---

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, 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, 2007                                                  
|                                                                                                             |                                                                                                
|OR                                                                                                          
|                                                                                                            
|o                                                                                                            | TRANSITION
  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934     
|                                                                                                             |                                                                                                
|OR                                                                                                          
|                                                                                                            
|o                                                                                                            | SHELL
  COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
  OF 1934
|                                                                                                             |                                                                                                
|                                                                                                             | Date of
  event requiring this shell company report ________________________                   
|                                                                                                             |                                                                                                
|                                                                                                             | For the
  transition period from ________________________ to ________________________          
|                                                                                                             |                                                                                                
|                                                                                                             | Commission file number
  0-30070                                                               
|                                                                                                             |                                                                                                
|AUDIOCODES
  LTD.                                                                                           
|                                                                                                            
|(Exact
  name of Registrant as specified in its charter
  and 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 class                                 | Name of each exchange on
  which registered
|Ordinary Shares, nominal
  value NIS 0.01 per share | NASDAQ Global Select Market                
|                                                   

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

|                                                                                            
|--------------------------------------------------------------------------------------------
|None                                                                                        
|                                                                                            
|(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, 2007, the Registrant had outstanding 43,089,552 Ordinary
Shares, nominal value NIS 0.01 per share.          Indicate by check mark if the
registrant is a well-known seasoned issuer, as defined in Rule 405 of the
Securities Act:

Yes  o    No  x

If
this report is an annual or transition report, indicate by check mark if the
registrant is not required to file reports pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934:  Yes  o    No  x

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 whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of accelerated
filer and large accelerated filer in Rule 12b-2 of the Exchange Act. (Check one):

Large
Accelerated filer o                    Accelerated
filer x                    Non-accelerated
filer o

Indicate
by check mark which basis of accounting the registrant has used to prepare the
financial statements included in this filing:

Indicate
by check mark which basis of accounting the registrant has used to prepare the
financial statements included in this filing:

|              |                                                            |        
|------------- | ---------------------------------------------------------- | -------
|U.S.
  GAAP x | International Financial
  Reporting Standards as issued by | Other o
|              | the International
  Accounting Standards Board o           |        

If
Other has been checked in response to the previous question, indicate by
check mark which financial statement item the registrant has elected to follow.

Item 17 o          Item
18 o

If
this is an annual report, indicate by check mark whether the registrant is a
shell company (as defined in Rule 12b-2 of the Exchange Act):  Yes o  No x

---

---



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, 2005, 2006 and 2007 and consolidated balance sheets data as of
December 31, 2006 and 2007 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, 2003 and 2004
and the consolidated balance sheets data as of December 31, 2003, 2004 and 2005
from audited consolidated financial statements that are not included in this
Annual Report.

1

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|                                                                                                   |  |                                       |        |      |   |        |  |         |         |         |   |         |  |   |         |  
|-------------------------------------------------------------------------------------------------- |  | ------------------------------------- | ------ | ---- | - | ------ |  | ------- | ------- | ------- | - | ------- |  | - | ------- | -
|                                                                                                   |  | Year Ended December 31,               |       
|                                                                                                   |  |                                       |       
|                                                                                                   |  |                                       |       
|                                                                                                   |  | 2003                                  |        | 2004 |   | 2005   |  | 2006(*) |         | 2007(*) |  
|                                                                                                   |  |                                       |        |      |   |        |  |         |         |         |   |         |  |   |         |  
|                                                                                                   |  |                                       |        |      |   |        |  |         |         |         |  
|                                                                                                   |  | (In thousands, except per share data) |       
|                                                                                                   |  |                                       |        |      |   |        |  |         |         |         |   |         |  |   |         |  
|Statement of Operations
Data:                                                                      |  |                                       |        |      |   |        |  |         |         |         |   |         |  |   |         |  
|                                                                                                   |  |                                       |        |      |   |        |  |         |         |         |   |         |  |   |         |  
|Revenues                                                                                           |  | $                                     | 44,228 |      | $ | 82,756 |  | $       | 115,827 |         | $ | 147,353 |  | $ | 158,235 |  
|                                                                                                   |  |                                       |        |      |   |        |  |         |         |         |   |         |  |   |         |  
|Cost of revenues                                                                                   |  |                                       | 20,037 |      |   | 34,375 |  |         | 46,993  |         |   | 61,242  |  |   | 69,185  |  
|                                                                                                   |  |                                       |        |      |   |        |  |         |         |         |   |         |  |   |         |  
|                                                                                                   |  |                                       |        |      |   |        |  |         |         |         |   |         |  |   |         |  
|Gross profit                                                                                       |  |                                       | 24,191 |      |   | 48,381 |  |         | 68,834  |         |   | 86,111  |  |   | 89,050  |  
|                                                                                                   |  |                                       |        |      |   |        |  |         |         |         |   |         |  |   |         |  
|Operating expense:                                                                                 |  |                                       |        |      |   |        |  |         |         |         |   |         |  |   |         |  
|                                                                                                   |  |                                       |        |      |   |        |  |         |         |         |   |         |  |   |         |  
|Research and development,
net                                                                      |  |                                       | 15,476 |      |   | 20,009 |  |         | 24,415  |         |   | 35,416  |  |   | 40,706  |  
|                                                                                                   |  |                                       |        |      |   |        |  |         |         |         |   |         |  |   |         |  
|Selling and marketing                                                                              |  |                                       | 14,537 |      |   | 19,891 |  |         | 25,944  |         |   | 37,664  |  |   | 42,900  |  
|                                                                                                   |  |                                       |        |      |   |        |  |         |         |         |   |         |  |   |         |  
|General and
administrative                                                                         |  |                                       | 4,066  |      |   | 4,851  |  |         | 6,004   |         |   | 8,766   |  |   | 9,637   |  
|                                                                                                   |  |                                       |        |      |   |        |  |         |         |         |   |         |  |   |         |  
|                                                                                                   |  |                                       |        |      |   |        |  |         |         |         |   |         |  |   |         |  
|Total operating expenses                                                                           |  |                                       | 34,079 |      |   | 44,751 |  |         | 56,363  |         |   | 81,846  |  |   | 93,243  |  
|                                                                                                   |  |                                       |        |      |   |        |  |         |         |         |   |         |  |   |         |  
|                                                                                                   |  |                                       |        |      |   |        |  |         |         |         |   |         |  |   |         |  
|Operating income (loss)                                                                            |  |                                       | (9,888 | )    |   | 3,630  |  |         | 12,471  |         |   | 4,265   |  |   | (4,193  | )
|                                                                                                   |  |                                       |        |      |   |        |  |         |         |         |   |         |  |   |         |  
|Financial income, net                                                                              |  |                                       | 1,883  |      |   | 2,165  |  |         | 2,457   |         |   | 3,817   |  |   | 2,670   |  
|                                                                                                   |  |                                       |        |      |   |        |  |         |         |         |   |         |  |   |         |  
|                                                                                                   |  |                                       |        |      |   |        |  |         |         |         |   |         |  |   |         |  
|Income (loss) before taxes on income (tax
benefit)                                                 |  |                                       | (8,005 | )    |   | 5,795  |  |         | 14,928  |         |   | 8,082   |  |   | (1,523  | )
|                                                                                                   |  |                                       |        |      |   |        |  |         |         |         |   |         |  |   |         |  
|Taxes on income, net                                                                               |  |                                       |       |      |   | 273    |  |         | 799     |         |   | 289     |  |   | 1,265   |  
|                                                                                                   |  |                                       |        |      |   |        |  |         |         |         |   |         |  |   |         |  
|Equity in losses of affiliated
companies                                                           |  |                                       | 429    |      |   | 516    |  |         | 693     |         |   | 916     |  |   | 1,097   |  
|                                                                                                   |  |                                       |        |      |   |        |  |         |         |         |   |         |  |   |         |  
|                                                                                                   |  |                                       |        |      |   |        |  |         |         |         |   |         |  |   |         |  
|Net income (loss)                                                                                  |  | $                                     | (8,434 | )    | $ | 5,006  |  | $       | 13,436  |         | $ | 6,877   |  | $ | (3,885  | )
|                                                                                                   |  |                                       |        |      |   |        |  |         |         |         |   |         |  |   |         |  
|                                                                                                   |  |                                       |        |      |   |        |  |         |         |         |   |         |  |   |         |  
|Basic net earnings (loss) per share                                                                |  | $                                     | (0.22  | )    | $ | 0.13   |  | $       | 0.33    |         | $ | 0.16    |  | $ | (0.09   | )
|                                                                                                   |  |                                       |        |      |   |        |  |         |         |         |   |         |  |   |         |  
|                                                                                                   |  |                                       |        |      |   |        |  |         |         |         |   |         |  |   |         |  
|Diluted net earnings (loss) per share                                                              |  | $                                     | (0.22  | )    | $ | 0.12   |  | $       | 0.31    |         | $ | 0.16    |  | $ | (0.09   | )
|                                                                                                   |  |                                       |        |      |   |        |  |         |         |         |   |         |  |   |         |  
|                                                                                                   |  |                                       |        |      |   |        |  |         |         |         |   |         |  |   |         |  
|Weighted average number of ordinary shares used
in computing basic
  net earnings (loss) per share |  |                                       | 37,509 |      |   | 38,614 |  |         | 40,296  |         |   | 41,717  |  |   | 42,699  |  
|                                                                                                   |  |                                       |        |      |   |        |  |         |         |         |   |         |  |   |         |  
|                                                                                                   |  |                                       |        |      |   |        |  |         |         |         |   |         |  |   |         |  
|Weighted average number of ordinary shares used
in computing diluted
  net earnings per share      |  |                                       | 37,509 |      |   | 42,607 |  |         | 43,086  |         |   | 43,689  |  |   | 42,699  |  
|                                                                                                   |  |                                       |        |      |   |        |  |         |         |         |   |         |  |   |         |  

|    |                                                                                                                                                                   
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(*) | Including stock-based
  compensation expenses related to options granted to employees and others as a
  result of the adoption of SFAS 123R as of January 1, 2006.

2

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|                                                                                         |  |              |         |      |   |         |  |      |         |      |   |         |  |   |         | 
|---------------------------------------------------------------------------------------- |  | ------------ | ------- | ---- | - | ------- |  | ---- | ------- | ---- | - | ------- |  | - | ------- | 
|                                                                                         |  | December 31, |        
|                                                                                         |  |              |        
|                                                                                         |  |              |        
|                                                                                         |  | 2003         |         | 2004 |   | 2005    |  | 2006 |         | 2007 |  
|                                                                                         |  |              |         |      |   |         |  |      |         |      |   |         |  |   |         | 
|                                                                                         |  |              |         |      |   |         |  |      |         |      |   |         |  |   |         | 
|Balance Sheet
Data:                                                                      |  |              |         |      |   |         |  |      |         |      |   |         |  |   |         | 
|                                                                                         |  |              |         |      |   |         |  |      |         |      |   |         |  |   |         | 
|Cash and cash equivalents                                                                |  | $            | 48,898  |      | $ | 166,832 |  | $    | 70,957  |      | $ | 25,171  |  | $ | 75,063  | 
|                                                                                         |  |              |         |      |   |         |  |      |         |      |   |         |  |   |         | 
|Short-term bank deposits, structured notes,
marketable securities and
  accrued interest |  |              |        |      |   |        |  |      | 71,792  |      |   | 58,080  |  |   | 35,309  | 
|                                                                                         |  |              |         |      |   |         |  |      |         |      |   |         |  |   |         | 
|Working capital                                                                          |  |              | 46,232  |      |   | 171,447 |  |      | 152,047 |      |   | 97,454  |  |   | 124,676 | 
|                                                                                         |  |              |         |      |   |         |  |      |         |      |   |         |  |   |         | 
|Long-term bank deposits, structured notes and
marketable securities                      |  |              | 50,270  |      |   | 50,195  |  |      | 77,572  |      |   | 50,377  |  |   | 32,670  | 
|                                                                                         |  |              |         |      |   |         |  |      |         |      |   |         |  |   |         | 
|Total assets                                                                             |  |              | 128,530 |      |   | 272,145 |  |      | 292,223 |      |   | 337,056 |  |   | 344,487 | 
|                                                                                         |  |              |         |      |   |         |  |      |         |      |   |         |  |   |         | 
|Senior convertible notes                                                                 |  |              |        |      |   | 120,660 |  |      | 120,836 |      |   | 121,015 |  |   | 121,198 | 
|                                                                                         |  |              |         |      |   |         |  |      |         |      |   |         |  |   |         | 
|Total shareholders equity                                                               |  |              | 106,518 |      |   | 121,985 |  |      | 139,106 |      |   | 164,685 |  |   | 174,492 | 
|                                                                                         |  |              |         |      |   |         |  |      |         |      |   |         |  |   |         | 
|Capital stock                                                                            |  |              | 116,639 |      |   | 126,826 |  |      | 130,744 |      |   | 149,336 |  |   | 162,103 | 

|   |                                          
|-- | -----------------------------------------
|B. | CAPITALIZATION AND INDEBTEDNESS          
|   |                                          
|   | Not
  applicable.                        
|   |                                          
|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.

3

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Risks Related to Our
Business and Industry

We reported a loss for 2007. We may
experience additional losses in the future.

After
reporting net income for 2004, 2005 and 2006, we reported a net loss of $3.9
million in 2007. We may continue to report losses in 2008. Our results in 2007
were impacted by weaker than expected performance by our recent acquisitions
and lower than expected sales of our boards business line. The majority of our
expenses are directly and indirectly related to the number of people we employ.
We may increase our expenses based on projections of revenue growth. If at any
given time we do not meet our expectations for growth in revenues our expenses
incurred in anticipation of projected revenues may cause us to incur a loss. We
may not be able to anticipate a loss in advance and adjust our expenses accordingly.
We will need to increase revenues and reduce expenses in order to return to
profitability.

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

We
are dependent on the development of the Voice over Internet Protocol, or VoIP,
market to increase our sales. Most existing networks are still not based on
Voice over Packet technology which we use in our products designed for the VoIP
market. We cannot be sure that the delivery of telephone and other
communications services over packet networks will expand at significant rates,
or that there will be a need to interconnect to other networks utilizing the
type of technology contained in our products. For example, the need for our
Media Gateway products depends on the need to inter connect VoIP networks with
traditional non-packet based networks. Our session border control products
depend on growth in the need to inter connect Voice over Packet networks with
each other. The adaptation process of connecting packet networks and telephone
networks can be time consuming and costly. Sales of our VoIP products will
depend on the development of packet networks and the commercialization of VoIP
services. If this market develops more slowly than we expect, we may not be
able to sell our products in a significant enough volume to be profitable.

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., now known as AudioCodes Inc. In 2005,
we invested in two Israeli-based companies, MailVision Ltd. and CTI Squared
Ltd., and continued investing in Natural Speech Communication Ltd. We have
recognized losses from our equity investment in Natural Speech Communication in our
results of operations in each of the past three years.

In
July 2006, we acquired Nuera Communications, Inc. (now called AudioCodes Inc.),
in August 2006, we acquired Netrake Corporation (now called AudioCodes Inc.),
and in April 2007, we completed our acquisition of CTI Squared Ltd.

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. Nuera is significantly larger than
any other acquisition we have made. As a result, we have experienced a
diversion of our managements time and resources in connection with the
integration and operation of Nueras business.

4

---



Acquired
businesses, technologies or joint ventures may not be successfully integrated
with our products and operations. The markets for the products produced by the
companies we acquire may take longer than we anticipated to develop and to
result in increased sales and profits for us. We may not realize the intended
benefits of any acquisition, investment or joint venture and we may incur
losses from any acquisition, investment or joint venture.

In
addition, 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;          
| |   |                                                                              
| |  | write-offs
  of in-process research and development;                         
| |   |                                                                              
| |  | reduction of
  management attention to other parts of the business;          
| |   |                                                                              
| |  | failure to
  invest in different areas or alternative investments;           
| |   |                                                                              
| |  | failure to
  generate expected financial results or reach business goals; and
| |   |                                                                              
| |  | increased expenditures on human resources and related costs.                 

If
acquisitions disrupt our sales or marketing efforts or operations, our business
may suffer.

We may not be able to raise additional
financing for our 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 to continue our longer term expansion
plans. To the extent that we cannot fund our activities and acquisition program
through our existing cash resources and any cash we generate from operations,
we may need to raise equity or debt funds through additional public or private
financings. In addition, we may be required to repay all or a portion of our
outstanding senior convertible notes in November 2009. 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, increase our financing costs
or, if we are unable to repay our senior convertible notes, cause us severe
financial difficulties.

A downturn in general economic conditions
could adversely affect our revenues, operating results and financial condition.

Periods
of economic slowdown or recession in the United States or other relevant
regions or countries in which we market our products or the public perception
that these periods of economic slowdown or recession may occur, may reduce
corporate and consumer spending and decrease the demand for our products. The
current weakness in the global economy, caused in part by the increase in
energy prices, could reduce corporate and consumer spending. Furthermore,
periods of economic slowdown or recession could adversely affect the financial
stability of our subcontractors, partners, distributors and resellers. If
general economic conditions fail to improve, or if they deteriorate, our
revenues, operating results and financial condition could be adversely
affected.

5

---



If new products we recently introduced or
expect to introduce in the future fail to generate the level of demand we
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 IPmedia products, the session border controller products that we now offer
as a result of our acquisition of Netrake, the software application products
that we now offer as a result of our acquisition of CTI Squared, 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.

Because of the rapid technological
development in the communications equipment market and the intense competition
we face, our products can become outmoded or obsolete in a relatively short
period of time, which requires us to provide frequent updates and/or
replacements to existing products. If we do not successfully manage the
transition process to the next generation of our products, our operating
results may be harmed.

The
communications equipment market is characterized by rapid technological
innovation and intense competition. Accordingly, our success depends in part on
our ability to develop next generation products in a timely and cost-effective
manner. The development of new products is expensive, complex and time
consuming. If we do not rapidly develop our next generation products ahead of
our competitors, we may lose both existing and potential customers to our
competitors. Further, if a competitor develops a new, less expensive product
using a different technological approach to delivering informational services
over existing networks, our products would no longer be competitive.
Conversely, even if we are successful in rapidly developing new products ahead
of our competitors and we do not cost-effectively manage our inventory levels
of existing products when making the transition to the new products, our
financial results could be negatively affected by high levels of obsolete
inventory. If any of the foregoing were to occur, then our operating results
would be harmed.

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 multimedia 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.

6

---



The increase in the number of IP networks may
adversely affect the demand for media gateway products.

