------------------------------------------------------------

|4.18 |  | AudioCodes
Ltd. 2001 Employee Stock Purchase Plan--Global Non U.S.§
|---- |  | -------------------------------------------------------------------

|4.19 |  | AudioCodes
Ltd. 2001 U.S. Employee Stock Purchase Plan.§
|---- |  | --------------------------------------------------------

|4.20 |  | Lease
Agreement between AudioCodes Ltd. And Gev-Yam Maman Nechasim BeLod Ltd.,  effective as of
December            1, 2000.**
|---- |  | -------------------------------------------------------------------------------------------------------------------------------

|4.21 |  | Lease
 Agreement  between  AudioCodes  Ltd.  and Nortel  Networks  (Marketing  and Sales)
 Israel  Ltd.,            effective as of December 31, 2002.**
|---- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------

|4.22 |  | Sublease
Agreement between Ai-Logix, Inc. and Continental Resources, Inc., dated December 30,
2003.§§
|---- |  | -----------------------------------------------------------------------------------------------------

|4.23 |  | Stock
 Purchase  Agreement  by  and  among  AudioCodes  Ltd.,  AudioCodes  Inc.,  Ai-Logix,
 Inc.and  AI            Technologies N.V, dated as of May 12, 2004. §§.
|---- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.24 |  | OEM
Purchase and Sale Agreement No. 011449 between  AudioCodes Ltd and Nortel Networks Ltd.,
dated as of            April 28, 2003 *****§§
|---- |  | ------------------------------------------------------------------------------------------------------------------------------------------

|4.25 |  | Amendment
No. 1 to OEM Purchase and Sale No. 011449  between  AudioCodes  Ltd and Nortel  Networks
Ltd.,            dated as of May 1, 2003 ***** §§.
|---- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------

- 99 -

---

---



|Exhibit No. |  | Exhibit
|----------- |  | -------

|4.26 |  | Purchase
and Sale Agreement by and among Nortel  Networks,  Ltd.,  AudioCodes Inc. and AudioCodes
 Ltd.,            dated as of April 7, 2003. §§
|---- |  | -------------------------------------------------------------------------------------------------------------------------------------------------

|4.27 |  | Purchase
 Agreement,  dated as of November 9, 2004,  between  AudioCodes  Ltd. and Merrill  Lynch & Co.,
           Merrill Lynch,  Pierce,  Fenner & Smith Incorporated and Lehman Brothers Inc.,
as representatives of the            initial purchasers of AudioCodes' 2.00% Senior
Convertible Notes due 2024.****
|---- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.28 |  | Registration
Rights Agreement,  dated as of November 9, 2004, between AudioCodes Ltd. and Merrill
Lynch,            Pierce, Fenner & Smith Incorporated, Lehman Brothers Inc. and CIBC
World Markets Corp.****
|---- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.29 |  | Amendment
No. 2 to OEM Purchase and Sale No. 011449  between  AudioCodes  Ltd and Nortel  Networks
Ltd.,            dated as of January 1, 2005 §§§
|---- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------

|4.30 |  | Amendment
No. 3 to OEM Purchase and Sale No. 011449  between  AudioCodes  Ltd and Nortel  Networks
Ltd.,            dated as of February 15, 2005
|---- |  | -------------------------------------------------------------------------------------------------------------------------------------------------

|4.31 |  | Amendment
No. 5 to OEM Purchase and Sale No. 011449  between  AudioCodes  Ltd and Nortel  Networks
Ltd.,            dated as of January 1, 2005 §§§
|---- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------

|4.32 |  | Amendment
No. 6 to OEM Purchase and Sale No. 011449  between  AudioCodes  Ltd and Nortel  Networks
Ltd.,            dated as of April 1, 2005
|---- |  | ---------------------------------------------------------------------------------------------------------------------------------------------

|4.33 |  | Lease
Agreement  between  AudioCodes  Inc. and CA-Gateway  Office Limited  Partnership,
 effective as of            December , 2004.
|---- |  | ------------------------------------------------------------------------------------------------------------------------------------

|8.1 |  | Subsidiaries
of the Registrant.
|--- |  | -------------------------------

|12.1 |  | Certification
of Shabtai Adlersberg,  President and Chief Executive Officer,  pursuant to Section 302
of            the Sarbanes-Oxley Act of 2002
|---- |  | --------------------------------------------------------------------------------------------------------------------------------------------------

|12.2 |  | Certification
of Nachum Falek,  Vice President and Chief Financial  Officer,  pursuant to Section 302
of            the Sarbanes-Oxley Act of 2002
|---- |  | --------------------------------------------------------------------------------------------------------------------------------------------------

|13.1 |  | Certification
 by Chief Executive  Officer  Pursuant to 18 U.S.C.  Section 1350, as Adopted  Pursuant
to            Section 906 of the Sarbanes-Oxley Act of 2002.
|---- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------

|13.2 |  | Certification
 by Chief Financial  Officer  Pursuant to 18 U.S.C.  Section 1350, as Adopted  Pursuant
to            Section 906 of the Sarbanes-Oxley Act of 2002.
|---- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------

|14.1 |  | Consent
of Kost Forer Gabbay & Kasierer, a member of Ernst & Young Global.
|---- |  | --------------------------------------------------------------------------

---

|* |  | Incorporated
herein by reference to Registrant's Registration Statement on Form F-1 (File          No.
333-10352) .
|- |  | -------------------------------------------------------------------------------------------------------------------



---

---



| | Hebrew
original and English summary of Hebrew original.
|- | -------------------------------------------------------

| | English
summary of Hebrew original.
|-- | -----------------------------------

| | Incorporated
herein by reference to Registrant's Registration Statement on Form S-8 (File          No.
333-13268) .
|- | -------------------------------------------------------------------------------------------------------------------

|§ | Incorporated
herein by reference to Registrant's Registration Statement on Form S-8 (File          No.
333-13378) .
|- | -------------------------------------------------------------------------------------------------------------------

|** | Incorporated
herein by reference to Registrant's Form 20-F for the fiscal year ended          December
31, 2000.
|-- | ----------------------------------------------------------------------------------------------------------------

|*** | Incorporated
herein by reference to Registrant's Form 20-F for the fiscal year ended          December
31, 2002.
|--- | ----------------------------------------------------------------------------------------------------------------

|**** | Incorporated
by reference herein to Registrant's Registration Statement on Form F-3 (File          No.
333-123859).
|---- | -------------------------------------------------------------------------------------------------------------------

|***** | Confidential
treatment has been granted for certain portions of the indicated document.          The
confidential portions have been omitted and filed separately with the Securities and
         Exchange Commission as required by Rule 24b-2 promulgated under the Securities
Exchange Act          of 1934.
|----- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|§§ | Incorporated
herein by reference to Registrant's Form 20-F for the fiscal year ended          December
31, 2003.
|-- | ----------------------------------------------------------------------------------------------------------------

|§§§ | A
request for confidentiality has been filed for certain portions of the indicated
         document.  Confidential portions have been omitted and filed separately with the
Securities          and Exchange Commission as required by Rule 24b-2 promulgated under
the Securities Exchange          Act of 1934.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

- 101 -

---

---



SIGNATURES

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

| |  | AUDIOCODES LTD.BY: /S/ NACHUM FALEK
Nachum FalekVice President Finance  andChief Financial Officer
| |  | ----------------------------------------------------------------------------------------------------------------

Date: June 2, 2005



---

---



# EXHIBIT INDEX

|Exhibit No. |  | Exhibit
|----------- |  | -------

|4.29 |  | Amendment
No. 2 to OEM Purchase and Sale No. 011449  between  AudioCodes  Ltd and Nortel  Networks
Ltd.,            dated as of January 1, 2005 *
|---- |  | -------------------------------------------------------------------------------------------------------------------------------------------------

|4.30 |  | Amendment
No. 3 to OEM Purchase and Sale No. 011449  between  AudioCodes  Ltd and Nortel  Networks
Ltd.,            dated as of February 15, 2005
|---- |  | -------------------------------------------------------------------------------------------------------------------------------------------------

|4.31 |  | Amendment
No. 5 to OEM Purchase and Sale No. 011449  between  AudioCodes  Ltd and Nortel  Networks
Ltd.,            dated as of January 1, 2005 *
|---- |  | -------------------------------------------------------------------------------------------------------------------------------------------------

|4.32 |  | Amendment
No. 6 to OEM Purchase and Sale No. 011449  between  AudioCodes  Ltd and Nortel  Networks
Ltd.,            dated as of April 1, 2005
|---- |  | ---------------------------------------------------------------------------------------------------------------------------------------------

|4.33 |  | Lease
Agreement  between  AudioCodes  Inc. and CA-Gateway  Office Limited  Partnership,
 effective as of            December 29, 2004.
|---- |  | --------------------------------------------------------------------------------------------------------------------------------------

|8.1 |  | Subsidiaries
of the Registrant.
|--- |  | -------------------------------

|12.1 |  | Certification
of Shabtai Adlersberg,  President and Chief Executive Officer,  pursuant to Section 302
of            the Sarbanes-Oxley Act of 2002.
|---- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------

|12.2 |  | Certification
of Nachum Falek,  Vice President and Chief Financial  Officer,  pursuant to Section 302
of            the Sarbanes-Oxley Act of 2002.
|---- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------

|13.1 |  | Certification
 by Chief Executive  Officer  Pursuant to 18 U.S.C.  Section 1350, as Adopted  Pursuant
to            Section 906 of the Sarbanes-Oxley Act of 2002.
|---- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------

|13.2 |  | Certification
 by Chief Financial  Officer  Pursuant to 18 U.S.C.  Section 1350, as Adopted  Pursuant
to            Section 906 of the Sarbanes-Oxley Act of 2002.
|---- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------

|14.1 |  | Consent
of Kost Forer and Gabbay & Kasierer, a member of Ernst & Young Global.
|---- |  | ------------------------------------------------------------------------------

---

*    A request
for confidentiality has been filed for certain portions of the indicated document. Confidential
portions have been omitted and filed separately with the Securities and Exchange
Commission as required by Rule 24b-2 promulgated
under the Securities Exchange Act of 1934.