Media
gateway products are primarily intended to transcode voice from traditional
telephony networks to IP networks and vise versa. Along with the growth in the
number of IP networks, there has been an increase in the amount of information
that is sent directly from one IP network to another IP network. This direct
network communication potentially obviates the need to use a media gateway or
transcoding. A reduction in the demand for media gateways may adversely affect
the demand for our media gateway products and, in turn, adversely affect our
results of operations.

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.

Our OEM 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 sold also as components or building blocks to large original
equipment manufacturers, or OEMs, or network equipment providers, or NEPs.
These customers incorporate our products into their product offerings, usually
in conjunction with value-added services of their own or of third parties. OEM
or NEP 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 better
profitability and/or greater control over supplies, specifications and
performance. Customers may therefore not buy components or products from an external
manufacturer such as us. This could have an adverse impact on our ability to
sell our products and our revenues.

7

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We have depended, and expect to continue to
depend, 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
24.8% of our revenues in 2005, 24.9% of our revenues in 2006 and 26.1% of our
revenues in 2007. Sales to Nortel Networks, our largest customer, accounted for
17.0% of our revenues in 2007 compared to 15.2% of our revenues in 2006 and
16.3% of our revenues in 2005. We do not enter into sales agreements in which a
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.

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. 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.

8

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Our
principal competitors in the sale of signal processing chips are Texas Instruments,
Broadcom, Infineon, Centillium, Surf and Mindspeed. Several large manufacturers
of generic signal processors, such as Motorola, Agere Systems, which merged
with LSI Corporation in April 2007, and Intel have begun, or are expected to
begin, marketing competing processors. Our principal competitors in the
communications board market are NMS Communications, Intel, Motorola, Cantata
Technology, Aculab 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, OKI and LG. In addition we face competition in low,
mid and high density gateways from internal development at companies such as
Nortel, Alcatel-Lucent, Nokia-Siemens, Huawei, Ericsson, UTstarcom, ZTE and
from Cisco Systems, Inc., Veraz Networks, Sonus Networks, General Bandwidth,
Dialogic/Cantat Technologies and Commatch (Telrad).

Our
principal competitors in the media server market segment are Cantata
Technology, NMS Communications, Convedia/Radisys, IP Unity Glenayre,
Cognitronics and Aculab. In addition, we face competition in software-based and
hardware-based media servers from internal development at companies such as
Hewlett-Packard, Comverse-NetCentrex, Nortel, Alcatel - Lucent, Nokia  Siemens
and Ericsson.

With
respect to session border controllers, we compete against Acme Packets,
Nextone/Nexpoint, Juniper and Sonus Networks. In the security gateway market,
we compete against private companies such as Reefpoint/Nexpoint and Azaire.

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, sales and marketing resources than we do.

Many
of our competitors have the ability to offer complete network solutions and
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 our customers with respect to sales to telephone
companies and other telecommunications infrastructure providers. Additional
competitors may include companies that currently provide computer software
products and services, such as telephone, media, publishing and cable
television. The ability of some of our competitors to bundle other enhanced
services or complete solutions with VoIP products could give these competitors an
advantage over us.

9

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

Our
product offerings range from media gateway building blocks, such as chips and
boards, to media gateways, media servers and session border control 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.

Offering to sell directly to carriers or
service providers may expose us to requirements for service which we may not be
able to meet.

We
also sell our products directly to telecommunications carriers, service
providers or other end-users. We have traditionally relied on third party
distributors and OEMs to test and or sell our products and inform us about the
requirements of end-users. We have limited experience selling our products directly
to end-user customers. Telecommunications carriers and other service providers
have great bargaining power in negotiating contracts. Generally, contracts with
end-users tend to be more complex and impose more obligations on us than
contracts with third party distributors. Contracts with end-users may also
require extensive support teams in the country where the end-user is deploying
its network. We may be unable to meet the requirements of these contracts. If
we are unable to meet the conditions of a contract with an end-user customer,
we may be subject to liquidated damages or liabilities that could result in a
material adverse effect on our results of operations.

Selling
directly to end-users may adversely affect our relationship with our current
third party distributors upon whom we will continue to rely for a significant
portion of our sales. Loss of third party distributors and OEMs, or a decreased
commitment by them to sell our products as a result of direct sales by us,
could adversely affect our sales and results of operations.

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.

10

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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.

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.

11

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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
as a result of slow moving items, technological obsolescence,
excess inventories, discontinued products and products with market prices lower
than cost. Write offs could adversely affect our operating
results and financial condition. We wrote-off inventory in a
total amount of $1.8 million in 2005, $1.9 million in 2006 and $700,000 in
2007.

The right of our customers to return products
and their right to exchange products may affect our ability to recognize
revenues which could adversely affect the results of our operations.

Some
of our customers expect us to permit them to return some or all of the products
they purchased from us. If we contractually agree to allow a customer to return
products, the customer may be entitled to a refund for the returned products or
to receive a credit for the purchase of replacement products. If we agree to
this type of contractual obligations, it could affect our ability to recognize
revenues. In addition, we may not be able to resell any products that are
returned. This could adversely affect our results of operations.

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.

12

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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.

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 if 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.

We
believe that the frequency of third party intellectual claims is increasing, as
patent holders, including entities that are not in our industry and that
purchase patents as an investment or to monetize such rights by obtaining
royalties, use infringement assertions as a competitive tactic and a source of
additional revenue. 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 secure 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.

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In
addition, claims alleging that the development, use, or sale of our products
infringes third parties intellectual property rights may be directed either at
us or at our direct or indirect customers. We may be required to indemnify such
customers against claims made against them. We may be required to indemnify
them even if we believe that the claim of infringement is without merit.

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.

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.

VoIP
and other services are not currently subject to all of the same regulations
that apply to traditional telephony. Nevertheless, it is possible that foreign
or U.S. federal or state legislatures may seek to impose increased fees and
administrative burdens on VoIP, data, and video providers. The FCC has already
required VoIP service providers to meet various emergency service requirements
relating to delivery of 911 calls, known as E911, and to accommodate law
enforcement interception or wiretapping requirements, such as the
Communications Assistance for Law Enforcement Act, or CALEA. In addition, the
FCC may seek to impose other traditional telephony requirements such as
disability access requirements, consumer protection requirements, number
assignment and portability requirements, and other obligations, including
additional obligations regarding E911 and CALEA.

The
cost of complying with FCC regulations could increase the cost of providing
Internet phone service which could result in slower growth and decreased
profitability for this industry, which would adversely affect our business.

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.

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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 of encryption 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.

We are subject to regulations that will
require us to use components based on environmentally friendly materials, and
we may be subject to various regulations relating to management and disposal of
waste with respect to electronic equipment. Compliance with these regulations
may increase our costs and adversely affect our results of operations.

We
are subject to telecommunications industry regulations requiring the use of
environmentally-friendly materials in telecommunications equipment. For
example, pursuant to a European Community directive, telecom equipment
suppliers were required to stop using specified materials that are not
environmentally friendly by July 1, 2006. In addition, telecom equipment
suppliers that take advantage of an exemption with respect to the use of lead
in solders are required by this directive to eliminate the lead in solders from
their products by 2010. Some of our customers may also require products that meet
higher standards than those required by the directive, such as complete removal
of additional harmful substances from our products. We will be dependent on our
suppliers for components and sub-system modules, such as semiconductors and
purchased assemblies and goods, to comply with these requirements. This may
harm our ability to sell our products in regions or to customers that may adopt
such directives.

Compliance
with these directives, especially with respect to the requirement that products
eliminate lead solders, will require us to undertake significant expenses with
respect to the re-design of our products. In addition, we may be required to
pay higher prices for components that comply with this directive. We may not be
able to pass these higher component costs on to our customers. We cannot at
this point estimate the expense that will be required to redesign our products
in order to include environmentally friendly components. We cannot be sure
that we will be able to timely comply with these regulations, that we will be
able to comply on a cost effective basis or that a sufficient supply of
compliant components will be available to us. Compliance with these regulations
could increase our product design costs. New designs may also require qualification
testing with both customers and government certification boards. We cannot be
certain of the reliability of any new designs that utilize non-lead components,
in part, due to the lack of experience with the replacement materials and
assembly technologies. In addition, the incorporation of new components may
adversely affect equipment reliability and durability.

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Some
of our operations use substances regulated under various federal, state, local
and international laws governing the environment, including laws governing the
management and disposal of waste with respect to electronic equipment. We could
incur substantial costs, including fines and civil or criminal sanctions, if we
were to violate or become liable under environmental laws or if our products
become non-compliant with environmental laws. We also face increasing
complexity in our product design and procurement operations as we adjust to new
and future requirements relating to the materials that compose our products.
The EU has enacted the Waste Electrical and Electronic Equipment Directive,
which makes producers of electrical goods financially responsible for specified
collection, recycling, treatment and disposal of past and future covered
products. Producers participating in the market became financially responsible
for implementing their responsibilities under the WEEE Legislation beginning in
August 2005. Implementation in certain EU member states was delayed. Similar
legislation has been or may be enacted in other jurisdictions, including the
United States, Canada, Mexico, China and Japan.

Our
inability or failure to comply with these regulations could have a material
adverse effect on our results of operations. In addition, manufacturers of
components that use lead solders may decide to stop manufacturing those
components prior to the 2010 compliance date. These actions by manufacturers of
components could result in a shortage of components that could adversely affect
our business and results of operations.

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

We
generated 32% of our revenues in 2005, 35% of our revenues in 2006 and 37% of
our revenues in 2007, 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;        
| |   |                                                                  
| |  | compliance
 with foreign laws and regulations;                   
| |   |                                                                  
| |  | different
 technical standards or product requirements;          
| |   |                                                                  
| |  | staffing and
 managing foreign operations;                       
| |   |                                                                  
| |  | foreign
 currency fluctuations;                                  
| |   |                                                                  
| |  | export
 control issues;                                          
| |   |                                                                  
| |  | governmental
 controls;                                          
| |   |                                                                  
| |  | import or
 currency control restrictions;                        
| |   |                                                                  
| |  | local
 taxation;                                                 
| |   |                                                                  
| |  | increased
 risk of collection; and                               
| |   |                                                                  
| |  | burdens that
 may be imposed by tariffs and other trade barriers.

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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.

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. Our sales to European customers denominated in Euros are increasing.
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.

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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 and Chairman of our Board of
Directors. 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. We are experiencing increasing competitive pressure
with respect to retaining and hiring employees in the high technology sector in
Israel. If we fail to hire and retain skilled employees, our business may be
adversely affected.

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, wireline, 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.

18

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Our gross profit percentage could be
negatively impacted by amortization expenses in connection with acquisitions,
increased manufacturing costs and other factors. This could adversely affect
our results of operations.

Our
gross profit percentage increased in 2005, but decreased in 2006 and 2007. The
decrease in our gross profit percentage in 2006 and 2007 was primarily
attributable to amortization expenses related to the acquisitions of Nuera and
Netrake beginning in the third quarter of 2006 and CTI Squared beginning in the
second quarter of 2007, as well as expenses related to equity-based
compensation resulting from the adoption of SFAS 123(R) beginning in 2006. Our
gross profit percentage could also 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.

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. 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. We may be required to supply enhanced 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.

19

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We are subject to ongoing costs and risks
associated with complying with extensive corporate governance and disclosure
requirements.

As
a foreign private issuer subject to U.S. federal securities laws, we spend a
significant amount of management time and resources to comply with laws,
regulations and standards relating to corporate governance and public disclosure,
including the Sarbanes-Oxley Act of 2002, SEC regulations and Nasdaq rules.
Section 404 of the Sarbanes-Oxley Act requires managements annual review and
evaluation of our internal control over financial reporting and attestations of
the effectiveness of these controls by our management and by our independent
registered public accounting firm. There is no guarantee that these efforts
will result in management assurance or an attestation by our independent
registered public accounting firm that our internal control over financial
reporting is adequate in future periods. In connection with our compliance with
Section 404 and the other applicable provisions of the Sarbanes-Oxley Act, our
management and other personnel devote a substantial amount of time, and may
need to hire additional accounting and financial staff, to assure that we
comply with these requirements. The additional management attention and costs
relating to compliance with the Sarbanes-Oxley Act could materially and
adversely affect our growth and financial results.

Terrorist attacks, or the threat of such
attacks, may negatively impact the global economy which may materially
adversely affect our business, financial condition and results of operation and
may cause our share price to decline.

The
financial, political, economic and other uncertainties following terrorist
attacks throughout the world have led to a worsening of the global economy. As
a result, many of our customers and potential customers have become much more
cautious in setting their capital expenditure budgets, thereby restricting
their telecommunications procurement. Uncertainties related to the threat of
terrorism have had a negative effect on global economy, causing businesses to
continue slowing spending on telecommunications products and services and
further lengthen already long sales cycles. Any escalation of these threats or
similar future events may disrupt our operations or those of our customers,
distributors and suppliers, which could adversely affect our business,
financial condition and results of operations.

A continuing decline in interest rates and
worsening of the credit crisis affecting capital markets could reduce our
interest-income, decrease the value of financial assets held by us and
adversely affect our profitability.

Our
investment portfolio consists of held-to-maturity marketable securities. Our
investments are exposed to market risk due to fluctuation in interest rates,
which may affect our interest income.

Additionally,
the performance of the capital markets affects the values of funds that are
held in marketable securities. These assets are subject to market fluctuations
and the credit worthiness of the institutions issuing the securities. This
could result in uncertain returns for these securities, which may fall below
our projected return rates and could affect the fair market value of our
investment portfolio. Due to recent credit crises and other market
developments, including a series of rating agency downgrades, the fair value of
these marketable securities may decline which may adversely affect our
profitability.

20

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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
executive offices and principal research and development facilities are located
in the State of Israel. Political, economic and military conditions in Israel
directly affect our operations. There has been an increase in unrest and
terrorist activity in Israel, which began in September 2000 and which has
continued with varying levels of severity through the current period of time.
This has led to ongoing hostilities between Israel, the Palestinian Authority
and other groups in the West Bank and Gaza Strip. The future effect of this
deterioration and violence on the Israeli economy and our operations is
unclear. Recently, there has been an
escalation in violence among Israel, Hamas, the Palestinian Authority and other
groups. There also was extensive hostilities along Israels northern border
with Lebanon in the summer of 2006, which involved rocket attacks on
populated areas in the northern parts of Israel. Since June 2007, when Hamas effectively took control of the Gaza
Strip, there have been extensive hostilities along Israels border with the
Gaza Strip, which have intensified since February 2008. Ongoing violence
between Israel and the Palestinians, as well as tension between Israel and the
neighboring Syria and Lebanon, may have a material adverse effect on our
business, financial conditions and results of operations.

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.
Additionally, some of our officers and employees in Israel are obligated to
perform annual military reserve duty 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 or an escalation in the political situation 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.

We are
adversely affected by the devaluation of the dollar against the New Israeli
Shekel and could be adversely affected by the rate of inflation in Israel.

Substantially
all of our revenues are generated in U.S. dollars and, in 2007, 33% of our
expenses, primarily salaries, related personnel expenses and the
leases of our buildings in Israel, were incurred in New Israeli Shekels (NIS). We anticipate that a significant portion of our expenses
will continue to be denominated in. NIS.

Our
NIS related costs, as expressed in US dollars, are influenced by the exchange
rate between the dollar and the NIS. During 2006 and 2007, the NIS appreciated against
the U.S. dollar, which resulted in a significant increase in the U.S. dollar
cost of our operations in Israel. If this continues, we could continue to experience
an increase in the cost of our operations, which are based in dollars in our
financial statements, which could adversely affect our results of operations.
In addition, in periods in which the U.S. dollar appreciates against the NIS,
we bear the risk that the rate of inflation in Israel will exceed the rate of
such devaluation of the NIS 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.

21

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As
a result, the devaluation of the U.S. dollar in relation to the NIS has and may
continue to have the effect of increasing the cost in dollars of these
expenses. As a result, our dollar-measured results of operations are and may
continue to be adversely affected. In order to manage the risks imposed by
foreign currency exchange rate fluctuations, from time to time, we enter into
currency forward contracts and put and call options to hedge some of our
foreign currency exposure. We can provide no assurance that our hedging
arrangements will be effective. In addition, if we wish to maintain the
dollar-denominated value of our products in non-U.S. markets, devaluation in
the local currencies of our customers relative to the U.S. dollar may cause our
customers to cancel or decrease orders or default on payment.

Because
exchange rates between the NIS and the dollar fluctuate continuously, exchange
rate fluctuations have an impact on our profitability and period-to-period
comparisons of our results of operations. In 2007, the value of the dollar
decreased in relation to the NIS by 9.0%, and the inflation rate in Israel was
3.4% and, as a result, adversely affected our results of operations in 2007. If
this trend continues, it will continue to adversely affect our result of
operations.

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. Until
recently, the designation required advance approval from the Investment Center
of the Israel Ministry of Industry, Trade and Labor (the Investment Center). To
be eligible for these programs and tax benefits, we must continue to meet
conditions relating principally to adherence to the approved programs and to
periodic reporting obligations. We believe that we are currently in compliance
with these requirements. However, if we fail to meet these conditions, we will
be subject to corporate tax at the rate then in effect under Israeli law for
such tax year.

In
April 2005, an amendment to the law came into effect (the Amendment) which
significantly changed the provisions of the law. The Amendment limited the
scope of enterprises which may be approved by the Investment Center by setting
criteria for the approval of a facility as a Privileged Enterprise, such as
provisions generally requiring that at least 25% of the Privileged Enterprises
income be derived from export. Additionally, the Amendment enacted major changes
in the manner in which tax benefits are awarded under the law so that companies
no longer require Investment Center approval in order to qualify for tax
benefits.

In
addition, the law provides that terms and benefits included in any certificate
of approval granted prior to December 31, 2004 will remain subject to the
provisions of the law as they were on the date of such approval. Therefore, our
existing Approved Enterprises will generally not be subject to the provisions
of the Amendment. As a result of the Amendment, tax-exempt income generated
under the provisions of the law as amended, will subject us to taxes upon
distribution or liquidation and we may be required to record a deferred tax
liability with respect to such tax-exempt income.

22

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In
2007, we recognized a grant of $791,000 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 our ability to manufacture products
and transfer technologies outside of Israel and require us to satisfy specified
conditions. If we fail to satisfy these conditions, we may be required to
refund grants previously received 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. An
amendment to the relevant law may facilitate the transfer of technology or
know-how developed with the funding of the OCS to third parties outside of
Israel, but any future transfer would still require the approval of the OCS,
which may not be granted, and is likely to involve a material payment to the
OCS. 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.

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, assert U.S. securities law
claims in Israel or serve process on substantially all of our officers and
directors.