---

---



AUDIOCODES LTD. AND ITS SUBSIDIARIES

CONSOLIDATED FINANCIAL STATEMENTS

AS OF DECEMBER 31, 2004

IN U.S. DOLLARS

INDEX

|                                                          |  | Page      
|--------------------------------------------------------- |  | ----------
|                                                          |  |           
|                                                          |  |           
|Report of Independent Registered Public Accounting
  Firm |  | F-2       
|                                                          |  |           
|Consolidated Balance Sheets                               |  | F-3       
|                                                          |  |           
|Consolidated Statements of Operations                     |  | F-4       
|                                                          |  |           
|Statements of Changes in Shareholders Equity             |  | F-5       
|                                                          |  |           
|Consolidated Statements of Cash Flows                     |  | F-6 - F-7 
|                                                          |  |           
|Notes to Consolidated Financial Statements                |  | F-8 - F-33

- - - - - - - - - - -

---

---

ERNST & YOUNG

REPORT OF INDEPENDENT REGISTERED
PUBLIC ACCOUNTING FIRM

To the Shareholders of

AUDIOCODES LTD.

We have
audited the accompanying consolidated balance sheets of AudioCodes Ltd. (the
Company) and its subsidiaries as of December 31, 2003 and 2004, and the
related consolidated statements of operations, changes in shareholders equity
and cash flows for each of the three years in the period ended December 31,
2004. Our audits also included the financial statement schedule listed in the
index at Item 2. These financial statements and schedule are the responsibility
of the Companys management. Our responsibility is to express an opinion on
these financial statements and schedule based on our audits.

We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we
plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. We were not engaged to
perform an audit of the Companys internal control over financial
reporting.  Our audit included consideration
of internal control over financial reporting as a basis for designing audit
procedures that are appropriate in the circumstances, but not for the purpose
of expressing an opinion on the effectiveness of the Companys internal control
over financial reporting. Accordingly, we express no such opinion.  An audit also includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement
presentation.  We believe that our
audits provide a reasonable basis for our opinion.

In our
opinion, the consolidated financial statements referred to above, present
fairly, in all material respects, the consolidated financial position of the
Company and its subsidiaries as of December 31, 2003 and 2004, and the related
consolidated results of their operations and their cash flows for each of the
three years in the period ended December 31, 2004, in conformity with U.S. generally
accepted accounting principles.

Also, in our
opinion, the related financial statement schedule, when considered in relation
to the basic financial statements taken as a whole, presents fairly in all
material respects the information set forth therein.

|Tel-Aviv,
  Israel |  | KOST FORER GABBAY & KASIERER    
|------------------ |  | --------------------------------
|January 24,
  2005 |  | A Member of Ernst & Young Global

- F-2 -

---

---

AUDIOCODES LTD. AND ITS SUBSIDIARIES

|CONSOLIDATED BALANCE SHEETS                               
|----------------------------------------------------------
|                                                          
|U.S. dollars in thousands, except share and par value data

|                                              |                                                                                                                                                                                                               | December
  31, |        
|--------------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | -------------- | -------
|                                              |                                                                                                                                                                                                               |                |        
|                                              |                                                                                                                                                                                                               | 2003           |        
|                                              |                                                                                                                                                                                                               |                |        
|ASSETS                                        |                                                                                                                                                                                                               |                |        
|                                              |                                                                                                                                                                                                               |                |        
|CURRENT
  ASSETS:                             |                                                                                                                                                                                                               |                |        
|                                              | Cash and
  cash equivalents                                                                                                                                                                                   |                | $      
|                                              | Trade
  receivables (net of allowance for doubtful accounts of $449 and $685 as of
     December 31, 2003 and 2004, respectively)                                                                             |                |        
|                                              | Other
  receivables and prepaid expenses                                                                                                                                                                      |                |        
|                                              | Inventories                                                                                                                                                                                                   |                |        
|                                              |                                                                                                                                                                                                               |                |        
|                                              |                                                                                                                                                                                                               |                |        
|Total
  current assets                        |                                                                                                                                                                                                               |                | 64,254 
|                                              |                                                                                                                                                                                                               |                |        
|                                              |                                                                                                                                                                                                               |                |        
|LONG-TERM
  INVESTMENTS:                      |                                                                                                                                                                                                               |                |        
|                                              | Long-term
  bank deposits and structured notes                                                                                                                                                                |                |        
|                                              | Investment
  in an affiliated company                                                                                                                                                                         |                |        
|                                              | Severance
  pay funds                                                                                                                                                                                         |                |        
|                                              |                                                                                                                                                                                                               |                |        
|                                              |                                                                                                                                                                                                               |                |        
|Total
  long-term investments                 |                                                                                                                                                                                                               |                | 54,379 
|                                              |                                                                                                                                                                                                               |                |        
|                                              |                                                                                                                                                                                                               |                |        
|PROPERTY AND
  EQUIPMENT, NET                 |                                                                                                                                                                                                               |                | 4,564  
|                                              |                                                                                                                                                                                                               |                |        
|                                              |                                                                                                                                                                                                               |                |        
|INTANGIBLE
  ASSETS AND DEFERRED CHARGES, NET |                                                                                                                                                                                                               |                | 1,013  
|                                              |                                                                                                                                                                                                               |                |        
|                                              |                                                                                                                                                                                                               |                |        
|GOODWILL                                      |                                                                                                                                                                                                               |                | 4,320  
|                                              |                                                                                                                                                                                                               |                |        
|                                              |                                                                                                                                                                                                               |                |        
|Total assets                                  |                                                                                                                                                                                                               | $              | 128,530
|                                              |                                                                                                                                                                                                               |                |        
|                                              |                                                                                                                                                                                                               |                |        
|LIABILITIES
  AND SHAREHOLDERS EQUITY        |                                                                                                                                                                                                               |                |        
|                                              |                                                                                                                                                                                                               |                |        
|CURRENT
  LIABILITIES:                        |                                                                                                                                                                                                               |                |        
|                                              | Trade
  payables                                                                                                                                                                                              |                | $      
|                                              | Other
  payables and accrued expenses                                                                                                                                                                         |                |        
|                                              |                                                                                                                                                                                                               |                |        
|                                              |                                                                                                                                                                                                               |                |        
|Total
  current liabilities                   |                                                                                                                                                                                                               |                | 18,022 
|                                              |                                                                                                                                                                                                               |                |        
|                                              |                                                                                                                                                                                                               |                |        
|ACCRUED
  SEVERANCE PAY                       |                                                                                                                                                                                                               |                | 3,990  
|                                              |                                                                                                                                                                                                               |                |        
|                                              |                                                                                                                                                                                                               |                |        
|SENIOR
  CONVERIBLE NOTES                     |                                                                                                                                                                                                               |                | -      
|                                              |                                                                                                                                                                                                               |                |        
|                                              |                                                                                                                                                                                                               |                |        
|COMMITMENTS
  AND CONTINGENT LIABILITIES      |                                                                                                                                                                                                               |                |        
|                                              |                                                                                                                                                                                                               |                |        
|SHAREHOLDERS
  EQUITY:                       |                                                                                                                                                                                                               |                |        
|                                              | Share
  capital -                                                                                                                                                                                             |                |        
|                                              | Ordinary
  shares of NIS 0.01 par value:                                                                                                                                                                      |                |        
|                                              | Authorized -
  100,000,000 as of December 31, 2003 and 2004;                                                                                                                                                  |                |        
|                                              | Issued -
  41,727,734 shares as of December 31, 2003 and 43,808,132 shares as of
  December 31, 2004; Outstanding - 37,785,595 shares as of December 31, 2003
  and 39,865,993 shares as of December 31, 2004 |                |        
|                                              | Additional
  paid-in capital                                                                                                                                                                                  |                |        
|                                              | Treasury
  stock                                                                                                                                                                                              |                |        
|                                              | Deferred
  stock compensation                                                                                                                                                                                 |                |        
|                                              | Accumulated
  other comprehensive income                                                                                                                                                                      |                |        
|                                              | Retained earnings                                                                                                                                                                                             |                |        
|                                              |                                                                                                                                                                                                               |                |        
|                                              |                                                                                                                                                                                                               |                |        
|Total
  shareholders equity                  |                                                                                                                                                                                                               |                | 106,518
|                                              |                                                                                                                                                                                                               |                |        
|                                              |                                                                                                                                                                                                               |                |        
|Total
  liabilities and shareholders equity  |                                                                                                                                                                                                               | $              | 128,530
|                                              |                                                                                                                                                                                                               |                |        

The accompanying notes are an integral part of the consolidated
financial statements.