We
are incorporated in Israel. Substantially all of our executive officers and
directors are nonresidents of the United States, and a majority of our assets
functional currency 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 or to effect service of
process upon these persons in the United States. 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.

23

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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.

Risks Relating to
the Ownership of 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, 2006 and June 10,
2008, our share price has fluctuated from a low of $2.50 to a high of $14.64.
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;                                                                   
| |   |                                                                                                       
| |  | integration
 of acquired businesses, technologies or joint ventures with our products and
 operations;
| |   |                                                                                                       
| |  | 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.                     

24

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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.

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 or below revenue levels and operating results
reached in prior quarters or in the corresponding quarters of the previous
year. 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;                                                                     
| |   |                                                                                                                                
| |  | competitive
 pricing pressures;                                                                                                
| |   |                                                                                                                                
| |  | the timing
 and approval of government research and development grants;                                                        
| |   |                                                                                                                                
| |  | accuracy of
 telecommunication 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.

Our actual financial results might vary from
our publicly disclosed financial forecasts.

From
time to time, we publicly disclose financial forecasts. Our forecasts reflect
numerous assumptions concerning our expected performance, as well as other
factors which are beyond our control and which might not turn out to be
correct. As a result, variations from our forecasts could be material. Our financial
results are subject to numerous risks and uncertainties, including those
identified throughout this Risk Factors section and elsewhere in this Annual
Report. If our actual financial results are worse than our financial forecasts,
the price of our ordinary shares may decline. For example, during the first
quarter of 2007 we lowered our forecast for the quarter which resulted in a
decrease in the price of our ordinary shares.

25

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We announced last year that we will not be
providing quarterly forecasts of the results of our operations. This change
could affect the willingness of analysts to provide research with respect to
our ordinary shares which could affect the trading market for our ordinary
shares.

We
announced last year that we will not be providing quarterly forecasts of the
results of our operations. This could result in the reduction of research
analysts who cover our ordinary shares. Any reduction in research coverage
could affect the willingness of investors, particularly institutional
investors, to invest in our shares which could affect the trading market for
our ordinary shares and the price at which our ordinary shares are traded.

Our ordinary shares are listed for trading in
more than one market and this may result in price variations.

Our ordinary shares are listed for trading on the Nasdaq Global Select
Market, or Nasdaq, and on The Tel-Aviv Stock Exchange, or TASE. Trading in our
ordinary shares on these markets is made in different currencies (U.S. dollars
on Nasdaq and New Israeli Shekels on TASE), and at different times (resulting
from different time zones, different trading days and different public holidays
in the United States and Israel). Actual trading volume on the TASE is
generally lower than trading volume on Nasdaq, and as such could be subject to
higher volatility. The trading prices of our ordinary shares on these two
markets often differ resulting from the factors described above, as well as
differences in exchange rates. Any decrease in the trading price of our ordinary
shares on one of these markets could cause a decrease in the trading price of
our ordinary shares on the other market.

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 face certain income tax
risks in connection with their acquisition, ownership and disposition of our
ordinary shares. In any tax year, we could be deemed a passive foreign
investment company, which could result in adverse U.S. federal income tax
consequences for U.S. shareholders.

Based
on the composition of our gross income and the composition and value of our
gross assets during 2004, 2005, 2006 and 2007, we do not believe that we were a
passive foreign investment company, or PFIC, for U.S. federal income tax
purposes during any of such tax years. It is likely, however, that we would be
deemed to have been a PFIC in 2001, 2002 and 2003. In addition, there can be no
assurance that we will not be deemed a PFIC for any future tax year in which,
for example, the value of our assets, as measured by the public market
valuation of our ordinary shares, declines in relation to the value of our
passive assets (generally, cash, cash equivalents and marketable securities).
If we are a PFIC for any tax year, U.S. shareholders who own our ordinary shares
during such year may be subject to increased U.S. 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.

26

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We
urge U.S. holders of our ordinary shares to carefully review Item 10E. 
Taxation  United States Tax Considerations  United States Federal Income
Taxes in this Annual Report and to consult their own tax advisors with respect
to the U.S. federal income tax risks related to owning and disposing of our
ordinary shares and the consequences of PFIC status.

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

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 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, 2008,
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.

27

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Our indebtedness and debt service obligations
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;
| |   |                                                                                                                                                                                                                                                                             
| |  | 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 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 depends
in part upon our future financial performance and upon our ability to refinance
this debt obligation or to raise additional equity capital. We may be required
to pay all or a portion of our notes in November 2009. Prevailing economic
conditions and financial, business and other factors, many of which are beyond
our control, will affect our ability to make these payments.

28

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If
we are unable to generate sufficient cash flow to meet our debt services
obligations or to repay the principal of our notes, 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
 debt or 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 our notes.

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, 2019, 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.

| |         |                           
| | ------- | --------------------------
| | 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. Our agent in the
United States is AudioCodes Inc., 2099 Gateway Plaza, San Jose, California
95134.

Major Developments
since January 1, 2007

In
January 2008, we merged most of our US subsidiaries into AudioCodes Inc. We did
this to simplify operational and financial procedures and to save costs. As a
result, most of our activities in the United States are conducted through
AudioCodes Inc.

Acquisition of CTI Squared Ltd.

In
April 2007, we acquired the remaining outstanding common stock of CTI
Squared Ltd. Prior to this acquisition, we had an investment in CTI Squared in the amount of $1.6 million.
In consideration for the acquisition, we paid $4.9 million in cash
at the closing of the transaction in April 2007 and committed to pay an additional $5.0 million by April 2008. In February 2008,
we paid the additional amount of $5.0 million. CTI Squared is a provider of enhanced messaging and communications platforms to service providers and
enterprises. CTI Squared Ltd.s platforms integrate data and voice messaging
services over internet, intranet, PSTN, cellular, cable and enterprise
networks.

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Other Recent
Developments

Acquisition of Nuera Communications, Inc.

In
July, 2006, we purchased Nuera Communications, Inc. for $82.5 million in cash,
subject to reduction for certain expenses. Nuera designs, manufactures and
sells packet voice getaways to communication service providers worldwide. These
products can be transmitted over cable, wireless, copper and fiber networks.
Nueras Open Reliable Communications Architecture, product portfolio of VoIP
gateways, softswitches and management systems provide telephony solutions for
cable and DSL networks, international long distance networks and enterprise
networks.

Acquisition of Netrake Corporation

In
August, 2006, we purchased Netrake Corporation for $13.8 million in cash.
Netrake is a provider of session border controllers and security gateways to
fixed and mobile service providers for real-time delivery of voice and
multimedia solutions across IP networks. Utilizing Netrakes session border
controllers and security gateways, service providers can leverage market
leading security capabilities, reliability, scalability, and feature richness
to interconnect and secure networks and users.

Investment in Other Companies

Through
December 31, 2007, we had invested an aggregate of $4.6 million in Natural
Speech Communication Ltd., a privately-held company engaged in speech
recognition, which is in a development stage, in order for the company to achieve substantive technological milestone.
As of December 31, 2007, we owned 45.2% of the outstanding share capital of this company and 41.5%
of the share capital of this company on a fully diluted basis.

In
July, 2005, we invested $707,000 in MailVision Ltd., a privately-held company
engaged in developing and marketing enhanced services platforms for wireless
service providers. During 2006 and 2007, we made convertible loans in the
aggregate amount of $272,000 to MailVision. The loans bear interest at the rate
of 9% per annum and may be converted into shares of MailVision. As of December
31, 2007, we owned 19.5% of the outstanding share capital of this company and 17.4% of the share capital of this company on a diluted basis
without taking into account shares that may be issued upon conversion of
the loans. In February 2008, we invested an additional $185,000 in shares of
this company, of which $106,000 was by converting a portion of the principal
amount of the loans we had previously made to this company. This investment
increased our ownership to approximately 20.1% of the share capital of this
company on a diluted basis without taking into account the additional shares
that may be issued upon conversion of the remaining principal balance of these
loans.

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In
December 2006, we made a convertible loan in the amount of $1,000,000 to Kayote
Networks Inc., a privately-held company engaged in VoIP interconnectivity and
interoperability services. This loan bears interest at the rate of LIBOR+2% per
annum and was due and payable in December 2007. In addition, the Company
received warrants to purchase shares at an exercise price of $941.91 per share
in exchange for up to $400,000 of the principal amount of the convertible loan.
In December, 2007 we requested repayment of the loan. We received payment for
$320,000 of the principal amount of the loan and expect to receive the
remaining balance of the loan during 2008.

BUSINESS
OVERVIEW

Introduction

We
design, develop and sell products for voice, data and video over IP networks.
In broad terms, VoIP networks consist of software switches, Internet protocol,
or IP, phones and media gateways. Our network and technology products primarily
provide the media gateway element in the network. Media gateways connect legacy
and IP networks. They essentially receive one type of code and convert it to an
IP code and vice versa. This is called trans-coding. Typically media gateways
utilize compression algorithms to compress the amount of information and reduce
the amount of packets required to convey the information (for example, a voice
communication).

Gateway
equipment for Internet protocol-based packet networks has continued to
experience significant development and growth. Gateway equipment can generally
be divided into two key categories: open telecommunications architecture
systems, built around industry standard platforms (e.g., personal computers,
compact personal computer interface, or PCI, advanced telecommunications
computing architecture, or ATCA, and IBM BladeCenter) 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 in homes.

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 media gateways or
access equipment, depending on the type of network. The processing of 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.

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.

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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 more traffic can be carried over the same amount of network resources.

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.

We
typically categorize our products into two main business lines: Network
Business Line and Technology Business Line. In 2007, sales of Network products
accounted for approximately 65% of our revenues and sales of Technolgy products
accounted for approximately 35% of our revenues. In 2007, sales of our Network
products increased by 31.6% and sales of Technology products decreased by 19.4%.

Network
products consist of customer premises equipment (CPE) media gateways for the
enterprise and service provider (or carrier) markets and of carrier grade
oriented mid and high density media gateways for service providers.
Complementing our media gateways as Network products are our media server,
session border controller, security gateway and value added application
products.

Technology
products are enabling in nature and consist of our chips and boards business
products. These are sold primarily to original equipment manufactures, or OEMs,
and system integrators through distribution channels. Our chips and boards
serve as building blocks that our customers incorporate in their products. In
contrast, our networking products are used by our customers as part of a
broader technological solution and are a box level product that interacts
directly with other third party products.

Our Products

Our products consist of:

| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Networking
 products include media servers, security gateways, session border controllers
 and media gateways. Media gateways are deployed in access networks, trunking
 applications in carrier networks, and enterprise networks. Additional
 emerging applications or segments where we believe our media gateways could
 be used are unified communication and fixed mobile convergence, or FMC. Our
 media gateway products include low density analog media gateways and low, mid
 and high density digital media gateways. We are part of Microsoft solution
 for unified messaging and unified communications.

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| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Our Media
 Gateways enable voice, video, data and fax to be transmitted over Internet
 and other protocols, and interface with third party equipment to facilitate
 enhanced voice and data services. Media servers enable conferencing,
 multi-language announcement functionality, and other applications for voice
 over packet networks.                                                                                                                                                                                                                                                                                                   
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| |  | Session
 border controllers enable connectivity, policies and security for real-time
 sessions such as VoIP and video when traversing IP to IP networks. In
 addition, security gateways enable secure real-time sessions across WIFI,
 broadband and wireless networks in fixed mobile convergence deployments.                                                                                                                                                                                                                                                                                                                               
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| |  | Unified communication applications offering solutions that
 enable the integration of voice, data, fax and messaging.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| |  | Our signal
 processor chips process and compresses voice, data and fax and enable
 connectivity between traditional telephone networks and packet networks.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| |  | Our
 communications boards and modules for communication system products 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, or CTI, deployments for contact centers, providing
 call logging and recording utilizing either industry standard or proprietary
 protocols.

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:

| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | New technologies. The introduction of
 broadband access technologies alongside related technologies, such as new
 voice compression algorithms, quality of service mechanisms and security and
 encryption algorithms and protocols, have enabled delivery of voice over
 packet to residential and enterprise customers with more reliability, higher
 quality and greater security. Examples of these broadband access technologies
 include: third generation cellular, WiMax, WiFi, data over cable, digital
 subscriber line technologies and fiber networks (FTTx). Packet technologies
 enable delivery of real time and non-real time services by different service
 providers that do not necessarily own the access network or the part of the
 network through which the subscriber accesses the network.. This allows for
 the growth of alternative or virtual service providers that do not own an
 access network.

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| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Competition
 by alternative service providers with incumbent and traditional service
 providers is causing incumbents to deploy advanced broadband access
 technologies and increase their competitiveness by offering bundled services
 to their subscribers, such as voice, video and data, and online gaming. In
 addition, the emergence of wide band vocoders that use a higher sampling rate
 than used in legacy time domain multiplexing, or TDM, networks allows service
 providers to offer higher quality voice and music over their newly
 established IP network.                                                                                                               
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |  | New services enabled by broadband access.
 Changes in the regulatory environment affecting service providers and the
 availability of new technologies or standards allow service providers to
 compete with one another in the provision of additional services over and
 above the traditional telephony service of voice, fax and dial-up modem
 internet connectivity. New services that could be offered include internet
 connectivity over broadband access or access to rich multimedia content such
 as music, video and games.                                                                                                                                                     
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |  | Increasing need for peering between VoIP networks.
 Service providers and enterprises are increasingly building out VoIP
 networks. As a result, there is an increasing need to connect between two
 VoIP networks. In order to interconnect between two VoIP networks, service
 providers and enterprises need session border controllers to provide
 connectivity and security.                                                                                                                                                                                                                                                                                                            
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |  | According to
 Infonetics 2007 worldwide service provider Market Share information,
 AudioCodes is ranked first for mid-density media gateway port shipments, with
 20% market share, and third for low-density media gateway port shipments,
 with 17% market share. According to Synergy First Quarter 2008 Service
 Provider VoIP Forecast, the service provider Wireline VoIP Media Gateway
 market has grown from $565 million in 2004, to $953 million in 2005, $1,277
 million in 2006 and $1,389 million in 2007, and is expected to grow at
 cumulative average growth rage of 25.5% to $3,442 million in 2011,
 presenting a significant opportunity for VoIP Media Gateway vendors.

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.

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| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Gateway Reliability. In order for a packet
 network to be efficient for voice or fax transmission, the VoIP gateway
 equipment that is installed in core networks must be able to deliver a higher
 level of performance than existing switching equipment located at central
 offices. The telecommunications 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.
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| |  | Connectivity and Security. In contrast with
 legacy circuit switched voice and video communications, Internet Protocol
 based communications are more susceptible to attacks, interceptions and fraud
 by unauthorized entities. In addition, the complexity and relative immaturity
 of IP networks and protocols pose significant quality of service and
 connectivity challenges when sessions cross between separate IP networks.                                                                                                                   
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| |  | Functionality. In order to effectively
 replace legacy 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.

Utilizing
our investment in developing standards-based VoIP protocol support for our
products, customers can integrate our media gateways with a large number of
industry leading IP-PBXs and carrier soft switches. Our interoperability teams
test our products against a variety of other products for interoperability,
focusing on the leading standard VoIP protocols: SIP (Session Initiation
Protocol) and MEGACO/H.248.

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.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           

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| |                                                                 |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| | --------------------------------------------------------------- | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |                                                                 |  | 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.                                    
| |                                                                 |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |                                                                 |  | Media gateway protocols design expertise.
 Our extensive experience in developing media gateway standard protocols,
 keeping ourselves up to date with new request for comments, or RFCs, and
 adjusting our features according to customers requirements and
 interoperability testing allows us to provide our customers with a single
 gateway that can interface with most of the leading solution providers in the
 VoIP market.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| |                                                                 |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| | 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
 and the proprietary system market. 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, wire line, cable and fixed-mobile convergence networks. Our
 session border controllers target access and peering networks.                                                                                                                                                                                                                     
| |                                                                 |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |                                                                 |  | Extensive feature set.Our products
 incorporate an extensive set of signal processing functions and features
 (such as coders, fax processing and echo cancellation), functionalities (such
 as H.323, media gateway control protocol, or MGCP, trunking gateway control
 protocol, or TGCP, media gateway control, or Megaco, and session initiated
 protocol, or 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, generation and
 other telephony signaling processing. Our Gateway products, media server and
 session border controller also offer wireless/mobile features to enable fixed
 mobile convergence.

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| |  |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| |  | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  |  | Cost effective solutions. We are able to
 address different market segments and applications with the same hardware
 platforms thus providing our customers with efficient and cost effective
 solutions.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| |  |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| |  |  | 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. Our
 networking products utilize industry standard control protocols that enable
 them to interoperate with other vendors and easily integrate into enterprise
 IP telephony systems as well as carrier IMS (IP Multimedia Subsystem)
 networks.                                                                                                                                                                                                                                           
| |  |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| |  |  | Various entry level products.Our wide
 product range (chips to media gateways, session border controllers 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.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| |  |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| |  |  | VoIPerfectTM architecture. 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 products and enabling technologies for
the transmission of voice, video, 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. We continually upgrade
 our product lines with additional functionalities, interfaces and densities.
 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.

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| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Strengthen and expand strategic relationships with key customers.
 Our strategy has been to sell our products to leading enterprise channels,
 regional system integrators, global equipment manufacturers and value-added
 resellers, or VARs, 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.
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| |  | 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 enable us to offer better solutions that are more complete
 and contain more features than competitive alternatives. We believe that the
 best opportunities for our growth and profitability will come from offering a
 broad range of highly-integrated network product lines and product features,
 such as our continuously updated analog and digital media gateways and products
 from our recently acquired companies, including session boarder controllers,
 security gateways, messaging platforms and cable telephony 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 multiple 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 (now part of AudioCodes Inc.), in May 2004.
 We also acquired Nuera (now part of AudioCodes Inc.) in July 2006, Netrake
 (now part of AudioCodes Inc.) in August 2006 and CTI Squared in April 2007.                                                                                                                                                                                                                    

39

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Products

Our
products facilitate the transmission of voice, video, data and fax over packet
networks. To date, we have incorporated our algorithms, technologies and
systems design expertise in product lines, which can be divided into two main
product lines:

Networking products

This
line of products includes products that are network level products. Our
networking products include:

|                    |                                                                                                                 |   |                                                                                                                                                                                                                                                                                                                                                                                                      
|------------------- | --------------------------------------------------------------------------------------------------------------- | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                    |                                                                                                                 |  | analog media
 gateways for toll bypass access and enterprise applications;                                                                                                                                                                                                                                                                                                                           
|                    |                                                                                                                 |   |                                                                                                                                                                                                                                                                                                                                                                                                      
|                    |                                                                                                                 |  | digital
 media gateways (MediantTM) with various capacities for wireless, wireline),
 cable, fixed mobile convergence, and unified communications;                                                                                                                                                                                                                                                   
|                    |                                                                                                                 |   |                                                                                                                                                                                                                                                                                                                                                                                                      
|                    |                                                                                                                 |  | media
 servers for enhanced voice and video services and functionalities such as
 conferencing, video sharing and messaging (IPmedia Media Servers);                                                                                                                                                                                                                                                
|                    |                                                                                                                 |   |                                                                                                                                                                                                                                                                                                                                                                                                      
|                    |                                                                                                                 |  | session
 border controllers, or SBCs (nCite), that enable connectivity, contain
 protocol and connectivity policies, and provide security for real-time
 sessions such as VoIP and video when traversing from a public to a private
 network. In addition, security gateways enable secure real-time sessions
 across wifi, broadband and wireless networks in fixed mobile convergence
 deployments;
|                    |                                                                                                                 |   |                                                                                                                                                                                                                                                                                                                                                                                                      
|                    |                                                                                                                 |  | element
 management system, or EMS; and                                                                                                                                                                                                                                                                                                                                                              
|                    |                                                                                                                 |   |                                                                                                                                                                                                                                                                                                                                                                                                      
|                    |                                                                                                                 |  | Value Added
 Applications for Unified Communications.                                                                                                                                                                                                                                                                                                                                                
|                    |                                                                                                                 |   |                                                                                                                                                                                                                                                                                                                                                                                                      
|                    |                                                                                                                 |  | 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, call centers, wireline, cable and
 wireless.                                                                   
|                    |                                                                                                                 |   |                                                                                                                                                                                                                                                                                                                                                                                                      
|Technology products
|                    |                                                                                                                 |   |                                                                                                                                                                                                                                                                                                                                                                                                      
|                    | This line of
 products serves as a building block for network level products. Our
 technology products include:
|                    |                                                                                                                 |   |                                                                                                                                                                                                                                                                                                                                                                                                      
|                    |                                                                                                                 |  | voice over packet processors;                                                                                                                                                                                                                                                                                                                                                                        
|                    |                                                                                                                 |   |                                                                                                                                                                                                                                                                                                                                                                                                      
|                    |                                                                                                                 |  | VoIP
 communication boards (TrunkPack®);                                                                                                                                                                                                                                                                                                                                                             
|                    |                                                                                                                 |   |                                                                                                                                                                                                                                                                                                                                                                                                      
|                    |                                                                                                                 |  | media
 processing boards for enhanced services and functionalities, such as
 conferencing and messaging (IPmediaTM);                                                                                                                                                                                                                                                                                 
|                    |                                                                                                                 |   |                                                                                                                                                                                                                                                                                                                                                                                                      
|                    |                                                                                                                 |  | voice and
 data logging hardware integration board products.                                                                                                                                                                                                                                                                                                                                         

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Our Product Families

Analog
Media Gateways for Toll Bypass Access and Enterprise Applications

MediaPackTM,
our analog and basic rate interface, or BRI, media gateways for toll bypass
access and enterprise applications, are designed to 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 is also capable of supporting some
unified communication and FMC applications.

Digital Media Gateways and Various Capacities
for Wireless, Wireline and Cable (Mediant)

MediantTM
is our family of converged media gateways for wireline, cable, wireless (GSM
and CDMA), fixed-mobile-convergence and enterprise networks. The MediantTM
product family offers scalability and functionality, providing a full suite of
standards compliant control protocols and public switched telephone network, or
PSTN, signaling interfaces for a variety of enterprise, wireline, cable and
wireless media gateway applications in most softswitch controlled environments.
This product family is compatible with popular wireline, cable and wireless
voice coders and protocols including code-division multiple access (CDMA),
global system for mobile communications (GSM), CDMA2000 and universal mobile
telecommunications service (UMTS) It builds on our TrunkPack® architecture,
which is installed in millions of lines worldwide. 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 Mediant family of
media gateways is capable of supporting some of the unified communication and
fixed mobile convergence applications which may be of increased interest to
enterprises and service providers. The Mediant gateway family shares our same
VoIP perfect architecture, designed to provide mature, field-proven solutions.

For
the cable market, the MediantTM gateway family complies with packet
telephony standards and is designed for either hybrid or all IP cable network
architecture. The Mediant gateway enables deployment of advanced packet-based
cable telephony at multiple service operators own pace, without costly hardware
changes. The MediantTM 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.

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Session Border Controllers and Security
Gateways

We
provide the nCite session border controller, or SBC, and security gateway
products that help service providers and network equipment providers enable
connectivity between different VoIP networks and provide security to
deployments of fixed mobile convergence, or FMC networks, for integrating
wireline and wireless networks.

nCite
session border controllers provide secure VoIP and multimedia traversal of
firewall, or FW, and network address translation, or NAT, systems, as well as
denial of service, or DoS, attack prevention at both the signaling and media
layers. NAT and FW traversal are necessary to allow VoIP and multimedia session
to pass from the Service Provider (SP) network to the residential or
enterprise networks. DoS attack prevention protects the SP network from attacks
that load the network until it crashes. The nCite SBCs also provide comprehensive
Quality of Service, or QoS, mechanisms and protocol interworking (translation
from one VoIP protocol to another, or between two variants of same VoIP
protocol to enable two softswitches to communicate with each other). AudioCodes
nCite solutions offer proven interoperability with major softswitches, SIP
servers, application servers, IP PBXs and a large number of IP-based voice and
video endpoints.

The
nCite security gateway enables secure (authenticated and encrypted) real-time
sessions across Wi-Fi, broadband and wireless networks in FMC deployments. The
nCite security gateway, or nCite SG, provides secure termination and
aggregation for IP phones, dual-mode Wi-Fi and cellular-capable VoIP handsets
that are used in converged wireline and wireless networks.

Element Management System

Our
element management system, or EMS, is an advanced solution for centralized,
standards-based management of our VoP gateways, covering all areas vital to the
efficient operations, administration, management and provisioning of our
MediantTM 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.

CTI2 Value Added Services Applications (InTouch)

The
InTouch platform is an enhanced value added services (VAS) platform for service
providers, such as cable, class 5, class 4, fixed-line, mobile, multiservice
virtual network operator, or MVNO, and operators. InTouch provides a suite of
next generation VAS. InTouch is an IP-based, email-centric and telco-grade
platform conforming to ultimate service providers requirements for
high-availability, reliability, scalability, and security. InTouch is designed
to smoothly scale from a very small system to a system with millions of
subscribers based on the same software and architecture, while enabling a rich
suite of applications at all sizes. InTouchs open architecture is based on
industry-standard protocols, facilitating interoperability and integration with
best of breed, third-party applications. InTouch acts as a mediator between
InTouch services and a large selection of clients and devices enabling service
providers to offer attractive packages.

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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.

VoIP 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 industry standards and allow
for interoperability with other gateways. 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.

IPmediaTM Boards and Servers for
Enhanced Services and Functionalities such as Conferencing, Video Sharing and
Messaging (IPmediaTM Platforms)

The
IPmediaTM product family is designed to allow OEMs and application
partners to provide sophisticated content and services that create revenue
streams and customer loyalty through the ability to provide additional
services. The IPmediaTM platform provides voice, video 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
and video services over packet networks, particularly network-based
applications like unified communications, call recording, conferencing and
video sharing 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 assistants. IPmediaTM products are
currently offered on our PCI and cCPI boards and on the 2000, 3000, 5000 and
8000 series (IPmediaTM 2000, IPmediaTM 3000, IPmediaTM
5000 and IPmediaTM 8000).

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. We have named our cross platform core technology VoIPerfect.
It essentially allows us to leverage the same feature set and interoperability
with other products across our product lines.

Low Bit Rate Voice Compression Algorithms

Voice
compression techniques are essential for the transmission of voice over limited
bandwidth 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, the 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 voice and video service applications for legacy and next
generation networks. We have developed media processing technologies such as
message recording/playback, announcements, voice and video 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 and video mail, video share and interactive voice response.

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.

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Our
voice over packet products provide a cost effective solution for these
convergence needs, complying with 2G and 3G cellular standards, for GSM/UMTS,
UMA, Femtocell 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 mediation (mobile to
mobile calls with no transcoding), support for handoff and lawful intercept and
various other cellular-specific capabilities.

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 Dense 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 we developed relates 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 to complete our offering. Our EMS enables the user to
provision and monitor a number of media gateways from a centralized location.

Customers

Our
customers consist of Service Providers and channels (such as distributors),
OEMs, network equipment providers and systems integrators. 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. Sales to Nortel Networks accounted for 16.3% of our revenues in 2005, 15.2%
of our revenues in 2006, and 17.0% of our revenues in 2007. No other customer
accounted for more than 10.0% of our revenues in 2005, 2006 or 2007.

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Sales and Marketing

Our
sales and marketing strategy is to secure the leading channels and system
integrators in each region, partner wth leading application companies and
achieve design wins with network equipment providers in our targeted markets.
Prospective customers and channels generally must make a significant commitment
of resources to test and evaluate our products and to integrate them into
larger systems, networks, and applications. 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. We have invested significant
resources in setting up local sales forces giving us a presence in relevant
markets. We have given particular emphasis to emerging markets such as Latin
America and Eastern Europe in addition to continuing to sell our products in
developed countries.

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. Other components are generic in nature and we believe
they can be obtained from multiple suppliers.

47

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We
have not entered into any long-term supply agreements. However, we have worked
for years in several countries with established global manufacturing leaders
such as Flextronics and have a good experience with their level of commitment
and ability to deliver. 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.

We
utilize contract manufacturing for substantially all of our manufacturing
processes. Most of our manufacturing is carried out by third-party
subcontractors in Israel and China. We have extended our manufacturing
capabilities through third party subcontractors in the United States and
Mexico. 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.

Industry Standards and Government Regulations

Our
products must comply with industry standards relating to telecommunications
equipment. Before completing sales in a country, our products must comply with
local telecommunications standards, recommendations of quasi-regulatory
authorities and recommendations of standards-setting committees. In addition,
public carriers require that equipment connected to their networks comply with
their own standards. Telecommunication-related policies and regulations are
continuously reviewed by governmental and industry standards-setting
organizations and are always subject to amendment or change. Although we
believe that our products currently meet applicable industry and government
standards, we cannot be sure that our products will comply with future
standards.

We
are subject to telecom industry regulations and requirements set by
telecommunication carriers that address a wide range of areas including
quality, final testing, safety, packaging and use of environmentally friendly
components. We comply with the European Unions Restriction of Hazardous
Substances Directive (under certain exemptions) that requires telecom equipment
suppliers to stop the usage of some materials that are not environmentally
friendly by July 1, 2006. These materials include cadmium, hexavalent chromium,
lead, mercury, polybrominated biphenyls and polybrominatel diphenyl ethers.
Under the directive, an extension for compliance through 2010 was granted with
respect to the usage of lead in solders in Network Infrastructure equipment. We
expect that other countries, including countries we operate in, will adopt
similar directives or other additional regulations in the near future.

Competition

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. 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.

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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, OKI and LG. In addition we face competition in low,
mid and high density gateways from internal development at companies such as
Nortel, Alcatel-Lucent, Nokia-Siemens, Huawei, Ericsson, UTstarcom, ZTE and
from Cisco Systems, Veraz Networks, Sonus Networks, General Bandwidth,
Dialogic/Cantata Technologies and Commatch (Telrad).

Our
principal competitors in the media server market segment are Cantata
Technology, NMS Communications, Convedia/Radisys, IP Unity/Glenayre,
Cognitronics and Aculab. In addition, we face competition in software-based and
hardware-based media servers from internal development at companies such as
Hewlett-Packard, Comverse-NetCentrex, Nortel, Alcatel - Lucent, Nokia-Siemens
and Ericsson.

With
respect to session border controllers, we compete against Acme Packets,
Nextpoint, Covergence and Sonus. In the security gateway market, we compete
against private companies such as Reefpoint and Azaire.

Our
principal competitors in the sale of signal processing chips are Texas
Instruments, Broadcom, Infineon, Centillium, Surf and Mindspeed. Several large
manufacturers of generic signal processors, such as Motorola, Agere Systems,
which merged with LSI Corporation in April 2007, and Intel have begun, or are
expected to begin marketing competing processors. Our principal competitors in
the communications board market are NMS Communications, Intel, Motorola,
Cantata Technology, Acculab and PIKA Technologies, Inc.

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, sales 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 our competitors
to bundle other enhanced services or complete solutions with VoIP products
could give these competitors an advantage over us.

49

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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 and session border
control technologies. 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, Université de Sherbrooke and
their agent, Sipro Lab Telecom, on the other hand, we and DSP Group, Inc.
granted to France Telecom and Université 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 Université 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.

50

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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.

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% - 0.9% of our revenues.

Legal Proceedings

We are not
a party to any material legal proceedings, except for the proceedings referred
to below related to our Nuera subsidiary.

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Prior
to the acquisition of Nuera by us, one of Nueras customers had been named as a
defendant in a patent infringement suit involving technology the customer
purchased from Nuera. In the suit, the plaintiff alleged that the customer used
devices to offer services that infringe upon a patent the plaintiff owns. The
customer has sought indemnification from Nuera pursuant to the terms of a
purchase agreement between Nuera and the customer relating to the allegedly
infringing technology at issue.

Prior
to the acquisition of Nuera by us, eight former employees of a French
subsidiary of Nuera filed a labor grievance against the subsidiary claiming
they were unfairly terminated. The French subsidiary filed for bankruptcy in
2004 and, in 2005, the court appointed liquidator sought to hold Nuera liable
for the obligations of its French subsidiary. In June 2006, the court ruled in
favor of Nuera that it was not liable for the obligations of its French
subsidiary. In March 2007, the liquidator appealed the judgment and in April
2008 the appeal was denied by the court.

|   |                         
|-- | ------------------------
|B. | ORGANIZATIONAL STRUCTURE

List of Significant Subsidiaries

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

AudioCodes UK
Limited and AudioCodes Europe Limited, our wholly-owned subsidiaries, are
incorporated in England.

CTI Squared
Ltd., our wholly-owned subsidiary, is organized under the laws of Israel.

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

We
lease our main facilities, located in Airport City, Lod, Israel, which occupy
approximately 128,000 square feet for annual lease payments (including
management fees) of approximately $2.6 million. In January 2008, we increased
the amount of space we lease by approximately 74,000 square feet for annual
lease payments (including management fees) of approximately $1.4 million. In
addition, we have entered into an agreement regarding the neighboring property
pursuant to which a building of approximately 145,000 square feet will be
erected and leased to us for period of eleven years. This new building is
expected to be completed in 2010. We estimate the annual lease payments (including
management fees) to be in the range of $2.0 million to $3.2 million, depending
on the amount expended by the lessor on improvements to the building.

Our
U.S. subsidiary, AudioCodes Inc., leases a 7,000 square foot facility in San
Jose, California. Our subsidiary has additional offices total of 20,000 square
foot in Raleigh, Chicago, Boston and Dallas. AudioCodes Inc. also leases a
29,000 square foot facility in Somerset, New Jersey, a 68,000 square foot
facility in San Diego, California, and a 20,000 square foot facility in Plano,
Texas. The annual lease payments (including management fees) for all our
offices in the United States is approximately $1.5 million.

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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.

| |          |                          
| | -------- | -------------------------
| | ITEM 4A. | UNRESOLVED STAFF COMMENTS

None.

| |         |                                             
| | ------- | --------------------------------------------
| | 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.

Critical Accounting Policies and Estimates

Our
consolidated financial statements are prepared in accordance with U.S.
generally accepted accounting principles, 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 companies,
goodwill and income taxes and valuation allowance. 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.

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:

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| |   |                                                      
| | - | -----------------------------------------------------
| |  | Revenue
 recognition and allowance for sales returns;
| |   |                                                      
| |  | Allowance
 for doubtful accounts;                    
| |   |                                                      
| |  | Inventories;                                         
| |   |                                                      
| |  | Marketable
 securities;                              
| |   |                                                      
| |  | Business
 combinations;                              
| |   |                                                      
| |  | Intangible
 assets;                                  
| |   |                                                      
| |  | Goodwill;                                            
| |   |                                                      
| |  | Income taxes
 and valuation allowance; and           
| |   |                                                      
| |  | Stock-based
 compensation.                           

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 customers include
original equipment manufacturers (OEMs), network equipment providers, systems
integrators and distributors in the telecommunications and networking
industries, all of whom are considered end users.

Revenues
from products are recognized in accordance with Staff Accounting Bulleting
(SAB) No. 104, Revenue Recognition in Financial Statements 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.

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 amounted to $545,000 in 2005, $636,000 in 2006 and
$559,000 in 2007.

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

Our
trade receivables are derived from sales to customers located primarily in the
Americas, the Far East, Israel and Europe. We perform ongoing credit
evaluations of our customers and to date have not experienced any material
losses from uncollected receivables. An allowance for doubtful accounts is
determined with respect to those amounts that we have determined to be doubtful
of collection. We usually do not require collateral on trade receivables because
most of our sales are to large and well-established companies.

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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 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 inventory in a total amount of $1.8 million
in 2005, $1.9 million in 2006 and $700,000 in 2007.

Marketable Securities

We
account for investments in marketable debt securities in accordance with SFAS
No. 115, Accounting for Certain Investments in Debt and Equity Securities
(SFAS 115). Management determines the appropriate classification of its
investments in marketable debt securities at the time of purchase and reevaluates such
determinations at each balance sheet date.

Debt securities are
classified as held-to-maturity since we have the intent and ability to hold the securities to maturity and, accordingly, debt securities are
stated at amortized cost. The amortized cost of held-to-maturity securities is
adjusted for amortization of premiums and accretion of discounts to maturity. Any amortization and interest is included in the consolidated statement of income as financial income or expense, as appropriate. The
accrued interest on short-term and long-term marketable securities is included in the balance of short-term marketable securities.

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Business Combinations

In
accordance with business combination accounting, we allocate the purchase price
of acquired companies to the tangible and intangible assets acquired and
liabilities assumed based on their estimated fair values. We engage third-party
appraisal firms to assist management in determining the fair values of certain
assets acquired and liabilities assumed. Such valuations require management to
make significant estimates and assumptions, especially with respect to
intangible assets.