- F-3 -

---

---

AUDIOCODES LTD. AND ITS SUBSIDIARIES

|CONSOLIDATED STATEMENTS OF OPERATIONS           
|------------------------------------------------
|                                                
|U.S. dollars in thousands, except per share data

|                                            |  | Year ended December 31, |        
|------------------------------------------- |  | ----------------------- | -------
|                                            |  |                         |        
|                                            |  | 2002                    |        
|                                            |  |                         |        
|                                            |  |                         |        
|Revenues                                    |  | $                       | 27,189 
|Cost of
  revenues                          |  |                         | 13,006 
|                                            |  |                         |        
|                                            |  |                         |        
|Gross profit                                |  |                         | 14,183 
|                                            |  |                         |        
|                                            |  |                         |        
|Operating
  expenses:                       |  |                         |        
|Research
  and development, net             |  |                         | 13,022 
|Selling
  and marketing                     |  |                         | 14,288 
|General
  and administrative                |  |                         | 3,353  
|                                            |  |                         |        
|                                            |  |                         |        
|Total
  operating expenses                  |  |                         | 30,663 
|                                            |  |                         |        
|                                            |  |                         |        
|Operating
  income (loss)                   |  |                         | (16,480
|Financial
  income, net                     |  |                         | 2,623  
|Equity in
  losses of an affiliated company |  |                         | 300    
|                                            |  |                         |        
|                                            |  |                         |        
|Income
  (loss) before taxes on income      |  |                         | (14,157
|Taxes on
  income                           |  |                         | -      
|                                            |  |                         |        
|                                            |  |                         |        
|Net income
  (loss)                         |  | $                       | (14,157
|                                            |  |                         |        
|                                            |  |                         |        
|Basic net
  earnings (loss) per share       |  | $                       | (0.37  
|                                            |  |                         |        
|                                            |  |                         |        
|Diluted net
  earnings (loss) per share     |  | $                       | (0.37  
|                                            |  |                         |        

The accompanying notes are an integral part of the consolidated
financial statements.

- F-4 -

---

---

AUDIOCODES LTD. AND ITS SUBSIDIARIES

|STATEMENTS OF CHANGES IN SHAREHOLDERS EQUITY
|---------------------------------------------
|                                             
|U.S. dollars in thousands                    

|                                |                                                                                        | Share
  capital |     | Additional
  paid-in
  capital |   | Treasury
  stock |        | Deferred
  stock
  compensation |         | Accumulated
  other
  comprehensive
  income |   | Retained
  earnings |      | Total
  comprehensive
  income (loss) |     | Total
  shareholders
  equity |  
|------------------------------- | -------------------------------------------------------------------------------------- | --------------- | --- | ------------------------------ | - | ---------------- | ------ | ------------------------------- | ------- | -------------------------------------------- | - | ------------------- | ---- | ------------------------------------- | --- | ------------------------------ | -
|                                |                                                                                        |                 |     |                                |   |                  |        |                                 |         |                                              |   |                     |      |                                       |     |                                |  
|Balance as of January 1, 2002   |                                                                                        | $               | 120 |                                | $ | 113,878          |        | $                               | (6,401  | )                                            | $ | (161                | )    | $                                     | -   |                                | $
|                                |                                                                                        |                 |     |                                |   |                  |        |                                 |         |                                              |   |                     |      |                                       |     |                                |  
|                                | Purchase of treasury stock                                                             |                 |     | -                              |   |                  | -      |                                 |         | (4,704                                       | ) |                     | -    |                                       |     | -                              |  
|                                | Issuance of shares upon exercise of options, warrants
and employee stock purchase plan |                 |     | *) -                           |   |                  | 757    |                                 |         | -                                            |   |                     | -    |                                       |     | -                              |  
|                                | Amortization of deferred stock compensation                                            |                 |     | -                              |   |                  | -      |                                 |         | -                                            |   |                     | 161  |                                       |     | -                              |  
|                                | Comprehensive loss, net:                                                               |                 |     |                                |   |                  |        |                                 |         |                                              |   |                     |      |                                       |     |                                |  
|                                | Unrealized gain on forward contracts, net                                              |                 | -   |                                |   | -                |        |                                 | -       |                                              |   | -                   |      |                                       | 72  |                                |  
|                                | Net loss                                                                               |                 |     | -                              |   |                  | -      |                                 |         | -                                            |   |                     | -    |                                       |     | -                              |  
|                                |                                                                                        |                 |     |                                |   |                  |        |                                 |         |                                              |   |                     |      |                                       |     |                                |  
|                                | Total comprehensive loss, net                                                          |                 |     |                                |   |                  |        |                                 |         |                                              |   |                     |      |                                       |     |                                |  
|                                |                                                                                        |                 |     |                                |   |                  |        |                                 |         |                                              |   |                     |      |                                       |     |                                |  
|Balance as of December 31, 2002 |                                                                                        |                 | 120 |                                |   | 114,635          |        |                                 | (11,105 | )                                            |   | -                   |      |                                       | 72  |                                |  
|                                |                                                                                        |                 |     |                                |   |                  |        |                                 |         |                                              |   |                     |      |                                       |     |                                |  
|                                | Purchase of treasury stock                                                             |                 |     | -                              |   |                  | -      |                                 |         | (215                                         | ) |                     | -    |                                       |     | -                              |  
|                                | Issuance of shares upon exercise of options, warrants
and employee stock purchase plan |                 |     | 1                              |   |                  | 1,659  |                                 |         | -                                            |   |                     | -    |                                       |     | -                              |  
|                                | Deferred stock compensation                                                            |                 |     | -                              |   |                  | 224    |                                 |         | -                                            |   |                     | (224 | )                                     |     | -                              |  
|                                | Amortization of deferred stock compensation                                            |                 |     | -                              |   |                  | -      |                                 |         | -                                            |   |                     | 50   |                                       |     | -                              |  
|                                | Comprehensive loss, net:                                                               |                 |     |                                |   |                  |        |                                 |         |                                              |   |                     |      |                                       |     |                                |  
|                                | Unrealized gain on forward contracts, net                                              |                 |     | -                              |   |                  | -      |                                 |         | -                                            |   |                     | -    |                                       |     | 73                             |  
|                                | Net loss                                                                               |                 |     | -                              |   |                  | -      |                                 |         | -                                            |   |                     | -    |                                       |     | -                              |  
|                                |                                                                                        |                 |     |                                |   |                  |        |                                 |         |                                              |   |                     |      |                                       |     |                                |  
|                                | Total comprehensive loss, net                                                          |                 |     |                                |   |                  |        |                                 |         |                                              |   |                     |      |                                       |     |                                |  
|                                |                                                                                        |                 |     |                                |   |                  |        |                                 |         |                                              |   |                     |      |                                       |     |                                |  
|Balance as of December 31, 2003 |                                                                                        |                 | 121 |                                |   | 116,518          |        |                                 | (11,320 | )                                            |   | (174                | )    |                                       | 145 |                                |  
|                                |                                                                                        |                 |     |                                |   |                  |        |                                 |         |                                              |   |                     |      |                                       |     |                                |  
|                                | Issuance of shares upon exercise of options and
employee
   stock purchase plan        |                 |     | 5                              |   |                  | 10,182 |                                 |         | -                                            |   |                     | -    |                                       |     | -                              |  
|                                | Amortization of deferred stock compensation                                            |                 |     | -                              |   |                  | -      |                                 |         | -                                            |   |                     | 66   |                                       |     | -                              |  
|                                | Comprehensive income, net:                                                             |                 |     |                                |   |                  |        |                                 |         |                                              |   |                     |      |                                       |     |                                |  
|                                | Unrealized gain on forward contracts, net                                              |                 |     | -                              |   |                  | -      |                                 |         | -                                            |   |                     | -    |                                       |     | 208                            |  
|                                | Net income                                                                             |                 |     | -                              |   |                  | -      |                                 |         | -                                            |   |                     | -    |                                       |     | -                              |  
|                                |                                                                                        |                 |     |                                |   |                  |        |                                 |         |                                              |   |                     |      |                                       |     |                                |  
|                                | Total comprehensive income, net                                                        |                 |     |                                |   |                  |        |                                 |         |                                              |   |                     |      |                                       |     |                                |  
|                                |                                                                                        |                 |     |                                |   |                  |        |                                 |         |                                              |   |                     |      |                                       |     |                                |  
|Balance as of December 31, 2004 |                                                                                        | $               | 126 |                                | $ | 126,700          |        | $                               | (11,320 | )                                            | $ | (108                | )    | $                                     | 353 |                                | $
|                                |                                                                                        |                 |     |                                |   |                  |        |                                 |         |                                              |   |                     |      |                                       |     |                                |  

*) Represents an amount lower than $1.

The accompanying notes are an integral part of the consolidated
financial statements.

- F-5 -

---

---

|AUDIOCODES LTD. AND ITS SUBSIDIARIES 
|-------------------------------------
|                                     
|CONSOLIDATED STATEMENTS OF CASH FLOWS
|                                     
|U.S. dollars in thousands            