Management
makes estimates of fair value based upon assumptions it believes to be
reasonable. These estimates are based on historical experience and information
obtained from the management of the acquired companies and are inherently
uncertain. Critical estimates in valuing certain of the intangible assets
include, but are not limited to, the following: future expected cash flows from
product sales, maintenance agreements, customer contracts and acquired developed
technologies and patents and estimated cash flows from the projects when
completed; the acquired companys brand and market position as well as
assumptions about the period of time the acquired brand will continue to be
used in the combined companys product portfolio; and discount rates.
Unanticipated events and circumstances may occur which may affect the accuracy
or validity of such assumptions, estimates or actual results. Changes to these
estimates, relating to circumstances that existed at the acquisition date, are
recorded as an adjustment to goodwill during the purchase price allocation
period (generally within one year of the acquisition date) and as operating
expenses, if otherwise.

In
connection with purchase price allocations, we estimate the fair value of the
support obligations assumed in connection with acquisitions. The estimated fair
value of the support obligations is determined utilizing a cost build-up
approach. The cost build-up approach determines fair value by estimating the
costs related to fulfilling the obligations plus a normal profit margin. The
sum of the costs and operating profit approximates, in theory, the amount that
we would be required to pay a third party to assume the support obligation.

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Intangible
assets

As a result
of our previous acquisitions, our balance sheet includes acquired intangible
assets, such as goodwill and current technology, in the aggregate amount of
approximately $131 million as of December 31, 2006 and $130 million as of December
31, 2007. In the course of the analysis and valuation of intangible assets, we
use financial and other information, including financial projections and
valuations provided by third parties. Although we evaluate our intangible
assets when there is an indication of impairment, our projections are based on
the information available at the respective valuation dates, and may differ
from actual results.

In
accordance with SFAS No. 144, as of December 31, 2007, no impairment losses
were recorded.

Goodwill

In
accordance with SFAS No. 142, Goodwill and Other Intangible Assets (SFAS
142) goodwill acquired in a business combination that closes on or after July
1, 2001 is deemed to have indefinite life and will not be amortized. SFAS 142 requires
goodwill to be tested for impairment on adoption and at least annually
thereafter or between annual tests in certain circumstances, and impaired,
rather than being amortized as previous accounting standards required.

As
of December 31, 2007, we had total goodwill of $120 million on our balance
sheet. Goodwill is tested for impairment by comparing the fair value of the
reporting unit with its carrying value. The fair value was determined based on
the Companys fair value. As of December 31, 2007 no impairment losses were
identified.

Income Taxes and Valuation Allowance

As
part of the process of preparing our consolidated financial statements, we are
required to estimate our income tax expense in each of the jurisdictions in
which we operate. This process involves us estimating our actual current tax
exposure, which is accrued as taxes payable, together with assessing temporary
differences resulting from differing treatment of items for tax and accounting
purposes. These differences result in deferred tax assets, which are included
within our consolidated balance sheet. We may record a valuation allowance to
reduce our deferred tax assets to the amount of future tax benefit that is more
likely than not to be realized.

Although
we believe that our estimates are reasonable, there is no assurance that the
final tax outcome and the valuation allowance will not be different than those
which are reflected in our historical income tax provisions and accruals.

We
have filed or are in the process of filing federal, state and foreign tax
returns that are subject to audit by the respective tax authorities. Although
the ultimate outcome is unknown, we believe that adequate amounts have been
provided for and any adjustments that may result from tax return audits are not
likely to materially adversely affect our consolidated results of operations,
financial condition or cash flows.

57

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In
June 2006, the FASB issued FIN 48, Accounting for Uncertainty in Income
Taxesan interpretation of FASB Statement No. 109 (FIN 48). FIN 48
clarifies the accounting for uncertainty in income taxes recognized under SFAS
No. 109. FIN 48 prescribes a recognition threshold and measurement
attribute for financial statement recognition and measurement of a tax position
taken or expected to be taken in a tax return and also provides guidance on
various related matters such as derecognition, interest and penalties, and
disclosure. On January 1, 2007, we adopted FIN 48. The initial application
of FIN 48 to our tax positions had no effect on our Shareholders equity.

Stock-based Compensation

Effective
January 1, 2006, we began accounting for stock-based compensation in accordance
with Statement of Financial Accounting Statements Standards No.
123R-Share-Based Payments. We utilize the Black-Scholes option pricing model
to estimate the fair value of stock-based compensation at the date of grant.
The Black-Scholes model requires subjective assumptions regarding dividend
yields, expected volatility, expected life of options and risk-free interest
rates. These assumptions reflect managements best estimates. Changes in these
inputs and assumptions can materially affect the estimate of fair value and the
amount of our stock-based compensation expenses. We recognized $8.7 million of
stock-based compensation expense in 2006 and $8.0 million of stock-based
compensation expense in 2007. As of December 31, 2007, there was approximately
$8.0 million of total unrecognized stock-based compensation expense related to
non-vested stock-based compensation arrangements granted by us. As of December
31, 2007, that expense is expected to be recognized over a weighted-average
period of 1.5 years.

|   |                  
|-- | -----------------
|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 system products for the
transmission of voice, data, fax and multimedia 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
network solutions and provide the building blocks to connect traditional
telephone networks to the new voice infrastructure, as well as connecting and
securing multimedia communication between different packet-based networks. Our
products are sold primarily to leading original equipment manufacturers, or
OEMs, system integrators and network equipment providers in the
telecommunications and networking industries. We have continued to broaden our
offerings, both from internal development and through acquisitions, as we have
expanded in the last few years from selling chips to boards, subsystems, media
gateway systems, media servers, session border controllers and messaging
platforms.

Our
headquarters and R&D facilities are located in Israel with R&D
extensions in the U.S. and in the U.K. We have other offices located in Europe,
the Far East, and Latin America.

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Effective
January 1, 2006, we account for stock-based compensation in accordance with
Statement of Financial Accounting Statements Standards No. 123R-Share-Based
Payments. SFAS No. 123(R) requires the fair value of all equity-based awards
granted to employees to be recognized in financial statements beginning in the
first quarter of 2006. The result is that we are required to record an expense
with respect to stock option grants, even if the exercise price of the stock
options is equal to the market price of the underlying shares on the date of
grant. The adoption of SFAS No. 123(R) had a material adverse affect on our
results of operations in 2006 and 2007, as we recognized $8.7 million of
stock-based compensation expense in 2006 and $8.0 million of stock-based
compensation expense in 2007.

Nortel
Networks accounted for 16.3% of our total revenues in 2005, 15.2% of our
revenues in 2006 and 17.0% of our revenues in 2007. Our top five customers
accounted for 31.1% of our revenues in 2005, 29.1% of our revenues in 2006 and
32.8% of our revenues in 2007. 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.

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

|         |  |      |       |      |  |       |   |  |       |  
|-------- |  | ---- | ----- | ---- |  | ----- | - |  | ----- | -
|         |  | 2005 |       | 2006 |  | 2007  |  
|         |  |      |       |      |  |       |  
|Americas |  |      | 57.5  | %    |  | 56.6  | % |  | 56.6  | %
|Far East |  |      | 12.5  |      |  | 12.8  |   |  | 11.2  |  
|Europe   |  |      | 19.4  |      |  | 22.2  |   |  | 25.5  |  
|Israel   |  |      | 10.6  |      |  | 8.4   |   |  | 6.7   |  
|         |  |      |       |      |  |       |  
|Total    |  |      | 100.0 | %    |  | 100.0 | % |  | 100.0 | %
|         |  |      |       |      |  |       |  

The
increase in the percentage of our revenues in 2006 and 2007 from customers
located in Europe was due to demand from service providers and system
integrators in Europe increasing at a higher rate compared to the other
locations.

Part
of our strategy over the past few years has involved the acquisition of
complementary businesses and technologies. We continued implementation of this
strategy with three additional acquisitions in the past two years. In July,
2006, we completed the acquisition of Nuera (merged into AudioCodes Inc. as of
December 31, 2007). Nuera provides Voice over Internet Protocol infrastructure
solutions for broadband and long distance networks. This transaction is
significantly larger than our other acquisitions and investments to date. Nuera
became a wholly-owned subsidiary of AudioCodes Inc. and, accordingly, its
results of operations have been included in our consolidated financial
statements since the acquisition date. We cannot be sure that we will be
successful in integrating Nueras products, employees and operations into our
organization or that we will be able to operate Nueras business in a
profitable manner.

In
August 2006, we acquired Netrake (merged into AudioCodes Inc. as of December
31, 2007), a provider of session border controller, or SBC, and security
gateway solutions. SBCs enable connectivity, policies and security for
real-time media sessions, such as VoIP, video or fax, between public or private
IP networks. Security gateways enable secure real-time sessions across wifi,
broadband and wireless networks in field mobile convergence deployments.

59

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In
April 2007, we completed the acquisition of CTI Squared. CTI Squared is a
provider of enhanced messaging and communications platforms deployed globally
by service providers and enterprises. CTI Squareds platforms integrate data
and voice messaging services over internet, intranet, PSTN, cellular, cable and
enterprise networks.

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.

The
demand for Voice over IP, or VoIP, technology has increased during the last
three years. In recent 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 developed countries, traditional and
alternative service providers adopt bundled triple play (voice, video and data)
and quadruple play (voice, video, data and mobile) offerings. This trend,
enabled by voice and multimedia over IP, has fueled competition among cable,
wireline, ISP and mobile operators, increasing the pressure for adopting and
deploying VoIP networks. In addition, underdeveloped markets without basic wire
line service in countries such as China and India and certain countries in
Eastern Europe are adopting the use of VoIP technology to deliver voice and
data services that were previously unavailable.

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:

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|                                               |  |                          |       |      |  |       |   |  |       |   
|---------------------------------------------- |  | ------------------------ | ----- | ---- |  | ----- | - |  | ----- | --
|                                               |  | Year Ended
 December 31, |      
|                                               |  |                          |      
|Statement of Operations Data:                  |  | 2005                     |       | 2006 |  | 2007  |  
|                                               |  |                          |       |      |  |       |  
|                                               |  |                          |       |      |  |       |   |  |       |   
|Revenues                                       |  |                          | 100.0 | %    |  | 100.0 | % |  | 100.0 | % 
|Cost of
 revenues                              |  |                          | 40.6  |      |  | 41.6  |   |  | 43.7  |   
|                                               |  |                          |       |      |  |       |   |  |       |   
|Gross profit                                   |  |                          | 59.4  |      |  | 58.4  |   |  | 56.3  |   
|Operating
 expenses:                           |  |                          |       |      |  |       |   |  |       |   
|Research and development, net                  |  |                          | 21.1  |      |  | 24.0  |   |  | 25.7  |   
|Selling and marketing                          |  |                          | 22.4  |      |  | 25.6  |   |  | 27.1  |   
|General and administrative                     |  |                          | 5.2   |      |  | 5.9   |   |  | 6.1   |   
|                                               |  |                          |       |      |  |       |   |  |       |   
|Total
 operating expenses                      |  |                          | 48.7  |      |  | 55.5  |   |  | 58.9  |   
|                                               |  |                          |       |      |  |       |   |  |       |   
|Operating
 income                              |  |                          | 10.7  |      |  | 2.9   |   |  | (2.6  | ) 
|Financial
 income, net                         |  |                          | 2.1   |      |  | 2.6   |   |  | 1.7   |   
|                                               |  |                          |       |      |  |       |   |  |       |   
|Income
 (loss) before taxes on income          |  |                          | 12.8  |      |  | 5.5   |   |  | (0.9  | ) 
|                                               |  |                          |       |      |  |       |   |  |       |   
|Taxes on
 income                               |  |                          | 0.7   |      |  | 0.2   |   |  | 0.8   |   
|Equity in
 losses of affiliated companies, net |  |                          | 0.6   |      |  | 0.6   |   |  | 0.7   |   
|                                               |  |                          |       |      |  |       |   |  |       |   
|                                               |  |                          |       |      |  |       |   |  |       |   
|Net income
 (loss)                             |  |                          | 11.6  | %    |  | 4.7   | % |  | (2.4  | )%
|                                               |  |                          |       |      |  |       |   |  |       |   

Year Ended December 31, 2007 Compared to Year
Ended December 31, 2006

Revenues.
Revenues increased 7.4% to $158.2 million in 2007 from $147.4 million in 2006.
The increase in revenues was primarily due to an increase in revenues from our
networking business. Our results of operation include CTI Squared beginning in
April 2007, Nuera beginning in July 2006 and Netrake beginning in August 2006.

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 $89.1 million in 2007 from $86.1 million in 2006. Gross profit as a
percentage of revenues decreased to 56.3% in 2007 from 58.4% in 2006. The
decrease in our gross profit percentage was primarily attributable to
amortization expenses in 2007 related to the acquisitions of CTI Squared during
the second quarter of 2007 and Nuera and Netrake during the third quarter of
2006. Amortization expense allocated to cost of revenues amounted to $2.5
million in 2007 and $1.2 million in 2006. The decrease in gross profit
percentage was partially offset by the higher sales volume that allowed us to
leverage our manufacturing overhead over a larger sales base. The decrease in
gross profit percentage was also offset by a reduction in manufacturing costs
which was primarily due to a reduction in our raw material costs.

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
14.9% to $40.7 million in 2007, from $35.4 million in 2006 and increased as a
percentage of revenues to 25.7% in 2007 from 24.0% in 2006. The increase in net
research and development expenses, both on an absolute and a percentage basis,
was primarily due to our research and development personnel resulting from the
acquisitions of CTI Squared in the second quarter of 2007 and the acquisitions
of Nuera and Netrake during the third quarter of 2006. We expect that research
and development expenses will continue to increase in absolute dollar terms in
2008 as a result of our continued development of new products, as well as the
inclusion of CTI Squared for a full year.

61

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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 13.9% in 2007 to $42.9 million from $37.7 million in 2006. As a
percentage of revenues, selling and marketing expenses increased to 27.1% in
2007 from 25.6% in 2006. The increase in selling and marketing expenses was due
to an increase in selling and marketing personnel and amortization expenses as
a result of the acquisitions of CTI Squared, Nuera and Netrake. Amortization
expense allocated to sales and marketing amounted to $1.0 million in 2007 and
$522,000 in 2006. 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, as well as the inclusion of CTI Squared
for a full year.

General
and Administrative Expenses. General and
administrative expenses consist primarily of compensation for finance, human
resources, general management, rent, network and bad debt reserve, as well as
insurance and professional services expenses. General and administrative
expenses increased 9.9% to $9.6 million in 2007 from $8.8 million in 2006. As a
percentage of revenues, general and administrative expenses increased to 6.1%
in 2007 from 5.9% in 2006. The increase in general and administrative expenses
was due to consolidating the expenses of our Nuera and Netrake subsidiaries,
which were acquired in July 2006 and August 2006, and consolidating the
expenses of our CTI Squared subsidiary, which was acquired in April 2007. We
expect that general and administrative expenses will increase in absolute
dollar terms to support our expected growth.

Financial
Income, Net. Financial income consists primarily of
interest derived on cash and cash equivalents, short-term and long-term
marketable securities, short-term 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 2007 was $2.7 million compared to
$3.8 million in 2006. The decrease in financial income, net in 2007 was
primarily due to lower interest rates and interest income, net, on the
remaining net proceeds from our sale of senior convertible notes in November
2004.

Taxes
on Income. Taxes on Income were $1.3 million in 2007
compared to approximately $289,000 in 2006. The increase is principally
attributable to a decrease in our deferred tax asset.

Equity
in Losses of Affiliated Companies, Net. Equity in
losses of affiliated companies, net was $1.1 million in 2007 compared to
$916,000 in 2006.

62

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Year Ended December 31, 2006 Compared to Year
Ended December 31, 2005

Revenues.
Revenues increased 27.2% to $147.4 million in 2006 from $115.8 million in 2005.
The increase in revenues was primarily due to an increase of $16.7 million in
sales in the United States and an increase of $10.7 million in sales in Europe.
Our results of operation include Nuera beginning in July 2006 and Netrake
beginning in August 2006. Our increase in revenues in 2006 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 $86.1 million in 2006 from $68.8 million in 2005. Gross profit as a
percentage of revenues decreased to 58.4% in 2005 from 59.4% in 2005. The
decrease in our gross profit percentage was primarily attributable to
amortization expenses in 2006 related to the acquisitions of Nuera and Netrake
during the third quarter of 2006. Amortization expense allocated to cost of
revenues amounted to $1.2 million in 2006. The decrease in our gross margin was
also due to expenses related to equity-based compensation resulting from the
adoption of SFAS 123(R). Equity-based compensation expenses allocated to cost
of revenues amounted to $620,000 in 2006. The decrease in gross profit
percentage was partially offset by the higher sales volume that allowed us to
leverage our manufacturing overhead over a larger sales base. The decrease in
gross profit percentage was also offset by a reduction in manufacturing costs
which was primarily due to a reduction in our raw material costs.

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 45.1% to $35.4 million in 2006, from $24.4 million in 2005 and
increased as a percentage of revenues to 24.0% in 2006 from 21.1% in 2005. The
increase in net research and development expenses, both on an absolute and a
percentage basis, was primarily due to expenses related to equity-based
compensation resulting from the adoption of SFAS 123(R). Equity-based
compensation expenses allocated to research and development expenses amounted
to $3.1 million in 2006. The increase in research and development expenses was
also due to additions to our research and development personnel resulting from
the acquisitions of Nuera and Netrake during the third quarter of 2006. We
expect that research and development expenses will continue to increase in
absolute dollar terms in 2007 as a result of our continued development of new
products, as well as the inclusion of Nuera and Netrake for a full year and the
inclusion of CTI Squared beginning in April 2007.

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 45.2% in 2006 to $37.7 million from $25.9 million in 2005. As a percentage
of revenues, selling and marketing expenses increased to 25.6% in 2006 from
22.4% in 2005. The increase in selling and marketing expenses, on an absolute
and a percentage basis, was primarily due to expenses related to equity-based
compensation resulting from the adoption of SFAS 123(R). Equity-based
compensation expenses allocated to selling and marketing expenses amounted to
$3.6 million in 2006. The increase in selling and marketing expenses was also
due to an increase in selling and marketing personnel and amortization expenses
as a result of the acquisitions of Nuera and Netrake. Amortization expense
allocated to sales and marketing amounted to $ 522 thousands in 2006. 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, as well as the inclusion of Nuera and Netrake for a full
year and the inclusion of CTI Squared beginning in April 2007.