|                                                       |                                                                                                                    | Year ended
  December 31, |        
|------------------------------------------------------ | ------------------------------------------------------------------------------------------------------------------ | ------------------------- | -------
|                                                       |                                                                                                                    |                           |        
|                                                       |                                                                                                                    | 2002                      |        
|                                                       |                                                                                                                    |                           |        
|Cash flows from operating
activities:                  |                                                                                                                    |                           |        
|                                                       | Net income (loss)                                                                                                  |                           | $      
|                                                       | Adjustments required to
reconcile net income (loss) to net cash provided by
       (used in) operating activities: |                           |        
|                                                       | Depreciation and
amortization                                                                                      |                           |        
|                                                       | Equity in losses of an
affiliated company                                                                          |                           |        
|                                                       | Increase (decrease) in
accrued severance pay, net                                                                  |                           |        
|                                                       | Amortization of deferred
stock compensation                                                                        |                           |        
|                                                       | Amortization of senior
convertible notes discount and deferred charges                                             |                           |        
|                                                       | Decrease (increase) in
accrued interest on short-term and long-term bank
   deposits and structured notes          |                           |        
|                                                       | Increase in trade
receivables, net                                                                                 |                           |        
|                                                       | Increase in other
receivables and prepaid expenses                                                                 |                           |        
|                                                       | Decrease (increase) in
inventories                                                                                 |                           |        
|                                                       | Increase in trade payables                                                                                         |                           |        
|                                                       | Increase (decrease) in
other payables and accrued expenses                                                         |                           |        
|                                                       | Other                                                                                                              |                           |        
|                                                       |                                                                                                                    |                           |        
|                                                       |                                                                                                                    |                           |        
|Net cash provided by (used
in) operating activities    |                                                                                                                    |                           | (11,660
|                                                       |                                                                                                                    |                           |        
|                                                       |                                                                                                                    |                           |        
|Cash flows from investing
activities:                  |                                                                                                                    |                           |        
|                                                       | Investment in an affiliated
company                                                                                |                           |        
|                                                       | Purchase of property and
equipment                                                                                 |                           |        
|                                                       | Proceeds from sale of
short-term bank deposits                                                                     |                           |        
|                                                       | Investment in long-term
bank deposits and structured notes                                                         |                           |        
|                                                       | Proceeds from structured
notes called by the banks                                                                 |                           |        
|                                                       | Payment for acquisition of
Universal Audio Server (UAS) (1)                                                      |                           |        
|                                                       | Payment for acquisition of
Ai-Logix (2)                                                                            |                           |        
|                                                       |                                                                                                                    |                           |        
|                                                       |                                                                                                                    |                           |        
|Net cash provided by (used
in) investing activities    |                                                                                                                    |                           | 13,320 
|                                                       |                                                                                                                    |                           |        
|                                                       |                                                                                                                    |                           |        
|Cash flows from financing
activities:                  |                                                                                                                    |                           |        
|                                                       | Proceeds from issuance of
senior convertible notes                                                                 |                           |        
|                                                       | Issuance costs for senior
convertible notes                                                                        |                           |        
|                                                       | Initial Purchasers discount
in respect of senior convertible notes                                                 |                           |        
|                                                       | Proceeds from issuance of
shares upon exercise of options, warrants and
   employee stock purchase plan            |                           |        
|                                                       | Purchase of treasury stock                                                                                         |                           |        
|                                                       |                                                                                                                    |                           |        
|                                                       |                                                                                                                    |                           |        
|Net cash provided by (used
in) financing activities    |                                                                                                                    |                           | (3,947 
|                                                       |                                                                                                                    |                           |        
|                                                       |                                                                                                                    |                           |        
|Increase (decrease) in cash
and cash equivalents       |                                                                                                                    |                           | (2,287 
|Cash and cash equivalents
at the beginning of the year |                                                                                                                    |                           | 50,086 
|                                                       |                                                                                                                    |                           |        
|                                                       |                                                                                                                    |                           |        
|Cash and cash equivalents
at the end of the year       |                                                                                                                    | $                         | 47,799 
|                                                       |                                                                                                                    |                           |        
|                                                       |                                                                                                                    |                           |        
|Supplemental disclosure of
cash flow activities:       |                                                                                                                    |                           |        
|                                                       | Cash paid during the year
for income taxes                                                                         |                           | $      
|                                                       |                                                                                                                    |                           |        

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

- F-6 -

---

---

|AUDIOCODES LTD. AND ITS SUBSIDIARIES 
|-------------------------------------
|                                     
|CONSOLIDATED STATEMENTS OF CASH FLOWS
|                                     
|U.S. dollars in thousands            

|    |                                       |                                                                                                                                | Year ended
  December 31, |  
|--- | ------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------ | ------------------------- | -
|    |                                       |                                                                                                                                |                           |  
|    |                                       |                                                                                                                                | 2002                      |  
|    |                                       |                                                                                                                                |                           |  
|(1) | Payment for acquisition of
  UAS      |                                                                                                                                |                           |  
|    |                                       |                                                                                                                                |                           |  
|    |                                       | Net fair value of assets
  acquired of UAS at the date of acquisition (see
         also Note 1b):                             |                           |  
|    |                                       | Property and equipment                                                                                                         |                           | $
|    |                                       | Technology                                                                                                                     |                           |  
|    |                                       | Goodwill                                                                                                                       |                           |  
|    |                                       |                                                                                                                                |                           |  
|    |                                       |                                                                                                                                |                           |  
|    |                                       |                                                                                                                                |                           | -
|    |                                       | Paid (unpaid) accrued
  liability                                                                                              |                           |  
|    |                                       |                                                                                                                                |                           |  
|    |                                       |                                                                                                                                |                           |  
|    |                                       |                                                                                                                                | $                         | -
|    |                                       |                                                                                                                                |                           |  
|    |                                       |                                                                                                                                |                           |  
|(2) | Payment for acquisition of
  Ai-Logix |                                                                                                                                |                           |  
|    |                                       |                                                                                                                                |                           |  
|    |                                       | Net fair value of assets
  acquired and liabilities assumed of Ai-Logix at
        the date of acquisition (see also Note 1c): |                           |  
|    |                                       | Working capital, net
  (excluding cash and cash equivalents)                                                                   |                           | $
|    |                                       | Property and equipment                                                                                                         |                           |  
|    |                                       | Technology                                                                                                                     |                           |  
|    |                                       | Goodwill                                                                                                                       |                           |  
|    |                                       |                                                                                                                                |                           |  
|    |                                       |                                                                                                                                |                           |  
|    |                                       |                                                                                                                                | $                         | -
|    |                                       |                                                                                                                                |                           |  

The accompanying notes are an integral part of the consolidated
financial statements.

- F-7 -

---

---

|AUDIOCODES LTD. AND ITS SUBSIDIARIES      
|------------------------------------------
|                                          
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          
|U.S. dollars in thousands                 
|                                          
|NOTE 1:-                                  
|                                          
|                                          
|                                          
|                                          
|                                          
|                                          
|                                          
|                                          
|                                          
|                                          
|                                          
|                                          
|                                          
|                                          
|                                          
|                                          

- F-8 -

---

---

|AUDIOCODES LTD. AND ITS SUBSIDIARIES      
|------------------------------------------
|                                          
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          
|U.S. dollars in thousands                 
|                                          
|NOTE 1:-                                  
|                                          
|                                          

| |                                       |  | April 7,
  2003 |  
| | ------------------------------------- |  | --------------- | -
| |                                       |  |                 |  
| |                                       |  |                 |  
| | Property and
  equipment              |  |                 | $
| | Technology (five
  years useful life) |  |                 |  
| | Goodwill *)                           |  |                 |  
| |                                       |  |                 |  
| |                                       |  |                 |  
| | Total assets
  acquired               |  |                 | $
| |                                       |  |                 |  

| |    | *)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          | Including
  $1,000 of the total acquisition cost which was allocated to goodwill in March
  2004.
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | -------------------------------------------------------------------------------------------------
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |    | Goodwill
  includes but is not limited to the synergistic value and potential
  competitive benefits that could be realized by the Company from the
  acquisition. Goodwill is not deductible for tax purposes. In accordance with
  SFAS No. 142, Goodwill and Other Intangible Assets, goodwill arising from
  this acquisition will not be amortized (see also Note 2k).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |    | The value
  assigned to tangible assets and intangible assets has been determined as
  follows:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |    | Property and
  equipment are presented at current replacement cost.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |    | The value
  assigned to technology amounted to $1,173. The fair value of technology was
  determined using the Income Approach.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |    | In
  accordance with the agreement, contingent payments in the maximum aggregate
  amount of $12,500 was to be paid to Nortel based on net orders for UAS
  products placed by Nortel over the 18 month period following the closing
  date. These contingent payments were not considered part of the acquisition
  cost and as accrued were offset against related revenues earned by the Group
  from orders by Nortel for each respective period. The Group periodically
  assessed the expected earn out payments, based on net sales from orders
  placed by Nortel. In 2003, the Group accrued earn out payments in the amount
  of $1,600, which were included in other payables and accrued expenses in the
  net amount. In 2004, the Group paid Nortel $4,917 in cash in respect of
  actual sales for the relevant 18 month period. As of December 31, 2004, no
  further obligation for contingent payments to Nortel remains.
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| | c. | Acquisition
  of Ai-Logix Inc. (Ai-Logix):                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |    | On May 12,
  2004, the Group acquired all of the outstanding Ordinary shares of Ai-Logix,
  a provider of advanced voice and data recording hardware integration cards
  for the call recording and voice or data logging industry. The Group has
  undertaken to apply Ai-Logixs technology, strategic partnerships and
  customer base to expand its business into the call recording and computer
  telephony integration markets.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     

- F-9 -

---

---

|AUDIOCODES LTD. AND ITS SUBSIDIARIES      
|------------------------------------------
|                                          
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          
|U.S. dollars in thousands                 
|                                          
|NOTE 1:-                                  
|                                          
|                                          
|                                          
|                                          
|                                          
|                                          
|                                          
|                                          

| |                                                 |  | May 12,
  2004 |  
| | ----------------------------------------------- |  | -------------- | -
| |                                                 |  |                |  
| |                                                 |  |                |  
| | Trade
  receivables                             |  |                | $
| | Inventories                                     |  |                |  
| | Prepaid
  expenses                              |  |                |  
| | Property and
  equipment                        |  |                |  
| |                                                 |  |                |  
| |                                                 |  |                |  
| | Total
  tangible assets acquired                |  |                |  
| |                                                 |  |                |  
| |                                                 |  |                |  
| | Technology
  (five years useful life)           |  |                |  
| | Goodwill                                        |  |                |  
| |                                                 |  |                |  
| |                                                 |  |                |  
| | Total
  intangible assets acquired              |  |                |  
| |                                                 |  |                |  
| |                                                 |  |                |  
| | Total
  tangible and intangible assets acquired |  |                |  
| |                                                 |  |                |  
| |                                                 |  |                |  
| | Trade
  payables                                |  |                |  
| | Accrued
  expenses                              |  |                |  
| | Other
  current liabilities                     |  |                |  
| |                                                 |  |                |  
| |                                                 |  |                |  
| | Total
  liabilities assumed                     |  |                |  
| |                                                 |  |                |  
| |                                                 |  |                |  
| | Net assets
  acquired                           |  |                | $
| |                                                 |  |                |  

| |  | Goodwill
  includes but is not limited to the synergistic value and potential
  competitive benefits that could be realized by the Company from the
  acquisition. Goodwill is not deductible for tax purposes. In accordance with
  SFAS No. 142, goodwill arising from this acquisition will not be amortized
  (see also Note 2k).
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

- F-10 -

---

---

|AUDIOCODES LTD. AND ITS SUBSIDIARIES      
|------------------------------------------
|                                          
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          
|U.S. dollars in thousands                 
|                                          
|NOTE 1:-                                  
|                                          
|                                          
|                                          
|                                          
|                                          
|                                          
|                                          
|                                          

| |                                         |  | Year ended
  December 31, |  
| | --------------------------------------- |  | ------------------------- | -
| |                                         |  |                           |  
| |                                         |  | 2003                      |  
| |                                         |  |                           |  
| |                                         |  | Unaudited                 |  
| |                                         |  |                           |  
| |                                         |  |                           |  
| | Revenues                                |  |                           | $
| |                                         |  |                           |  
| |                                         |  |                           |  
| | Net income
  (loss)                     |  |                           | $
| |                                         |  |                           |  
| |                                         |  |                           |  
| | Basic net
  earnings (loss) per share   |  |                           | $
| |                                         |  |                           |  
| |                                         |  |                           |  
| | Diluted net
  earnings (loss) per share |  |                           | $
| |                                         |  |                           |  

| | d. | The Group is
  dependent upon sole source suppliers for certain key components used in its
  products, including certain digital signal processing chips. Although there
  is a limited number of manufacturers of these particular components,
  management believes that other suppliers could provide similar components at
  comparable terms. A change in suppliers, however, could cause a delay in
  manufacturing and a possible loss of sales, which could adversely affect the
  operating results of the Group and its financial position.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| | e. | As to a
  major customer data, see Note 15b.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         

- F-11 -

---

---

|AUDIOCODES LTD. AND ITS SUBSIDIARIES      
|------------------------------------------
|                                          
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          
|U.S. dollars in thousands                 
|                                          
|NOTE 2:-                                  
|                                          
|                                          
|                                          
|                                          
|                                          
|                                          
|                                          
|                                          
|                                          
|                                          
|                                          
|                                          
|                                          
|                                          
|                                          
|                                          
|                                          
|                                          
|                                          
|                                          
|                                          
|                                          
|                                          
|                                          
|                                          
|                                          
|                                          
|                                          
|                                          

- F-12 -

---

---

|AUDIOCODES LTD. AND ITS SUBSIDIARIES      
|------------------------------------------
|                                          
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          
|U.S. dollars in thousands                 
|                                          
|NOTE 2:-                                  
|                                          
|                                          
|                                          
|                                          
|                                          
|                                          
|                                          
|                                          
|                                          
|                                          
|                                          
|                                          
|                                          
|                                          
|                                          
|                                          

- F-13 -

---

---

|AUDIOCODES LTD. AND ITS SUBSIDIARIES      
|------------------------------------------
|                                          
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          
|U.S. dollars in thousands                 
|                                          
|NOTE 2:-                                  
|                                          
|                                          
|                                          
|                                          
|                                          
|                                          
|                                          
|                                          
|                                          
|                                          
|                                          
|                                          
|                                          
|                                          
|                                          
|                                          
|                                          
|                                          
|                                          
|                                          
|                                          
|                                          
|                                          
|                                          
|                                          

- F-14 -

---

---

|AUDIOCODES LTD. AND ITS SUBSIDIARIES            
|------------------------------------------------
|                                                
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS      
|                                                
|U.S. dollars in thousands, except per share data
|                                                
|NOTE 2:-                                        
|                                                
|                                                
|                                                
|                                                
|                                                
|                                                
|                                                
|                                                
|                                                
|                                                
|                                                
|                                                
|                                                
|                                                
|                                                
|                                                
|                                                
|                                                

- F-15 -

---

---

|AUDIOCODES LTD. AND ITS SUBSIDIARIES       
|-------------------------------------------
|                                           
|NOTES
 TO CONSOLIDATED FINANCIAL STATEMENTS
|                                           
|U.S.
 dollars in thousands                 

|NOTE 2:- | SIGNIFICANT ACCOUNTING POLICIES (Cont.)
|-------- | ---------------------------------------
|         |                                        
|         | m.                                     
|         |                                        
|         |                                        
|         |                                        
|         | n.                                     
|         |                                        
|         |                                        
|         |                                        
|         |                                        
|         |                                        
|         | o.                                     
|         |                                        
|         |                                        
|         |                                        
|         | p.                                     
|         |                                        
|         |                                        
|         |                                        
|         |                                        

- F-16 -

---

---

|AUDIOCODES LTD. AND ITS SUBSIDIARIES       
|-------------------------------------------
|                                           
|NOTES
 TO CONSOLIDATED FINANCIAL STATEMENTS
|                                           
|U.S.
 dollars in thousands                 

|NOTE 2:- | SIGNIFICANT ACCOUNTING POLICIES (Cont.)
|-------- | ---------------------------------------
|         |                                        
|         |                                        
|         |                                        
|         | q.                                     
|         |                                        
|         |                                        
|         |                                        
|         | r.                                     
|         |                                        
|         |                                        
|         |                                        
|         |                                        
|         |                                        
|         |                                        
|         |                                        
|         | s.                                     
|         |                                        
|         |                                        

- F-17 -

---

---

|AUDIOCODES LTD. AND ITS SUBSIDIARIES             
|-------------------------------------------------
|                                                 
|NOTES
 TO CONSOLIDATED FINANCIAL STATEMENTS      
|                                                 
|U.S.
 dollars in thousands, except per share data

|NOTE 2:- | SIGNIFICANT ACCOUNTING POLICIES (Cont.)
|-------- | ---------------------------------------
|         |                                        
|         |                                        
|         |                                        
|         |                                        
|         |                                        
|         |                                        

| |                     |  | 2002     |   | 2003     |   | 2004     |  
| | ------------------- |  | -------- | - | -------- | - | -------- | -
| |                     |  |          |   |          |   |          |  
| |                     |  |          |   |          |   |          |  
| | Dividend yield      |  | 0        | % | 0        | % | 0        | %
| | Expected volatility |  | 113      | % | 108      | % | 87       | %
| | Risk-free interest  |  | 3        | % | 3        | % | 3        | %
| | Expected life       |  | 5
 years |   | 4
 years |   | 4
 years |  

| | Black-Scholes
 pricing-model was used to estimate the fair value of the ESPP compensation.
 Assumptions are not provided due to immateriality.
| | ----------------------------------------------------------------------------------------------------------------------------------------------
| |                                                                                                                                               
| | Pro forma
 information under SFAS No. 123 is as follows:                                                                                      

| |                                                                                                                                                 |  | Year ended
 December 31, |        
| | ----------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------ | -------
| |                                                                                                                                                 |  |                          |        
| |                                                                                                                                                 |  | 2002                     |        
| |                                                                                                                                                 |  |                          |        
| |                                                                                                                                                 |  |                          |        
| | Net income (loss) as reported                                                                                                                   |  | $                        | (14,157
| | Add: stock-based compensation expenses
    determined under the intrinsic value based
    method included in the reported net income
    (loss) |  |                          | 161    
| | Deduct: stock-based compensation expenses
    determined under the fair value based
    method for all awards                                   |  |                          | (15,398
| |                                                                                                                                                 |  |                          |        
| |                                                                                                                                                 |  |                          |        
| | Pro forma net loss                                                                                                                              |  | $                        | (29,394
| |                                                                                                                                                 |  |                          |        
| |                                                                                                                                                 |  |                          |        
| | Basic net earnings (loss) per share as reported                                                                                                 |  | $                        | (0.37  
| |                                                                                                                                                 |  |                          |        
| | Diluted net earnings (loss) per share as
    reported                                                                                           |  | $                        | (0.37  
| |                                                                                                                                                 |  |                          |        
| |                                                                                                                                                 |  |                          |        
| | Pro forma basic net loss per share                                                                                                              |  | $                        | (0.76  
| |                                                                                                                                                 |  |                          |        
| |                                                                                                                                                 |  |                          |        
| | Pro forma  diluted net loss
 per share                                                                                                          |  | $                        | (0.76  
| |                                                                                                                                                 |  |                          |        

- F-18 -

---

---

|AUDIOCODES LTD. AND ITS SUBSIDIARIES       
|-------------------------------------------
|                                           
|NOTES
 TO CONSOLIDATED FINANCIAL STATEMENTS
|                                           
|U.S.
 dollars in thousands                 

|NOTE 2:- | SIGNIFICANT ACCOUNTING POLICIES (Cont.)
|-------- | ---------------------------------------
|         |                                        
|         |                                        
|         |                                        
|         | t.                                     
|         |                                        
|         |                                        
|         |                                        
|         |                                        
|         |                                        
|         |                                        
|         |                                        
|         | u.                                     
|         |                                        
|         |                                        
|         |                                        
|         | v.                                     
|         |                                        
|         |                                        
|         |                                        
|         |                                        
|         |                                        
|         |                                        
|         |                                        
|         |                                        
|         |                                        
|         |                                        

- F-19 -

---

---

|AUDIOCODES LTD. AND ITS SUBSIDIARIES       
|-------------------------------------------
|                                           
|NOTES
 TO CONSOLIDATED FINANCIAL STATEMENTS
|                                           
|U.S.
 dollars in thousands                 

|NOTE 2:- | SIGNIFICANT ACCOUNTING POLICIES (Cont.)
|-------- | ---------------------------------------
|         |                                        
|         | w.                                     
|         |                                        
|         |                                        
|         |                                        
|         |                                        
|         |                                        
|         |                                        
|         |                                        
|         |                                        
|         |                                        
|         |                                        
|         |                                        
|         | x.                                     
|         |                                        
|         |                                        