63

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General
and Administrative Expenses. General and
administrative expenses consist primarily of compensation for finance, human
resources, general management, rent, network and bad debt reserve, as well as
insurance and professional services expenses. General and administrative
expenses increased 46.0% to $8.8 million in 2006 from $6.0 million in 2005. As
a percentage of revenues, general and administrative expenses increased to 5.9%
in 2006 from 5.2% in 2005. The increase in general and administrative expenses,
both on an absolute and a percentage basis, in 2006 was primarily the result of
expenses related to equity-based compensation resulting from the adoption of
SFAS 123(R). Equity-based compensation expenses allocated to general and
administrative expenses amounted to $1.4 million in 2006. The increase in
general and administrative expenses was also due to consolidating the expenses
of our Nuera and Netrake subsidiaries, which were acquired in July 2006 and
August 2006. We expect that general and administrative expenses will increase
in absolute dollar terms to support our expected growth, as well as the
inclusion of Nuera and Netrake for a full year and the inclusion of CTI Squared
beginning in April 2007.

Financial
Income, Net. Financial income consists primarily of
interest derived on cash and cash equivalents, short-term and long-term
marketable securities, short-term 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 2006 was $3.8 million compared to
$2.5 million in 2005. The increase in financial income, net in 2006 was
primarily due to higher interest rates and interest income, net, on the
remaining net proceeds from our sale of senior convertible notes in November
2004.

Taxes
on Income. Our effective tax rate was 4.0% in 2006 and
5.6% in 2005. These relatively low tax rates were mainly the result of the
utilization of net operating losses and the Approved Enterprise status granted
to our production facilities in Israel.

Equity
in Losses of Affiliated Companies, Net. Equity in
losses of affiliated companies, net were $916,000 in 2006 compared to $693,000
in 2005. We believe that the products being developed by affiliated companies
may enable us to enter new markets and to offer new products.

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 majority 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.

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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 inflationadjusted fordevaluation 
 % |      
|                               |  |                                |      |                              |  |                                              |      
|                               |  |                                |      |                              |  |                                              |       |   |  |  |      |   | 
|2005                           |  |                                | 2.4  |                              |  |                                              | 6.8   |   |  |  | (4.4 | ) | 
|2006                           |  |                                | (0.1 | )                            |  |                                              | (8.2  | ) |  |  | 8.1  |   | 
|2007                           |  |                                | 3.4  |                              |  |                                              | (9.0  | ) |  |  | 12.4 |   | 
|                               |  |                                |      |                              |  |                                              |       |   |  |  |      |   | 
|Five months
 ended May 31,2008 |  |                                | 2.2  |                              |  |                                              | (15.9 | ) |  |  | 18.2 |   | 

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Recent Accounting Pronouncements

In
September 2006, the Financial Accounting Standards Board (FASB) issued SFAS
No. 157, Fair Value Measurements (SFAS No. 157). This Standard defines
fair value, establishes a framework for measuring fair value in generally
accepted accounting principles and expands disclosures about fair value
measurements. The provisions of SFAS No. 157 are effective for us
beginning January 1, 2008. The FASB issued a FASB Staff Position (FSP
157-2) to defer the effective date of SFAS No. 157 for one year for all
nonfinancial assets and nonfinancial liabilities, except for those items that
are recognized or disclosed at fair value in the financial statements on a
recurring basis. We do not expect that the adoption of SFAS No. 157
will have material impact on our consolidated financial statements.

In
February 2007, the FASB issued SFAS No. 159, The Fair Value Option
for Financial Assets and Financial Liabilities (SFAS No. 159).
SFAS No. 159 permits companies to choose to measure certain financial
instruments and other items at fair value. The standard requires that
unrealized gains and losses are reported in earnings for items measured using
the fair value option. SFAS No. 159 is effective for us beginning in
the first quarter of fiscal year 2008. We have determined that the adoption of
SFAS 159 will not have an impact on our consolidated financial statements since
we have not elected the fair value option for any of our existing assets or liabilities
as of FAS 159 effective date.

In
December 2007, the FASB issued SFAS No. 141 (revised 2007), Business
Combinations (SFAS 141R). SFAS 141R establishes principles and
requirements for how an acquirer recognizes and measures in its financial
statements the identifiable assets acquired, the liabilities assumed, any non
controlling interest in the acquiree and the goodwill acquired. SFAS 141R
also establishes disclosure requirements to enable the evaluation of the nature
and financial effects of the business combination. SFAS 141R is effective
for fiscal years beginning after December 15, 2008. Earlier adoption is
prohibited. The adoption of SFAS 141R could have a material effect on our
consolidated financial statements if we were to enter into a business
combination after December 31, 2008.

In
December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in
Consolidated Financial Statements, an amendment of ARB No. 51. SFAS
No. 160 establishes accounting and reporting standards that require that
the ownership interests in subsidiaries held by parties other than the parent
be clearly identified, labeled, and presented in the consolidated statement of
financial position within equity, but separate from the parents equity; the
amount of consolidated net income attributable to the parent and to the
noncontrolling interest be clearly identified and presented on the face of the
consolidated statement of income; and changes in a parents ownership interest
while the parent retains its controlling financial interest in its subsidiary
be accounted for consistently. SFAS No. 160 is effective for fiscal years,
and interim periods within those fiscal years, beginning on or after
December 15, 2008. The adoption of the provisions of Statement No. 160 is
not anticipated to materially impact our consolidated financial position and
results of operations.

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In
December, 2007 the SEC staff issued Staff Accounting Bulletin No. 110 (SAB
110), which, effective January 1, 2008, amends and replaces SAB 107,
Share-Based Payment. SAB 110 expresses the views of the SEC staff regarding the
use of a simplified method in developing an estimate of the expected term of
plain vanilla share options in accordance with FASB Statement No. 123(R),
Share-Based Payment. Under the simplified method, the expected term is
calculated as the midpoint between the vesting date and the end of the
contractual term of the option. The use of the simplified method, which was
first described in Staff Accounting Bulletin No. 107, was scheduled to expire
on December 31, 2007. SAB 110 extends the use of the simplified method for
plain vanilla awards in certain situations. The SEC staff does not expect the
simplified method to be used when sufficient information regarding exercise
behavior, such as historical exercise data or exercise information from
external sources, becomes available.

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

We
have financed our operations for the last three years, from our sale of
convertible notes, as well as with cash from operations in those years. 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. 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.

As
of December 31, 2007, we had $143.0 million in cash and cash equivalents,
short-term and long-term marketable securities, short-term and long-term bank
deposits and structured notes, an increase of approximately $9.4 million from
$133.6 million at December 31, 2006. During 2007, we used $4.9 million of cash
in connection with our acquisition of CTI Squared. We used an additional $5.0
million of cash in February 2008 in connection with our acquisition of CTI
Squared.

In
January 2008, our Board approved a program to repurchase up to 4,000,000 of our
ordinary shares. Purchases will be made from time-to-time at the discretion of
management subject, among other things, to our share price and market
conditions. If management elects to have us purchase our shares, we will use a
portion of our cash to effect these purchases. As of May 31, 2008, we had
repurchased 2.3 million shares at an aggregate cost of $9.1 million.

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Our
operating activities provided cash in the amount of $12.4 million in 2007,
primarily due to a decrease of $5.0 million in trade receivables and non-cash charges of $8.0 million for
stock-based compensation and $7.8 million for depreciation and amortization,
offset, in part, by our net loss and a decrease of $5.1 million in trade and
other payables and an increase of $2.6 million in inventories. Our operating
activities provided cash in the amount of $6.6 million in 2006, primarily due
to our net income and non-cash charges of $8.7 million for stock-based
compensation and $5.5 million for depreciation and amortization, which were
partially offset by an increase of $9.8 million in trade receivables and a
decrease of $4.7 million in trade and other payables. Our receivables increased
primarily as a result of higher sales volume. Our payables decreased due to
repayment of payable balances after the acquisitions of Nuera and Netrake. Our
operating activities provided cash in the amount of $13.3 million in 2005,
primarily due to our net income and non-cash charges of $3.4 million for
depreciation and amortization, which were partially offset by an increase of
$3.5 million in trade receivables and $2.0 million in deferred tax assets. Our
receivables increased as a result of higher sales volume and our deferred tax
assets increased due to the utilization of net operating losses.

In
2007, our investing activities provided cash in the amount of $32.7 million,
primarily due to our proceeds from the maturity of marketable securities and structured
notes. In 2006, our investing activities used cash in the amount of $61.6
million, primarily due to our investment in Nuera and Netrake, offset in part
by the net proceeds from the maturity of bank deposits. In 2005, our investing
activities used cash in the amount of $113.0 million, primarily due to our
investment of a significant portion of the proceeds from our sale of
convertible notes in short-term and long-term marketable securities, short-term
and long-term bank deposits and structured notes and payments in connection
with the acquisition of AudioCodes USA.

In
2007, financing activities provided $4.8 million due to proceeds from issuance
of our shares upon exercise of options and from purchases of our shares under
our Employee Stock Purchase Plans. In 2006, financing activities provided $9.2
million due to proceeds from issuance of our shares upon exercise of options
and from purchases of our shares under our Employee Stock Purchase Plans. In
2005, financing activities provided $3.8 million due to proceeds from issuance
of our shares upon exercise of options and from purchases of our shares under
our Employee Stock Purchase Plans.

In
April 2008 we entered into a loan agreement with a bank in Israel that provide
for borrowings of up to $15.0 million. The loan bears interest at LIBOR plus 1.5%
with respect to $11.5 million of borrowings and LIBOR plus 0.65% with respect
to $3.5 million of borrowings. The principal amount borrowed is repayable in 20
equal quarterly payments through May 2013. The bank has a lien on our assets
and we are required to maintain $3.5 million of compensating balances with the
bank. The agreement requires us, among other things, to maintain shareholders
equity at specified levels and to achieve certain levels of operating income.
The agreement also restricts us from paying dividends. As of June 22, 2008,
there was $15.0 million outstanding under this loan agreement.

We
anticipate that our operating expenses and acquisitions 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 operating cash requirements
for at least the next twelve months. 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 additional 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.

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|   |                                                     
|-- | ----------------------------------------------------
|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, analog and digital media gateways for carrier and
enterprise applications, media servers and session border controllers. Our
platforms will feature increased trunk capacity, new functionalities, enhanced
signaling software and compliance with new control protocols. As of December
31, 2007, 297 of our employees were engaged primarily in research and
development on a full-time basis. We also employed 6 employees on a part-time
basis.

Our
research and development expenses were $40.7 million in 2007 compared to $35.4
million in 2006 and $24.4 million in 2005. 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 and may
further require material payments. The OCS approval is not required for the
export of any products resulting from such research or development. Through
December 31, 2007, we had obtained grants from the OCS aggregating $3.7 million
for certain of our research and development projects. We are obligated to pay
royalties to the OCS, amounting to 3%-4.5% 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.

|   |                  
|-- | -----------------
|D. | TREND INFORMATION

The
accelerated demand for VoIP technology has impacted our business during the
last few years. Over the past few 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 wire line service in countries such as China and India
and certain countries in Eastern Europe are beginning to use VoP technology to
deliver voice and data services that were previously unavailable. In addition,
the growth in broadband access and related technologies has driven the
emergence of alternative service providers. This in turn stimulates competition
with incumbent providers, encouraging them to adopt voice over packet
technologies. The entry of new industry players and the demand for new
equipment have impacted our business in the last few years.

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In
2007, 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 new system level products, and
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.

|   |                               
|-- | ------------------------------
|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, 2007, our contractual obligations were as follows (in
thousands):

|                             |  |                        |         |                   |  |           |  |           |       |                   |  |       |  |  |       | 
|---------------------------- |  | ---------------------- | ------- | ----------------- |  | --------- |  | --------- | ----- | ----------------- |  | ----- |  |  | ----- | 
|                             |  | PAYMENTS DUE BY PERIOD |        
|                             |  | TOTAL                  |         | LESS THAN
 1 YEAR |  | 1-3
YEARS |  | 3-5
YEARS |       | MORE THAN 5 YEARS | 
|                             |  |                        |         |                   |  |           |  |           |       |                   | 
|Senior convertible notes     |  |                        | 125,000 |                   |  |           |  |           |       |                   |  |       |  |  |       | 
|Rent and lease commitments   |  |                        | 17,587  |                   |  | 4,967     |  |           | 9,352 |                   |  | 2,242 |  |  | 1,026 | 
|Severance pay fund (1)       |  |                        | 1,369   |                   |  |           |  |           |       |                   |  |       |  |  |       | 
|Uncertain tax positions
 (2) |  |                        | 288     |                   |  |           |  |           |       |                   |  |       |  |  |       | 
|Other commitments            |  |                        | 3,096   |                   |  | 3,096     |  |           |      |                   |  |      |  |  |      | 

(1) Our
obligation for accrued severance pay under Israels Severance Pay Law as of
December 31, 2007 was $11.2 million. This obligation is payable only upon
termination, retirement or death of the respective employee. $9.8 million was
funded through deposits into severance pay funds, leaving a net obligation of
approximately $1.4 million.

(2) Uncertain income tax
position under FASB Interpretation No 48, Accounting for Uncertainty in Income
Taxes, (FIN 48) are due upon settlement and we are unable to reasonably
estimate the ultimate amount of timing of settlement. See also Note 13f in our
Consolidated Financial Statements for further information regarding the
Companys liability under FIN 48.

|   |                                 |                                           
|-- | ------------------------------- | ------------------------------------------
|   | 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 June 10, 2008:

70

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|                    |      |    |  |                                                               |  |  |          | 
|------------------- | ---- | -- |  | ------------------------------------------------------------- |  |  | -------- | 
|                    | Name |    |  | Age                                                           |  |  | Position | 
|                    |      |    |  |                                                               |  |  |          | 
|Shabtai
 Adlersberg |      | 55 |  | Chairman of the
 Board, President and Chief Executive Officer
|Nachum Falek        |      | 37 |  | Vice
 President, and Chief Financial Officer                 
|Hanan Maoz          |      | 45 |  | Vice
 President, Business Operations                         
|Eyal
 Frishberg     |      | 50 |  | Vice
 President, Operations                                  
|Eli Nir             |      | 42 |  | Vice
 President, Research and Development                    
|Lior Aldema         |      | 42 |  | Vice
 President, Marketing and Product Management            
|Yehuda
 Hershkovits |      | 41 |  | Vice
 President, Systems                                     
|Tal Dor             |      | 39 |  | Vice
 President, Human Resources                             
|Gary Drutin         |      | 47 |  | Vice
 President, Global Sales                                
|Moshe Tal           |      | 53 |  | Vice
 President , NA Business Operations                     
|David E.
 Perez     |      | 47 |  | Vice
 President, Sales, Asia Pacific                         
|Joseph Tenne        |      | 52 |  | Director                                                     
|Dr. Eyal
 Kishon    |      | 47 |  | Director                                                     
|Doron Nevo          |      | 52 |  | Director                                                     
|Osnat Ronen         |      | 46 |  | 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. and as
a director of MailVision Ltd and CTI Squared 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
Falekjoined 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.

Hanan
Maozjoined AudioCodes in February 2007 as Vice
President of Business Operations. Mr. Maoz has over 17 years of experience in
enterprise software sales and operations. From August 2003 until joining
AudioCodes in 2007, Mr. Maoz was a Managing Director and Co-Founder of
PerformanceSoft Israel, a privately held consulting firm providing corporate
performance planning and business monitoring. From June 1996 to June 2003, Mr.
Maoz worked for Oracle Corp. (Israel) in a variety of executive sales,
alliances and business development positions. Mr. Maoz has an MBA in Finance
and a MSc. in Information Technologies, both from the Tel-Aviv University, and
is expecting his PhD in Industrial Engineering and Management from Ben-Gurion
University.

71

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Eyal
Frishberghas 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
Nirhas 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.

Lior
Aldemahas 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. Mr. Aldema holds an M.B.A. from Tel Aviv University and a B.Sc.
from the Technion.

Yehuda
Hershkovitshas 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
Dorhas 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.

Gary
Drutincurrently serves as our VP Global Sales. Mr.
Drutin was the Vice President Sales for Europe, Middle East and Latin America
from 2005 until 2007 and Vice President of Channel Operations and Marketing
from 2004 until 2005. 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.

72

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Moshe
Taljoined us in May 2004 in connection with our
acquisition of Ai-Logix, now known as AudioCodes Inc. and serves as the
President and CEO of our AudioCodes USA subsidiary (now called AudioCodes
Inc.). Mr. Tal co-founded Ai-Logix 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.

David
E. Perezjoined us in February 2002, and became our
Vice President of the Asia Pacific region in January 2006. Mr. Perez served as
our Vice President of Sales for Latin America, Iberia and the Mediterranean area
from 2003 until January 2006. Commencing in 2008, Mr. Perez serves as a
director of Ramdor Systems Ltd., an Israeli public company traded on the
Tel-Aviv Stock Exchange offering hosted software application solutions. Between
1998 and 2002, Mr. Perez served as Director of the Consulting Division and
member of the management team for Oracle in Israel. From 1988 to 1998 Mr. Perez
led the implementation group for New Applicom, a member of the Matrix group.
Mr. Perez holds a BS.c in Industrial Engineering and Information Systems from
the Technion.

Joseph
Tennehas 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. Since January 2006, Mr. Tenne has
served as the Chief Financial Officer of Ormat Industries Ltd., an Israeli
holding company listed on the Tel-Aviv Stock Exchange and the parent company of
Ormat Technologies, Inc. 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.

Dr.
Eyal Kishonhas 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.
Prior to that, Dr. Kishon served as Chief Technology Officer at Yozma Venture
Capital from 1992 to 1993. Dr. Kishon serves as a director of Allot
Communications Ltd and Celtro Inc. 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 
Israel Institute of Technology and an M.Sc. and a Ph.D. in Computer Science
from New York University.

73

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Doron
Nevohas served as one of our directors since 2000.
Mr. Nevo is President and CEO of KiloLambda Technologies Ltd., an optical
subsystems company, which he co-founded in 2001. From 1999 to 2001, Mr. Nevo
was involved in fund raising activities for Israeli-based startup companies.
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
telecom service provider in Israel. He also serves on the board of a number of
companies, including Utility Wireless Corp. (a manufacturer of radio frequency
sub-systems), Elcom Technologies (manufacturer of Satcom and digital radio
synthesizers), Notox, Ltd. (a biotech company), BioCancell, Inc. and Bank
Adanim. Mr. Nevo holds a B.Sc. in Electrical Engineering from the Technion 
Israel Institute of Technology and an M.Sc. in Telecommunications Management
from Brooklyn Polytechnic.