- F-20 -

---

---

|AUDIOCODES LTD. AND ITS SUBSIDIARIES       
|-------------------------------------------
|                                           
|NOTES
 TO CONSOLIDATED FINANCIAL STATEMENTS
|                                           
|U.S.
 dollars in thousands                 

|NOTE 2:- | SIGNIFICANT ACCOUNTING POLICIES (Cont.)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|-------- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|         | In November 2004, the FASB issued SFAS No.
 151, Inventory Costs, an amendment of ARB No. 43, Chapter 4. SFAS No. 151
 amends Accounting Research Bulletin (ARB) No. 43, Restatement and Revision
 of Accounting Research Bulletins, Chapter 4, to clarify that abnormal amounts of idle facility
 expense, freight handling costs and wasted materials (spoilage) should be
 recognized as current-period charges. In addition, SFAS No. 151 requires that
 the allocation of fixed production overheads to the costs of conversion be
 based on the normal capacity of the production facilities. SFAS No. 151 is
 effective for inventory costs incurred during fiscal years beginning after
 June 15, 2005. The Group does not expect that the adoption of SFAS No. 151
 will have a material effect on its financial position or results of
 operations.
|         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|NOTE 3:- | INVENTORIES                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        

| |                   |  | December
 31, |      
| | ----------------- |  | ------------- | -----
| |                   |  |               |      
| |                   |  | 2003          |      
| |                   |  |               |      
| |                   |  |               |      
| | Raw materials     |  | $             | 2,515
| | Finished products |  |               | 2,152
| |                   |  |               |      
| |                   |  |               |      
| |                   |  | $             | 4,667
| |                   |  |               |      

|         | In the years
 ended December 31, 2002, 2003 and 2004, the Group wrote-off and wrote-down
 inventory in a total amount of $1,684, $835 and $1,237, respectively. These
 amounts are included in cost of revenues.
|-------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|         |                                                                                                                                                                                                                 
|NOTE 4:- | LONG-TERM BANK DEPOSITS AND STRUCTURED NOTES                                                                                                                                                                    
|         |                                                                                                                                                                                                                 
|         | Long-term
 bank deposits and structured notes are composed as follows:                                                                                                                                          

| |                                                |  | December 31,              |    
| | ---------------------------------------------- |  | ------------------------- | ---
| |                                                |  |                           |    
| |                                                |  | 2003                      |    
| |                                                |  |                           |    
| |                                                |  | Weighted average interest |    
| |                                                |  |                           |    
| | Long-term
 bank deposits (in U.S.
    dollars) |  |                           | 2.7
| | Structured
 notes (1)                          |  |                           | 4.4
| |                                                |  |                           |    
| |                                                |  |                           |    
| |                                                |  |                           |    
| |                                                |  |                           |    

| | (1) | During 2003,
 the Group purchased callable structured notes at par value totaling $25,000
 for settlement during 2006 from several banks. During 2004, part of the
 structured notes purchased in 2003 at par amount of $18,000, were called by
 the banks, and the Group purchased different structured notes at par value
 totaling $18,000 for settlement during 2007. Under the arrangements with the
 banks, whether or not the structured notes bear interest depends upon the
 rate of the three months to one year LIBOR.
| | --- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| |     | For each day
 in which the relevant LIBOR rate is below an agreed annual fixed rate, which
 ranges from 2% to 5% the structured notes bear interest at the rate of 3.08%
 to 4.5% per annum. On all other days, the structured notes do not bear any
 interest. As of December 31, 2004, investments in structured notes securities
 approximate their market value.                                                                                                                                                             

- F-21 -

---

---

|AUDIOCODES LTD. AND ITS SUBSIDIARIES       
|-------------------------------------------
|                                           
|NOTES
 TO CONSOLIDATED FINANCIAL STATEMENTS
|                                           
|U.S.
 dollars in thousands                 

|NOTE 5:- | INVESTMENT IN AN AFFILIATED COMPANY                                                                                                                                                                                                                                                                                                                                                                   
|-------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|         |                                                                                                                                                                                                                                                                                                                                                                                                       
|         | In December
 2000, the Company signed an agreement to invest in an unrelated
 privately-held company (affiliated company).                                                                                                                                                                                                                                                                          
|         |                                                                                                                                                                                                                                                                                                                                                                                                       
|         | The
 Preferred shares owned in the affiliated company have a preference in liquidation
 and are convertible at the holders option or upon an Initial Public Offering
 into Ordinary shares and on weighted average ratchet basis. During 2004, the
 Company invested an additional amount of $512 in consideration for Series F
 Preferred shares, as part of an aggregate capital raising of $1,200.

| |                                |  | December
 31, |       
| | ------------------------------ |  | ------------- | ------
| |                                |  |               |       
| |                                |  | 2003          |       
| |                                |  |               |       
| | Net equity:                    |  |               |       
| | Net equity as of purchase date |  | $             | 93    
| | Unamortized goodwill           |  |               | 1,877 
| | Accumulated net losses         |  |               | (1,479
| |                                |  |               |       
| |                                |  |               |       
| | Total investment               |  | $             | 491   
| |                                |  |               |       

|         | As of
 December 31, 2004, the Company holds 40% of the affiliated companys share
 capital.
|-------- | -------------------------------------------------------------------------------------------
|         |                                                                                            
|NOTE 6:- | PROPERTY AND EQUIPMENT, NET                                                                

| |                           |                                    | December
 31, |       
| | ------------------------- | ---------------------------------- | ------------- | ------
| |                           |                                    |               |       
| |                           |                                    | 2003          |       
| |                           |                                    |               |       
| | Cost:                     |                                    |               |       
| |                           | Computers and peripheral equipment |               | $     
| |                           | Office furniture and equipment     |               |       
| |                           | Motor vehicles                     |               |       
| |                           | Leasehold improvements             |               |       
| |                           |                                    |               |       
| |                           |                                    |               |       
| |                           |                                    |               | 12,887
| |                           |                                    |               |       
| | Accumulated depreciation: |                                    |               |       
| |                           | Computers and peripheral equipment |               |       
| |                           | Office furniture and equipment     |               |       
| |                           | Motor vehicles                     |               |       
| |                           | Leasehold improvements             |               |       
| |                           |                                    |               |       
| |                           |                                    |               |       
| |                           |                                    |               | 8,323 
| |                           |                                    |               |       
| |                           |                                    |               |       
| | Depreciated cost          |                                    | $             | 4,564 
| |                           |                                    |               |       

| | Depreciation
 expenses amounted to $2,073, $2,880 and $2,352 for the years ended December
 31, 2002, 2003 and 2004, respectively.
| | ---------------------------------------------------------------------------------------------------------------------------------

- F-22 -

---

---

|AUDIOCODES LTD. AND ITS SUBSIDIARIES       
|-------------------------------------------
|                                           
|NOTES
 TO CONSOLIDATED FINANCIAL STATEMENTS
|                                           
|U.S.
 dollars in thousands                 

|NOTE 7:- | INTANGIBLE ASSETS AND DEFERRED CHARGES
|-------- | --------------------------------------

| |    |                           |  | December
 31, |      
| | -- | ------------------------- |  | ------------- | -----
| |    |                           |  |               |      
| |    |                           |  | 2003          |      
| |    |                           |  |               |      
| |    |                           |  |               |      
| | a. | Cost:                     |  |               |      
| |    | Acquired technology       |  | $             | 1,173
| |    | Deferred charges          |  |               | -    
| |    |                           |  |               |      
| |    |                           |  |               |      
| |    |                           |  |               | 1,173
| |    |                           |  |               |      
| |    | Accumulated amortization: |  |               |      
| |    | Acquired technology       |  |               | 160  
| |    | Deferred charges          |  |               | -    
| |    |                           |  |               |      
| |    |                           |  |               |      
| |    |                           |  |               | 160  
| |    |                           |  |               |      
| |    |                           |  |               |      
| |    | Amortized cost            |  | $             | 1,013
| |    |                           |  |               |      

| | b. | Amortization
 expenses related to acquired technology amounted to $0, $160 and $627 for the
 years ended December 31, 2002, 2003 and 2004, respectively.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------
| |    |                                                                                                                                                         
| | c. | Expected amortization expenses related
 to acquired technology for the years ended December 31:                                                         

|2005 |  | $ | 860   | 
|---- |  | - | ----- | 
|2006 |  |   | 860   | 
|2007 |  |   | 860   | 
|2008 |  |   | 700   | 
|2009 |  |   | 206   | 
|     |  |   |       | 
|     |  |   |       | 
|     |  | $ | 3,486 | 
|     |  |   |       | 

|         | d.                                  | Amortization
 expenses related to deferred charges amounted to $3 for the year ended
 December 31, 2004.
|-------- | ----------------------------------- | --------------------------------------------------------------------------------------------------------
|         |                                    
|NOTE 8:- | OTHER PAYABLES AND ACCRUED EXPENSES

| |                                                      |  | December
 31, |       
| | ---------------------------------------------------- |  | ------------- | ------
| |                                                      |  |               |       
| |                                                      |  | 2003          |       
| |                                                      |  |               |       
| |                                                      |  |               |       
| | Employees and payroll accruals                       |  | $             | 4,040 
| | Technology licensing fee provision                   |  |               | 4,332 
| | Government authorities                               |  |               | 594   
| | Accrued expenses                                     |  |               | 2,106 
| | Deferred revenues                                    |  |               | -     
| | Third payment to Nortel with respect to
 acquisition |  |               | 1,500 
| | Accrual payment to Nortel, net                       |  |               | 1,000 
| | Others                                               |  |               | 253   
| |                                                      |  |               |       
| |                                                      |  |               |       
| |                                                      |  | $             | 13,825
| |                                                      |  |               |       

- F-23 -

---

---

|AUDIOCODES LTD. AND ITS SUBSIDIARIES                       
|-----------------------------------------------------------
|                                                           
|NOTES
 TO CONSOLIDATED FINANCIAL STATEMENTS                
|                                                           
|U.S.
 dollars in thousands, except share and per share data

|NOTE 9:-  | SENIOR CONVERTIBLE NOTES                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|--------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|          |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|          | In November
 2004, the Company issued $125,000 (including the exercise of the option as
 described below) aggregate principal amount of 2% Senior Convertible Notes
 due November 9, 2024 (the Notes). The Company is obligated to pay interest
 on the Notes semi-annually on May 9 and November 9 of each year commencing
 May 9, 2005.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|          |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|          | The Notes
 are convertible, at the option of the holders at any time before the maturity
 date, into Ordinary shares of the Company at a conversion rate of 53.4474
 Ordinary shares per one thousand dollars principal amount of Notes,
 representing a conversion price of approximately $18.71 per share. The Notes
 are subject to redemption at any time on or after November 9, 2009, in whole
 or in part, at the option of the Company, at a redemption price of 100% of
 the principal amount plus accrued and unpaid interest. The Notes are subject
 to repurchase, at the holders option, on November 9, 2009, November 9,
 2014 or November 9, 2019, at a repurchase price equal to 100% of the
 principal amount plus accrued and unpaid interest, if any, on such repurchase
 date. The Company can choose to pay the repurchase price in cash, Ordinary
 shares or a combination of cash and Ordinary shares. As of December 31, 2004,
 the Notes are presented as a long-term liability.
|          |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|          | The Notes
 were issued with a conversion price equal to $18.71 per share, which
 reflected the closing share price on the Nasdaq on the date of the offering,
 which was $14.12, plus a premium of 32.5%. 
 In accordance with EITF No. 00-27, no beneficial conversion features
 was recognized nor recorded.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|          |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|          | The
 additional amount that the Company can be required to pay in respect of the
 withholding taxes is accounted for as a contingency until resolved.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|          |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|          | As part of
 the offering, the Company granted the Initial Purchasers an option to
 purchase at any time during 30 days from the date of the offering, up to an
 additional $25,000 principal amount of senior convertible notes. The option,
 in accordance with SFAS No. 133, is not embedded and therefore should be
 measured on a stand-alone basis. On November 16, 2004, the option was
 exercised in full. Due to immateriality, the Company did not record this
 option and its exercise in the financial statements.                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|          |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|NOTE 10:- | COMMITMENTS AND CONTINGENT LIABILITIES                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|          |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|          | a.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|          |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|          |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|          |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|          |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           

| | 2005       |  | $ | 2,705  | 
| | ---------- |  | - | ------ | 
| | 2006       |  |   | 2,591  | 
| | 2007       |  |   | 2,504  | 
| | 2008       |  |   | 2,371  | 
| | 2009       |  |   | 2,387  | 
| | Thereafter |  |   | 8,445  | 
| |            |  |   |        | 
| |            |  |   |        | 
| |            |  | $ | 21,003 | 
| |            |  |   |        | 

- F-24 -

---

---

|AUDIOCODES LTD. AND ITS SUBSIDIARIES       
|-------------------------------------------
|                                           
|NOTES
 TO CONSOLIDATED FINANCIAL STATEMENTS
|                                           
|U.S.
 dollars in thousands                 

|NOTE 10:- | COMMITMENTS AND CONTINGENT LIABILITIES (Cont.)
|--------- | ----------------------------------------------
|          |                                               
|          |                                               
|          |                                               
|          | b.                                            
|          |                                               
|          |                                               
|          |                                               
|          |                                               
|          |                                               
|          |                                               
|          |                                               
|          | c.                                            
|          |                                               
|          |                                               
|          |                                               
|          |                                               

- F-25 -

---

---

|AUDIOCODES LTD. AND ITS SUBSIDIARIES                       
|-----------------------------------------------------------
|                                                           
|NOTES
 TO CONSOLIDATED FINANCIAL STATEMENTS                
|                                                           
|U.S.
 dollars in thousands, except share and per share data

|NOTE 11:- | SHAREHOLDERS EQUITY
|--------- | --------------------
|          |                     
|          | a.                  
|          |                     
|          |                     
|          |                     
|          | b.                  
|          |                     
|          |                     
|          |                     
|          |                     
|          |                     
|          | c.                  
|          |                     
|          |                     
|          |                     
|          |                     
|          |                     
|          | d.                  
|          |                     
|          |                     
|          |                     
|          |                     
|          |                     
|          |                     

- F-26 -

---

---

|AUDIOCODES LTD. AND ITS SUBSIDIARIES                       
|-----------------------------------------------------------
|                                                           
|NOTES
 TO CONSOLIDATED FINANCIAL STATEMENTS                
|                                                           
|U.S.
 dollars in thousands, except share and per share data

|NOTE 11:- | SHAREHOLDERS EQUITY (Cont.)
|--------- | ----------------------------
|          |                             
|          |                             

| |                                                |           | Year ended December 31, |           
| | ---------------------------------------------- | --------- | ----------------------- | ----------
| |                                                |           |                         |           
| |                                                |           | 2002                    |           
| |                                                |           |                         |           
| |                                                |           | Numberof options        |           
| |                                                |           |                         |           
| |                                                |           |                         |           
| | Outstanding at the beginning
    of the year   |           | 7,042,392               |           
| |                                                | Granted   |                         | 1,376,289 
| |                                                | Exercised |                         | (195,000  
| |                                                | Forfeited |                         | (1,021,593
| |                                                |           |                         |           
| |                                                |           |                         |           
| | Outstanding at the end of the
    year         |           | 7,202,088               |           
| |                                                |           |                         |           
| |                                                |           |                         |           
| | Options exercisable at the end
    of the year |           | 3,181,218               |           
| |                                                |           |                         |           

| | The options
 outstanding as of December 31, 2004, have been separated into ranges of
 exercise prices, as follows:
| | ------------------------------------------------------------------------------------------------------------------

| | Range of
 exercise
 price |  | Options
 outstandingas ofDecember 31,2004 |           | Weightedaverageremainingcontractuallife |  | Weighted
 average
 exerciseprice |  | Options
 exercisableas ofDecember 31,2004 |       | Weightedaverageexercise price ofexercisableoptions
| | ------------------------- |  | ----------------------------------------- | --------- | --------------------------------------- |  | -------------------------------- |  | ----------------------------------------- | ----- | --------------------------------------------------
| |                           |  |                                           |           |                                         |  |                                  |  |                                           |       |                                                   
| | $                         |  |                                           |           | (years)                                 |  | $                                |  |                                           |       | $                                                 
| |                           |  |                                           |           |                                         |  |                                  |  |                                           |       |                                                   
| |                           |  |                                           |           |                                         |  |                                  |  |                                           |       |                                                   
| | 0-0.61                    |  |                                           | 161,400   |                                         |  | 3.01                             |  |                                           | 0.61  |                                                   
| | 1.1                       |  |                                           | 199,600   |                                         |  | 3.06                             |  |                                           | 1.10  |                                                   
| | 1.73-2.51                 |  |                                           | 974,823   |                                         |  | 4.60                             |  |                                           | 2.26  |                                                   
| | 2.67-4                    |  |                                           | 646,322   |                                         |  | 4.40                             |  |                                           | 3.16  |                                                   
| | 4.1-6.04                  |  |                                           | 1,355,722 |                                         |  | 4.43                             |  |                                           | 4.46  |                                                   
| | 6.51-9.24                 |  |                                           | 1,380,283 |                                         |  | 3.60                             |  |                                           | 7.62  |                                                   
| | 9.32-14                   |  |                                           | 2,118,750 |                                         |  | 6.19                             |  |                                           | 11.41 |                                                   
| | 18.82-20.38               |  |                                           | 152,500   |                                         |  | 4.73                             |  |                                           | 17.80 |                                                   
| | 25.5-36.56                |  |                                           | 819,400   |                                         |  | 2.26                             |  |                                           | 29.41 |                                                   
| | 50.50                     |  |                                           | 44,000    |                                         |  | 1.43                             |  |                                           | 50.50 |                                                   
| |                           |  |                                           |           |                                         |  |                                  |  |                                           |       |                                                   
| |                           |  |                                           |           |                                         |  |                                  |  |                                           |       |                                                   
| |                           |  |                                           | 7,852,800 |                                         |  |                                  |  |                                           | 9.46  |                                                   
| |                           |  |                                           |           |                                         |  |                                  |  |                                           |       |                                                   

| | The Company
 has recorded deferred stock compensation for options issued with an exercise
 price below the fair market value of the Ordinary shares on the date of
 grant. The deferred stock compensation has been amortized and recorded as
 compensation expense ratably over the vesting period of the options.
 Compensation expenses of approximately $161, $50 and $66 were recognized
 during the years ended December 31, 2002, 2003 and 2004, respectively.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

- F-27 -

---

---

|AUDIOCODES LTD. AND ITS SUBSIDIARIES                       
|-----------------------------------------------------------
|                                                           
|NOTES
 TO CONSOLIDATED FINANCIAL STATEMENTS                
|                                                           
|U.S.
 dollars in thousands, except share and per share data

|NOTE 11:- | SHAREHOLDERS EQUITY (Cont.)
|--------- | ----------------------------
|          |                             
|          |                             
|          |                             
|          | e.                          
|          |                             
|          |                             
|          |                             
|NOTE 12:- | TAXES ON INCOME             
|          |                             
|          | a.                          
|          |                             
|          |                             
|          |                             
|          | b.                          
|          |                             
|          |                             
|          |                             
|          |                             
|          |                             
|          |                             
|          |                             
|          |                             