Osnat
Ronenhas served as one of our directors since
December 2007. Ms. Ronen has been the Deputy Chief Executive Officer of Leumi
& Co. Investment House, the private equity investment arm and investment
banking services arm of the Leumi Group, since 2001. Prior to this position,
she was Deputy Head of the Subsidiaries Division of Leumi Group from 1999 until
2001. Ms. Ronen joined Viola PE, in January 2008. Ms. Ronen serves as a
director of Leumi Leasing and Investments Ltd., National Consultants
(Netconsultant) Ltd., Fox-Wizel Ltd., Paz Oil Company Ltd. and Keshet
Broadcasting Ltd. Ms. Ronen received an M.B.A. degree and a B.Sc degree in
mathematics and computer science from the Tel Aviv University.

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

The
aggregate direct remuneration paid to the 15 persons who served in the capacity
of director or senior executive officer during the year ended December 31, 2007
was approximately $2.7 million, including approximately $269,000 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 three or five equal annual installments, commencing one year
from the date of grant.

A
summary of our stock option activity and related information for the years
ended December 31, 2005, 2006 and 2007 for the 15 persons who served in the
capacity of director or senior executive officer during the year ended December
31, 2007 is as follows:

|                                          |  |                     |           |                                    |   |                     |  |                                    |           |                     |   |                                    |  |  |           |   |   |      | 
|----------------------------------------- |  | ------------------- | --------- | ---------------------------------- | - | ------------------- |  | ---------------------------------- | --------- | ------------------- | - | ---------------------------------- |  |  | --------- | - | - | ---- | 
|                                          |  | 2005                |           | 2006                               |   | 2007                | 
|                                          |  |                     |           |                                    |   |                     | 
|                                          |  | Number
 of
 Options |           | Weighted
 Average
 Exercise
 Price |   | Number
 of
 Options |  | Weighted
 Average
 Exercise
 Price |           | Number
 of
 Options |   | Weighted
 Average
 Exercise
 Price | 
|                                          |  |                     |           |                                    |   |                     |  |                                    |           |                     |   |                                    | 
|Outstanding at the
 beginning of the year |  |                     | 1,999,435 |                                    | $ | 9.01                |  |                                    | 2,006,685 |                     | $ | 9.06                               |  |  | 2,071,835 |   | $ | 9.42 | 
|Adjustments to opening balance            |  |                     | 42,500    |                                    |   |                     |  |                                    | (44,000   | )                   |   |                                    |  |  | (194,566  | ) |   |      | 
|Granted                                   |  |                     | 60,000    |                                    | $ | 10.17               |  |                                    | 220,000   |                     | $ | 10.33                              |  |  | 352,500   |   | $ | 6.42 | 
|Cancelled                                 |  |                     |          |                                    |   |                     |  |                                    | (20,000   | )                   |   |                                    |  |  | (176,000  | ) |   |      | 
|Exercised                                 |  |                     | (5,250    | )                                  | $ | 3.77                |  |                                    | (90,850   | )                   | $ | 5.02                               |  |  | (16,500   | ) | $ | 2.31 | 
|                                          |  |                     |           |                                    |   |                     |  |                                    |           |                     |   |                                    | 
|                                         
|Outstanding at the end of
 the year       |  |                     | 2,006,685 |                                    | $ | 9.06                |  |                                    | 2,071,835 |                     | $ | 9.42                               |  |  | 2,037,269 |   | $ | 7.54 | 
|                                          |  |                     |           |                                    |   |                     |  |                                    |           |                     |   |                                    | 

74

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As
of December 31, 2007, options to purchase 1,342,081 ordinary shares were
exercisable by the 15 persons who served as an officer or director during 2007
at an average exercise price of $6.79 per share.

Under
the Israeli Companies Law, the compensation arrangements for officers who are
not directors require the approval of the board of directors, unless the
articles of association provide otherwise. Arrangements regarding the
compensation of directors require the approval of the audit committee, the
board and the shareholders, in that order.

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

Corporate Governance Practices

We are
incorporated in Israel and therefore are subject to various corporate
governance practices under the Israeli Companies Law, 1999, or the Companies
Law, relating to such matters as outside directors, the audit committee, the
internal auditor and approvals of interested party transactions. These matters
are in addition to the ongoing listing conditions of the Nasdaq Global Select Market
and other relevant provisions of U.S. securities laws. Under the Nasdaq rules,
a foreign private issuer may generally follow its home country rules of
corporate governance in lieu of the comparable Nasdaq requirements, except for
certain matters such as composition and responsibilities of the audit committee
and the independence of its members. We have elected to follow the Companies
Law with respect to the corporate approvals required to adopt or amend equity
incentive plans and the distribution of annual reports to shareholders, rather
than comply with the relevant Nasdaq requirements. 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.

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, Dr. Eyal Kishon and Osnat Ronen are our
outside directors. Under the requirements for listing on the Nasdaq Global
Select Market, we are required to have a majority of our directors be
independent as defined by Nasdaq rules. Doron Nevo, Dr. Eyal Kishon, Osnat
Ronen and Joseph Tenne are independent directors for purposes of the Nasdaq
rules.

75

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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. Pursuant to the Israeli Companies
Law, at least one of the outside directors appointed by a publicly-traded
company must have financial and accounting expertise. The other outside
directors are required to possess financial and accounting expertise or
professional expertise, as these terms are defined in regulations promulgated
under the Companies Law. Joseph Tenne is designated as the audit committees
financial expert. This requirement does not apply to outside directors elected
prior to January 2006.

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
additional three-year terms. An outside director can be removed from office
only under very limited circumstances. All of the outside directors must serve
on a companys statutory audit committee and each other committee of a
companys board of directors is required to include at least one outside
director. If, at the time an outside director is elected, all current members
of the board of directors are of the same gender, then the elected outside
director must be of the other gender.

Under
the Companies Law and the requirements for listing on the Nasdaq Global Select
Market, our board of directors is required to appoint an audit committee. Our
audit committee must be comprised of at least three directors, including all of
the outside directors. The audit committee consists of: Dr. Eyal Kishon, Doron
Nevo, Joseph Tenne and Osnat Ronen. Our Board of Directors has determined that
Joseph Tenne is an audit committee financial expert and that all members of
the Audit Committee are independent under the applicable Securities and
Exchange Commission and Nasdaq rules.

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.

We
have adopted an audit committee charter as required by the Nasdaq rules. Our
audit committee assists the board of directors in fulfilling its responsibility
for oversight of the quality and integrity of our accounting, auditing and
financial reporting practices and financial statements and the independence
qualifications and performance of our independent auditors. The audit committee
also has the authority and responsibility to oversee our independent auditors,
to recommend for shareholder approval the appointment and, where appropriate,
replacement of our independent auditors and to pre-approve audit fees and all
permitted non-audit services and fees.

76

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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.

Nasdaq
rules require that director nominees be selected or recommended for the boards
selection either by a committee composed solely of independent directors or by
a majority of independent directors. Our Nominating Committee assists the board
of directors in its selection of individuals as nominees for election to the
board of directors and/or to fill any vacancies or newly created directorships
on the board of directors. The Nominating Committee consists of four members:
Dr. Eyal Kishon, Doron Nevo, Joseph Tenne and Osnat Ronen. All members of the
Nominating Committee are independent under the applicable Securities and
Exchange Commission and Nasdaq rules.

Nasdaq
rules also provide that the compensation of a companys chief executive officer
and other executive officers is required to be approved either by a majority of
the independent directors on the board or a committee comprised solely of
independent directors. Our board of directors has appointed Dr. Eyal Kishon and
Joseph Tenne to serve on the compensation committee of the board of directors.

Pursuant
to our articles of association, our directors, other than our outside
directors, are 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:

| |                     |  |           |  |     
| | ------------------- |  | --------- |  | ----
| | Vacant              |  | Class I   |  | 2010
| | Joseph Tenne        |  | Class II  |  | 2008
| | Shabtai
 Adlersberg |  | Class III |  | 2009

We
currently do not have a Class I director.

Our
outside directors under the Companies Law, Doron Nevo, Dr. Eyal Kishon and
Osnat Ronen, are not members of any class and serve in accordance with the
provisions of the Companies Law. Mr. Nevos term ends in 2009, Dr. Kishons
term ends in 2008, and Ms. Ronens term ends in 2010.

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

We
had the following number of employees as of December 31, 2005, 2006 and 2007 in
the areas set forth in the table below:

|                                                |  |                    |     |      |  |      |  |  |     | 
|----------------------------------------------- |  | ------------------ | --- | ---- |  | ---- |  |  | --- | 
|                                                |  | As of December 31, |    
|                                                |  |                    |    
|                                                |  | 2005               |     | 2006 |  | 2007 | 
|                                                |  |                    |     |      |  |      | 
|Research and development                        |  |                    | 233 |      |  | 312  |  |  | 296 | 
|Sales & marketing,
 technical service & support |  |                    | 186 |      |  | 240  |  |  | 249 | 
|Operations                                      |  |                    | 73  |      |  | 102  |  |  | 99  | 
|Management and
 administration                  |  |                    | 30  |      |  | 47   |  |  | 44  | 
|                                                |  |                    |     |      |  |      | 
|                                                |  |                    | 522 |      |  | 701  |  |  | 688 | 
|                                                |  |                    |     |      |  |      | 

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Our
employees were located in the following areas as of December 31, 2005, 2006 and
2007.

|              |  |                    |     |      |  |      |  |  |     | 
|------------- |  | ------------------ | --- | ---- |  | ---- |  |  | --- | 
|              |  | As of December 31, |    
|              |  |                    |    
|              |  | 2005               |     | 2006 |  | 2007 | 
|              |  |                    |     |      |  |      | 
|Israel        |  |                    | 373 |      |  | 416  |  |  | 425 | 
|United States |  |                    | 124 |      |  | 234  |  |  | 197 | 
|Europe        |  |                    | 5   |      |  | 25   |  |  | 29  | 
|Far East      |  |                    | 17  |      |  | 22   |  |  | 31  | 
|Latin America |  |                    | 3   |      |  | 4    |  |  | 6   | 
|              |  |                    |     |      |  |      | 
|              |  |                    | 522 |      |  | 701  |  |  | 688 | 
|              |  |                    |     |      |  |      | 

The
growth in the number of our employees in 2006 was primarily attributable to our
acquisitions of Nuera, now part of AudioCodes Inc., and Netrake, now part of
AudioCodes Inc. The decrease in the number of employees in 2007 was primarily
attributable to our cost reduction plan implemented in 2007, partially offset
by the employees added as a result of our acquisition of CTI Squared Ltd.

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, which include payments for national health insurance. The payments
to the National Insurance Institute currently range from approximately 5% to
17% of wages up to specified wage levels, of which the employee contributes
approximately 65% and the employer contributes approximately 35%.

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 Minister
of Industry, Trade and Labor. 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.

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Pursuant to a recent order issued in December 2007 by the Israeli Minister
of Industry, Trade and Labor, new provisions relating to pension arrangements
in the collective bargaining agreements between
the Histadrut and the Coordination Bureau of Economic Organizations will
apply to all employees in Israel, including
our employees. 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.

79

---



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

The
following table sets forth the share ownership and outstanding number of
options of our directors and officers as of June 10, 2008.

|                          |                                         |                                    |                     
|------------------------- | --------------------------------------- | ---------------------------------- | --------------------
|Name                      | Total
  Shares 
  Beneficially 
  Owned | Percentage
  of 
  Ordinary Shares | Number of 
  Options
|Shabtai
  Adlersberg      | 5,342,762                               | 13.8                               | 533,718             
|Nachum Falek              | *                                       |                                    | *                   
|Hanan Maoz                | *                                       |                                    | *                   
|Eyal Frishberg            | *                                       |                                    | *                   
|Eli Nir                   | *                                       |                                    | *                   
|Lior Aldema               | *                                       |                                    | *                   
|Yehuda Hershkovitz        | *                                       |                                    | *                   
|Tal Dor                   | *                                       |                                    | *                   
|Gary Drutin               | *                                       |                                    | *                   
|Moshe Tal                 | *                                       |                                    | *                   
|David E.
  Perez          | *                                       |                                    | *                   
|Joseph Tenne              | *                                       |                                    | *                   
|Dr. Eyal
  Kishon         | *                                       |                                    | *                   
|Doron Nevo                | *                                       |                                    | *                   
|Osnat Ronen               | *                                       |                                    | *                   
|                         
|*Less than
  one percent. |                                         |                                    |                     

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

The
following table sets forth information with respect to the options to purchase
our ordinary shares held by Mr. Adlersberg as of June 10, 2008.

|                     |                      |                   |           |           |           |                     
|-------------------- | -------------------- | ----------------- | --------- | --------- | --------- | --------------------
|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      
|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            |          |          | 5
  years | September
  23, 2011

Employee Share Plans

We
have Employee Share Purchase Plans and Employee Share Option Plans for the
granting of options to our employees, officers, directors and consultants. 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 at least
for a period commencing on the date of grant and ending no later than 30 months
after the date of grant, in accordance with the period of time specified by
Section 102 of Israels Income Tax Ordinance, 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.

80

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Employee Share Purchase Plans

We
implemented two Employee Share Purchase Plans in May 2001. One plan, the global
plan, was for our non-U.S., employees and the other our U.S. employees. We
amended and restated the global plan in July 2007 and adopted an additional
plan for U.S. employees in July 2007. Under these Plans, a maximum of 6,500,000
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, 2007, we had issued
1,940,323 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.

As
of December 31, 2007, options to purchase a total of 5,723,072 shares are
outstanding under the 1997 and 1999 Israeli Plans and options to purchase a
total of 1,668,188 shares are outstanding under the 1997 U.S. Plan. In
addition, a reserve of 970,620 shares has been made available for grant under
the 1999 Israeli Plan and a reserve of 1,120,250 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 current practice of our board of
directors is to grant options with exercise prices that equal 100% of the
closing price of our ordinary shares on the applicable date of grant.

81

---



|   |                    |                                                  
|-- | ------------------ | -------------------------------------------------
|   | 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 May 31,
2008, 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)                                                  | 5,766,480      | 13.9%             
|Leon Bialik(2)                                                           | 4,030,882      | 9.8%              
|Soros Fund
  Management LLC(3)                                           | 4,937,043      | 10.7%             
|FMR Corp.(4)                                                             | 2,969,427      | 7.1%              
|Rima
  Management, LLC(5)                                                | 2,382,113      | 5.8%              
|All
  directors and senior executive officers as a group (15 persons)(6) | 6,808,593      | 16.0%             

|    |                                                                                                                                                                                                                                                                                                                                                                      
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|   
|(1) | Includes
  options to purchase 423,718 shares, exercisable within sixty days of December
  31, 2008.                                                                                                                                                                                                                                                                 
|   
|(2) | The
  information is derived from a statement on Schedule 13G/A, dated February 12,
  2008 of Leon Bialik filed with the Securities and Exchange Commission.                                                                                                                                                                                                         
|   
|(3) | The
  information is derived from a statement on Schedule 13G, dated February 19,
  2008, of Soros Fund Management LLC, George Soros, Robert Soros and Jonathan
  Soros filed with the Securities and Exchange Commission. All of the shares
  beneficially owned are issuable upon conversion of our senior convertible
  notes held by Soros Fund Management.      
|   
|(4) | The
  information is derived from the joint statement on Schedule 13G/A, dated
  February 14, 2008, of FMR Corp., Edward C. Johnson 3d and Fidelity Management
  & Research Company filed with the Securities and Exchange Commission. The
  shares beneficially owned include 534,474 shares issuable upon conversion of
  our senior convertible notes held by FMR.
|   
|(5) | The
  information is derived from a statement on Schedule 13G, dated May 28, 2008,
  of Rima Management, LLC and Richard Mashaal filed with the Securities and
  Exchange Commission.                                                                                                                                                                                
|   
|(6) | Includes
  1,465,831 ordinary shares which may be purchased pursuant to options
  exercisable within sixty days following May 31, 2008.                                                                                                                                                                                                                              

Mr.
Adlersberg held 13.9% of our ordinary shares as of December 31, 2007, as
compared to 13.1% of our ordinary shares as of December 31, 2006 and 13.3% of
our ordinary shares as of December 31, 2005.

Mr.
Bialik held 9.8% of our ordinary shares as of December 31, 2007 as compared to
9.6% of our ordinary shares as of December 31, 2006 and 9.9% of our ordinary
shares as of December 31, 2005.

Soros
Fund Management LLC benecially owned 10.7% our ordinary shares as of February
14, 2008 and 10.6% of our ordinary shares as of December 31, 2007 (in each case
issuable upon conversion of our senior convertible notes), and less than 5.0%
of our ordinary shares as of December 31, 2006 and 2005.

82

---



FMR
Corp. held 7.1% of our ordinary shares as of December 31, 2007 (including
shares issuable upon conversion of our senior convertible notes), as compared
to 6.4% of our ordinary shares as of December 31, 2006 and 14.2% of our
ordinary shares as of December 31, 2005.

Kern
Capital held 5.5% of our ordinary shares as of December 31, 2006 and 6.9% of
our ordinary shares as of December 31, 2005. As of December 31, 2007, Kern
Capital ceased to be a beneficial owner of more than 5.0% of our ordinary
shares.

Rima
Management, LLC held 5.8% of our ordinary shares as of May 28, 3008 and less
than 5.0% of our ordinary shares as of December 31, 2007, 2006 and 2005.

As
of May 31, 2008, there were approximately 22 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

None.

INTERESTS OF EXPERTS AND COUNSEL

Not
applicable.

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

See
Item 18.