- F-28 -

---

---

|AUDIOCODES LTD. AND ITS SUBSIDIARIES       
|-------------------------------------------
|                                           
|NOTES
 TO CONSOLIDATED FINANCIAL STATEMENTS
|                                           
|U.S.
 dollars in thousands                 

|NOTE 12:- | TAXES ON INCOME (Cont.)
|--------- | -----------------------
|          |                        
|          |                        
|          |                        
|          |                        
|          |                        
|          |                        
|          |                        
|          |                        
|          |                        
|          |                        
|          |                        
|          |                        
|          |                        
|          |                        
|          |                        
|          |                        
|          |                        
|          | c.                     
|          |                        
|          |                        
|          |                        
|          |                        

- F-29 -

---

---

|AUDIOCODES LTD. AND ITS SUBSIDIARIES       
|-------------------------------------------
|                                           
|NOTES
 TO CONSOLIDATED FINANCIAL STATEMENTS
|                                           
|U.S.
 dollars in thousands                 

|NOTE 12:- | TAXES ON INCOME (Cont.)
|--------- | -----------------------
|          |                        
|          |                        
|          |                        
|          |                        
|          |                        
|          | d.                     
|          |                        
|          |                        
|          |                        
|          | e.                     

| |          |  | Year ended
 December 31, |        
| | -------- |  | ------------------------ | -------
| |          |  |                          |        
| |          |  | 2002                     |        
| |          |  |                          |        
| |          |  |                          |        
| | Domestic |  | $                        | (8,746 
| | Foreign  |  |                          | (5,411 
| |          |  |                          |        
| |          |  |                          |        
| |          |  | $                        | (14,157
| |          |  |                          |        

| | f. | Income taxes
 are comprised as follows:
| | -- | ---------------------------------------

| | Current taxes |  | $ | - |  | $ | - |  | $ | 273 | 
| | ------------- |  | - | - |  | - | - |  | - | --- | 
| |               |  |   |   |  |   |   |  |   |     | 
| |               |  |   |   |  |   |   |  |   |     | 
| | Foreign       |  | $ | - |  | $ | - |  | $ | 273 | 
| |               |  |   |   |  |   |   |  |   |     | 

| | g. | Deferred
 income taxes:                                                                                                                                                                                                                                                                                       
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |    |                                                                                                                                                                                                                                                                                                               
| |    | Deferred
 income taxes reflect the net tax effects of temporary differences between the
 carrying amounts of assets and liabilities for financial reporting purposes
 and the amounts used for income tax purposes. Significant components of the
 Groups deferred tax liabilities and assets are as follows:

| |                                                     |                                  | December 31, |        
| | --------------------------------------------------- | -------------------------------- | ------------ | -------
| |                                                     |                                  |              |        
| |                                                     |                                  | 2003         |        
| |                                                     |                                  |              |        
| | Deferred tax assets:                                |                                  |              |        
| |                                                     | Reserves and allowances          |              | $      
| |                                                     | Net operating loss carryforwards |              |        
| |                                                     |                                  |              |        
| |                                                     |                                  |              |        
| | Net deferred tax assets before valuation
 allowance |                                  |              | 40,043 
| | Valuation allowance                                 |                                  |              | (40,043
| |                                                     |                                  |              |        
| |                                                     |                                  |              |        
| | Net deferred tax assets                             |                                  | $            | -      
| |                                                     |                                  |              |        

- F-30 -

---

---

|AUDIOCODES LTD. AND ITS SUBSIDIARIES       
|-------------------------------------------
|                                           
|NOTES
 TO CONSOLIDATED FINANCIAL STATEMENTS
|                                           
|U.S.
 dollars in thousands                 

|NOTE 12:- | TAXES ON INCOME (Cont.)
|--------- | -----------------------
|          |                        
|          |                        
|          |                        
|          |                        
|          |                        
|          |                        
|          |                        
|          | h.                     
|          |                        
|          |                        
|          |                        
|          | i.                     
|          |                        
|          |                        
|          |                        
|          |                        
|          |                        
|          |                        

- F-31 -

---

---

|AUDIOCODES LTD. AND ITS SUBSIDIARIES       
|-------------------------------------------
|                                           
|NOTES
 TO CONSOLIDATED FINANCIAL STATEMENTS
|                                           
|U.S.
 dollars in thousands                 

|NOTE 13:- | BASIC AND DILUTED
 NET EARNINGS (LOSS) PER SHARE
|--------- | ------------------------------------------------

| |                                                                                                                               |                                 | Year ended
 December 31, |           
| | ----------------------------------------------------------------------------------------------------------------------------- | ------------------------------- | ------------------------ | ----------
| |                                                                                                                               |                                 |                          |           
| |                                                                                                                               |                                 | 2002                     |           
| |                                                                                                                               |                                 |                          |           
| | Numerator:                                                                                                                    |                                 |                          |           
| |                                                                                                                               |                                 |                          |           
| | Net income
 (loss) available to shareholders of Ordinary
    Shares                                                           |                                 | $                        | (14,157   
| |                                                                                                                               |                                 |                          |           
| | Numerator
 for diluted net earnings (loss) per share -
    income (loss) available to shareholders of
 Ordinary
    shares    |                                 | $                        | (14,157   
| |                                                                                                                               |                                 |                          |           
| | Denominator:                                                                                                                  |                                 |                          |           
| |                                                                                                                               |                                 |                          |           
| | Denominator
 for basic earnings (loss) per share -
    weighted average number of Ordinary shares, net
 of
    treasury stock |                                 |                          | 38,518,000
| | Effect of dilutive securities:                                                                                                |                                 |                          |           
| |                                                                                                                               | Employee stock options and ESPP |                          |           
| | Senior convertible notes                                                                                                      |                                 |                          | -         
| |                                                                                                                               |                                 |                          |           
| | Denominator
 for diluted net earnings (loss) per share - adjusted weighted average number of shares                           |                                 |                          | 38,518,000
| |                                                                                                                               |                                 |                          |           
| |                                                                                                                               |                                 |                          |           

|          | *) | Antidilutive.                   
|--------- | -- | --------------------------------
|          |    |                                 
|NOTE 14:- |    | FINANCIAL INCOME (EXPENSES), NET

| |                     |                                          | Year ended
 December 31, |      
| | ------------------- | ---------------------------------------- | ------------------------ | -----
| |                     |                                          |                          |      
| |                     |                                          | 2002                     |      
| |                     |                                          |                          |      
| |                     |                                          |                          |      
| | Financial expenses: |                                          |                          |      
| |                     | Interest and others                      |                          | $    
| |                     |                                          |                          |      
| |                     |                                          |                          |      
| | Financial income:   |                                          |                          |      
| |                     | Foreign currency translation differences |                          |      
| |                     | Interest and others                      |                          |      
| |                     |                                          |                          |      
| |                     |                                          |                          |      
| |                     |                                          |                          | 2,762
| |                     |                                          |                          |      
| |                     |                                          |                          |      
| |                     |                                          | $                        | 2,623
| |                     |                                          |                          |      

|NOTE 15:- | MAJOR CUSTOMERS AND GEOGRAPHIC INFORMATION
|--------- | ------------------------------------------
|          |                                           
|          | a.                                        
|          |                                           
|          |                                           

- F-32 -

---

---

|AUDIOCODES LTD. AND ITS SUBSIDIARIES       
|-------------------------------------------
|                                           
|NOTES
 TO CONSOLIDATED FINANCIAL STATEMENTS
|                                           
|U.S.
 dollars in thousands                 

|NOTE 15:- | MAJOR CUSTOMERS AND GEOGRAPHIC INFORMATION (Cont.)
|--------- | --------------------------------------------------
|          |                                                   
|          |                                                   

| |          |  | 2002          |        | 2003               |   | 2004            | 
| | -------- |  | ------------- | ------ | ------------------ | - | --------------- | 
| |          |  |               |        |                    |   |                 | 
| |          |  | Totalrevenues |        | Long-lived
 assets |   | Total
 revenues | 
| |          |  |               |        |                    |   |                 | 
| |          |  |               |        |                    |   |                 | 
| | Israel   |  | $             | 3,227  |                    | $ | 4,694           | 
| | Americas |  |               | 10,864 |                    |   | 373             | 
| | Europe   |  |               | 2,919  |                    |   | -               | 
| | Far East |  |               | 10,179 |                    |   | -               | 
| |          |  |               |        |                    |   |                 | 
| |          |  |               |        |                    |   |                 | 
| |          |  | $             | 27,189 |                    | $ | 5,067           | 
| |          |  |               |        |                    |   |                 | 

| | b. | Major
 customers data as a percentage of total revenues:
| | -- | ---------------------------------------------------------

| |            |  | Year ended
 December 31, |  
| | ---------- |  | ------------------------ | -
| |            |  |                          |  
| |            |  | 2002                     |  
| |            |  |                          |  
| |            |  |                          |  
| | Customer A |  |                          | 1

|NOTE 16:- | RELATED PARTIES                                                                                                     
|--------- | --------------------------------------------------------------------------------------------------------------------
|          |                                                                                                                     
|          | The
 following transactions and balances with DSP Group, Inc., are included in the
 financial statements as follows:

| |                             |  | Year ended December 31, |    
| | --------------------------- |  | ----------------------- | ---
| |                             |  |                         |    
| |                             |  | 2002                    |    
| |                             |  |                         |    
| |                             |  |                         |    
| | Revenues
 from royalty fees |  | $                       | 209
| |                             |  |                         |    
| |                             |  |                         |    
| | Purchase of
 raw materials  |  | $                       | 19 
| |                             |  |                         |    
| |                             |  |                         |    

| | In October
 1999, the Company entered into a development agreement with DSP Group Ltd., a
 company affiliated with DSP Group, Inc., and a third party. According to the
 agreement, DSP Group Ltd. will pay royalties for every chip actually sold by
 DSP Group Ltd. to third parties. During 2004, DSP Group, Inc. sold all its
 holdings in the Company.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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- F-33 -

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