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

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

83

---



The
following table sets forth, for the periods indicated, the high and low sales
prices of our ordinary shares as reported by the Nasdaq Global Select Market.

|                |  |                 |       |     |   |      | 
|--------------- |  | --------------- | ----- | --- | - | ---- | 
|Calendar
  Year |  | Price Per Share |      
|                |  |                 |      
|                |  | High            |       | Low |  
|                |  |                 |       |     |  
|2007            |  | $               | 10.40 |     | $ | 4.55 | 
|2006            |  | $               | 14.64 |     | $ | 8.77 | 
|2005            |  | $               | 17.00 |     | $ | 8.67 | 
|2004            |  | $               | 16.88 |     | $ | 8.48 | 
|2003            |  | $               | 11.74 |     | $ | 2.10 | 

|                |                                          |  |                 |       |     |   |       | 
|--------------- | ---------------------------------------- |  | --------------- | ----- | --- | - | ----- | 
|Calendar Period |                                          |  | Price Per Share |      
|                |                                          |  |                 |      
|                |                                          |  | High            |       | Low |  
|                |                                          |  |                 |       |     |  
|2008            |                                          |  |                 |       |     |   |       | 
|                | Second quarter (through
  June 10, 2008) |  | $               | 4.73  |     | $ | 3.65  | 
|                | First quarter                            |  | $               | 5.26  |     | $ | 2.50  | 
|2007            |                                          |  |                 |       |     |   |       | 
|                | Fourth quarter                           |  | $               | 7.04  |     | $ | 4.87  | 
|                | Third quarter                            |  | $               | 6.59  |     | $ | 4.55  | 
|                | Second quarter                           |  | $               | 7.19  |     | $ | 5.01  | 
|                | First quarter                            |  | $               | 10.40 |     | $ | 6.60  | 
|2006            |                                          |  |                 |       |     |   |       | 
|                | Fourth quarter                           |  | $               | 11.24 |     | $ | 8.77  | 
|                | Third quarter                            |  | $               | 11.33 |     | $ | 9.13  | 
|                | Second quarter                           |  | $               | 14.33 |     | $ | 10.38 | 
|                | First quarter                            |  | $               | 14.64 |     | $ | 11.36 | 
|                |                                          |  |                 |       |     |   |       | 
|Calendar Month  |                                          |  | Price Per Share |      
|                |                                          |  |                 |      
|                |                                          |  | High            |       | Low |  
|                |                                          |  |                 |       |     |  
|2008            |                                          |  |                 |       |     |   |       | 
|                | May                                      |  | $               | 4.73  |     | $ | 3.90  | 
|                | April                                    |  | $               | 4.29  |     | $ | 3.65  | 
|                | March                                    |  | $               | 4.26  |     | $ | 3.15  | 
|                | February                                 |  | $               | 5.04  |     | $ | 4.16  | 
|                | January                                  |  | $               | 5.26  |     | $ | 3.78  | 
|2007            |                                          |  |                 |       |     |   |       | 
|                | December                                 |  | $               | 5.61  |     | $ | 4.87  | 

84

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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. All
share prices shown in the following table are in NIS. As of December 31, 2007,
the exchange rate was equal to approximately 3.553 NIS per U.S. $1.00.

|                |                                          |  |                 |             |     |  |              | 
|--------------- | ---------------------------------------- |  | --------------- | ----------- | --- |  | ------------ | 
|Calendar Year   |                                          |  | Price Per Share |            
|                |                                          |  |                 |            
|                |                                          |  | High            |             | Low | 
|                |                                          |  |                 |             |     | 
|2007            |                                          |  |                 | NIS
  44.00 |     |  | NIS
  18.90  | 
|2006            |                                          |  |                 | NIS
  66.27 |     |  | NIS
  38.10  | 
|2005            |                                          |  |                 | NIS
  73.80 |     |  | NIS
  40.20  | 
|2004            |                                          |  |                 | NIS
  74.90 |     |  | NIS
  39.10  | 
|2003            |                                          |  |                 | NIS
  53.50 |     |  | NIS
  10.42  | 
|2002            |                                          |  |                 | NIS
  26.94 |     |  | NIS  
  7.41 | 
|               
|Calendar Period |                                          |  | Price Per Share |            
|                |                                          |  |                 |            
|2008            |                                          |  |                 |             |     |  |              | 
|                | Second quarter (through
  June 10, 2008) |  |                 | NIS
  15.62 |     |  | NIS
  12.60  | 
|                | First quarter                            |  |                 | NIS
  20.20 |     |  | NIS
  10.81  | 
|2007            |                                          |  |                 |             |     |  |              | 
|                | Fourth quarter                           |  |                 | NIS
  28.00 |     |  | NIS
  18.90  | 
|                | Third quarter                            |  |                 | NIS
  27.78 |     |  | NIS
  19.32  | 
|                | Second quarter                           |  |                 | NIS
  28.66 |     |  | NIS
  22.00  | 
|                | First quarter                            |  |                 | NIS
  44.00 |     |  | NIS
  27.82  | 
|2006            |                                          |  |                 |             |     |  |              | 
|                | Fourth quarter                           |  |                 | NIS
  48.20 |     |  | NIS
  38.10  | 
|                | Third quarter                            |  |                 | NIS
  45.40 |     |  | NIS
  41.00  | 
|                | Second quarter                           |  |                 | NIS
  65.27 |     |  | NIS
  47.65  | 
|                | First quarter                            |  |                 | NIS
  66.27 |     |  | NIS
  50.90  | 
|                |                                          |  |                 |             |     |  |              | 
|Calendar Month  |                                          |  | Price Per Share |            
|                |                                          |  |                 |            
|                |                                          |  | High            |             | Low | 
|                |                                          |  |                 |             |     | 
|2008            |                                          |  |                 |             |     |  |              | 
|                | May                                      |  |                 | NIS
  15.62 |     |  | NIS
  13.25  | 
|                | April                                    |  |                 | NIS
  15.14 |     |  | NIS
  12.60  | 
|                | March                                    |  |                 | NIS
  15.65 |     |  | NIS
  10.81  | 
|                | February                                 |  |                 | NIS
  17.69 |     |  | NIS
  15.45  | 
|                | January                                  |  |                 | NIS
  20.20 |     |  | NIS
  14.05  | 
|2007            |                                          |  |                 |             |     |  |              | 
|                | December                                 |  |                 | NIS
  21.61 |     |  | NIS
  18.90  | 

85

---



|   |                     
|-- | --------------------
|B. | PLAN OF DISTRIBUTION
|   |                     
|   | Not
  applicable.   
|   |                     
|C. | MARKETS             

Our
ordinary shares are listed for trading on the Nasdaq Global 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.                     
|   |                                       
|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

We
were incorporated in 1992 under the laws of the State of Israel. 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.                                                                                     

86

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Share Capital

Our
authorized share capital consists of NIS 1,025,000 divided into 100,000,000
ordinary shares, nominal value NIS 0.01 per share, and 2,500,000 preferred
shares, nominal value NIS 0.01 per share. As of May 31, 2008, we had 41,158,796 ordinary shares outstanding and no
preferred shares outstanding.

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

Under
the Israeli Companies Law, 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 we
will not distribute any amounts of our undistributed tax exempt income as
dividend. We intend to reinvest our tax-exempt income and not to distribute
such income as a dividend. Accordingly, no deferred income taxes have been
provided on income attributable to our Approved Enterprise program as the
undistributed tax exempt income is essentially permanent in duration.

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, we may 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.

87

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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

Subject
to our undertaking to the Tel-Aviv Stock Exchange as described above, we may
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
75% 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 75% 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.

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.

88

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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 or
35 days in advance of the meeting. Notice of a meeting of shareholders must
also be published in two Israeli newspapers at least five days 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.

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.

Fiduciary Duties; 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.

Duty of
care.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. This includes the duty to use
reasonable means to obtain information regarding the advisability of a given
action submitted for his or her approval or performed by virtue of his or her
position and all other relevant information material to these actions.

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Duty
of loyalty.The duty of loyalty generally requires an
office holder to act in good faith and for the benefit 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. A company may approve any of the acts mentioned
above provided that all the following conditions apply: the office holder acted
in good faith and neither the act nor the approval of the act prejudices the
good of the company, and the office holder disclosed the essence of his or her
personal interest in the act, including any substantial fact or document, a
reasonable time before the date for discussion of the approval.

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.

Compensation.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.

Disclosure
of personal interest.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, as defined in the Companies Law, 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. Personal interest does not apply to a personal interest stemming
merely from holding shares in the company.

The
office holder must make the disclosure of his personal interest no later than
the first meeting of the companys board of directors that discusses the
particular transaction. 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. The Companies Law defines an extraordinary transaction as 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, and a relative as a spouse,
sibling, parent, grandparent, descendent, spouses descendant and the spouse of
any of the foregoing.

Approvals.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. Our articles of association do not
provide otherwise. Such approval must determine that the transaction is not
adverse to the companys interest. If the transaction is an extraordinary
transaction, or if it concerns exculpation, indemnification or insurance of an
office holder, 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. An office holder who has a personal interest in a matter that
is considered at a meeting of the board of directors or the audit committee
generally may not be present at this meeting or vote on this matter unless a
majority of the board of directors or the audit committee has a personal
interest in the matter. If a majority of the board of directors or the audit
committee has a personal interest in the transaction, shareholder approval also
would be required.

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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. Two or more shareholders with
a personal interest in the approval of the same transaction are deemed to be
one shareholder for the purpose of being a controlling shareholder.

Approval of the audit committee, the board of
directors and our shareholders, in that order, is required for:

| |   |                                                                                                                                                                 
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | extraordinary
  transactions, including a private placement, with a controlling shareholder
  or in which a controlling shareholder has a personal interest; and
| |   |                                                                                                                                                                 
| |  | the terms of
  compensation or employment of a controlling shareholder or his or her
  relative, as an officer holder or employee of our company.               

The
shareholders approval must include the majority of shares voted at the meeting.
In addition to the majority vote, the shareholder approval must satisfy either
of two additional tests:

| |   |                                                                                                                                                                                                                 
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | the majority
  includes at least one-third of the shares voted by shareholders who have no
  personal interest in the transaction; or                                                                           
| |   |                                                                                                                                                                                                                 
| |  | the total
  number of shares, other than shares held by the disinterested shareholders,
  that voted against the approval of the transaction does not exceed 1% of the
  aggregate voting rights of our company.

Under the Companies Law, a shareholder has a duty
to act in good faith and in a customary manner towards the company and other
shareholders, and to refrain from abusing his or her power in the company,
including when voting in a shareholders meeting or in a class meeting on
matters such as the following:

| |   |                                                                            
| | - | ---------------------------------------------------------------------------
| |  | an amendment
  to our articles of association;                             
| |   |                                                                            
| |  | an increase
  in our authorized share capital;                             
| |   |                                                                            
| |  | a merger; or                                                               
| |   |                                                                            
| |  | approval of
  related party transactions that require shareholder approval.

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In
addition, any controlling shareholder, any shareholder who knows that he or she
possesses the power to determine the outcome of a shareholders meeting or a
shareholders class meeting and any shareholder who has the power to prevent the
appointment of an office holder, is under a duty to act with fairness towards
the company. The Companies Law does not define the substance of this duty of
fairness, except to state that the remedies generally available upon a breach
of contract will also apply in the event of a breach of the duty to act with
fairness, taking into account the position in the company of those who breached
the duty of fairness.

Insurance, Indemnification and Exculpation of
Directors and Officers; Limitations on Liability

Insurance of Office Holders

The
Companies Law permits a company, if permitted by its articles of association,
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                                                                                                                          
| |   |                                                                                                                                                                                                          
| |  | the breach of
  his or her duty of loyalty 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 imposed on the office
holder in favor of a third party as a result of an act or omission that the
office holder committed in connection with his or her serving as an office
holder.

Indemnification of Office Holders

Under
the Companies Law, a company can, if permitted by its articles of association,
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 either:
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| |  | no financial
  liability was imposed on the office holder in lieu of criminal proceedings,
  or                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| |  | financial
  liability was imposed on the office holder in lieu of criminal proceedings
  but the alleged criminal offense does not require proof of criminal intent,
  and                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       

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| |   |                                                                                                                                                    
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------
| |  | reasonable
  litigation expenses, including attorneys fees, actually incurred by the
  office holder or imposed upon the office holder by a court,
| |   |                                                                                                                                                    
| |  | in an action
  brought against the office holder by the company, on behalf of the company or
  on behalf of a third party;                         
| |   |                                                                                                                                                    
| |  | in a
  criminal action in which the office holder is found innocent; or                                                                            
| |   |                                                                                                                                                    
| |  | in a
  criminal action in which the office holder is convicted but in which proof of
  criminal intent is not required.                            

A
company may indemnify an office holder in respect of these liabilities either
in advance of an event or following an event. If a company undertakes to
indemnify an office holder in advance of an event, the indemnification, other
than legal costs, must be limited to foreseeable events in light of the
companys actual activities when the company undertook such indemnification,
and reasonable amounts or standards, as determined by the board of directors.

Exculpation of Office Holders

Under
the Companies Law, a company may, if permitted by its articles of association,
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.

Limitations on Exculpation, Insurance and
Indemnification

Under
the Companies Law, a company may indemnify or insure an office holder against a
breach of duty of loyalty only to the extent that the office holder acted in
good faith and had reasonable grounds to assume that the action would not
prejudice the company. In addition, a company may not indemnify, insure or
exculpate an office holder against a breach of duty of care if committed
intentionally or recklessly (excluding mere negligence), or committed with the
intent to derive an unlawful personal gain, or for a fine or forfeit levied
against the office holder in connection with a criminal offense.

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. Pursuant to the Companies
Law, exculpation of, procurement of insurance coverage for, and an undertaking
to indemnify or indemnification of, our office holders must be approved by our
audit committee and our board of directors and, if the office holder is a
director, also by our shareholders.

We
have entered into agreements with each of our directors and senior officers to
insure, indemnify and exculpate them to the full extent permitted by law
against some types of claims, subject to dollar limits and other limitations.
These agreements have 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.

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

On
July 6, 2006, we completed the acquisition of Nuera, which became our
wholly-owned subsidiary. Under the acquisition agreement, Nuera was acquired
for a purchase price of $82.5 million in cash, subject to reduction for certain
expenses.

On
August 14, 2006, we completed the acquisition of Netrake, which became our
wholly-owned subsidiary. Under the definitive agreement, Netrake was acquired
for a purchase price of $13.8 million in cash.

In
April 2007, we acquired the remaining outstanding common stock of CTI
Squared Ltd. Prior to this acquisition, we had an investment in CTI Squared in the amount of $1.6 million. In consideration for the acquisition, we paid $4.9 million in cash
at the closing of the transaction in April 2007 and committed to pay an additional $5.0 million by April, 2008. In February
2008, we paid the additional amount of $5.0 million.

In
April 2008, we entered into a loan agreement with First International Bank of
Israel that provides for borrowings in the aggregate amount of $15 million. See
Item 5B of this Annual Report on Form 20-F for a summary of the loan agreement.

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

Non-residents
of Israel who own our ordinary shares may freely convert all amounts received
in Israeli currency in respect of such ordinary shares, whether as a dividend,
liquidation distribution or as proceeds from the sale of the ordinary shares,
into freely-repatriable non-Israeli currencies at the rate of exchange
prevailing at the time of conversion (provided in each case that the applicable
Israeli income tax, if any, is paid or withheld).

Since
January 1, 2003, all exchange control restrictions on transactions in foreign
currency in Israel have been eliminated, although there are still reporting
requirements for foreign currency transactions. Legislation remains in effect,
however, pursuant to which currency controls may be imposed by administrative
action at any time.

The
State of Israel does not restrict in any way the ownership or voting of our
ordinary shares by non-residents of Israel, except with respect to subjects of
countries that are in a state of war with Israel.

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

The
following is a summary of the material Israeli and United States federal 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.
Potential investors are urged to consult their own tax advisors as to the
Israeli tax, United States federal income tax and other tax consequences of the
purchase, ownership and disposition of ordinary shares, including, in
particular, the effect of any foreign, state or local taxes.

Israeli Tax
Considerations

General Corporate Tax Structure

Israeli
companies were generally subject to corporate tax at the rate of 29% of their
taxable income in 2007. Pursuant to tax reform legislation that came into
effect in 2005, the corporate tax rate is to undergo further staged reductions
to 25% by the year 2010. In order to implement these reductions, the corporate
tax rate in Israel is scheduled to decline to 27% in 2008 and 26% in 2009.
However, the effective tax rate payable by a company that derives income from
an approved enterprise (as discussed below) may be considerably less.

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. Until recently, the
designation required advance approval from the Investment Center of the Israel
Ministry of Industry, Trade and Labor (the Investment Center). 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.

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 (these limits do not apply to the
exemption period). 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).

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We
have elected the alternative package of tax exemptions and reduced tax rates
for our production facilities that have received Approved Enterprise status.
Accordingly, income derived from these facilities is generally entitled to a
tax-exemption period of two years and a reduced corporate tax rate of 10% to
25% for an additional period of five to eight years, based on our percentage of
foreign investment. The tax benefits for our existing Approved Enterprise
programs are scheduled to gradually expire by 2013. The period of tax benefits
for each capital investment plan expires upon the earlier of: (1) twelve years
from completion of the investment under the approved plan, or (2) fourteen
years from receipt of approval (these limits do not apply to the exemption
period).

Out
of our retained earnings as of December 31, 2007, approximately $540,000 are
tax-exempt. If we were to distribute this tax-exempt income before our complete
liquidation, it would be taxed at the reduced corporate tax rate applicable to
these profits (10% to 25%), and an income tax liability of up to approximately
$135,000 would be incurred. Our board of directors has currently determined
that we will not distribute any amounts of our undistributed tax exempt income
as dividend. We intend to reinvest our tax-exempt income and not to distribute
such income as a dividend. Accordingly, no deferred income taxes have been
provided on income attributable to our Approved Enterprise.

If
we fail to meet the requirements of an Approved Enterprise we would be subject
to corporate tax in Israel at the regular statutory rate. We could also be
required to refund tax benefits, with interest and adjustments for inflation
based on the Israeli consumer price index.

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 2013.

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.

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Future
approved enterprises will be reviewed separately, and the decisions whether to
approve or reject a designation as an approved enterprise or privileged
enterprise will be based, among other things, on the criteria set forth in the
Investment Law and related regulations (as amended in April 2005 as described
below), 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, 2007, management believes that we meet all of the
aforementioned conditions.

On
April 1, 2005, an amendment to the law came into effect (the Amendment) and
has significantly changed the provisions of the law. The Amendment limits the
scope of enterprises which may be approved by the Investment Center by setting
criteria for the approval of a facility as a Privileged Enterprise, such as
provisions generally requiring that at least 25% of the Privileged Enterprises
income will be derived from export. Additionally, the Amendment enacted major
changes in the manner in which tax benefits are awarded under the law so that
companies no longer require Investment Center approval in order to qualify for
tax benefits.

In
addition, the law provides that terms and benefits included in any certificate
of approval granted prior to December 31, 2004 will remain subject to the
provisions of the law as they were on the date of such approval. Therefore, our
existing Approved Enterprises will generally not be subject to the provisions
of the Amendment. As a result of the Amendment, tax-exempt income generated
under the provisions of the law as amended, will subject us to taxes upon distribution
or liquidation and we may be required to record a deferred tax liability with
respect to such tax-exempt income.

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.

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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 since 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 2005 amendment to the Research Law 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.

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:

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| |   |                                                                                                                                                                                                                    
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | 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; and                                                                                                                                                    
| |   |                                                                                                                                                                                                                    
| |  | deductions
 over a three-year period of expenses involved with the issuance and listing
 of shares on the Tel Aviv Stock Exchange or, on or after January 1, 2003, on
 a recognized stock market outside of Israel.

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.

Special Provisions Relating to Measurement of
Taxable Income

We
elected to measure our taxable income and file our tax return under the Israeli
Income Tax Regulations (Principles Regarding the Management of Books of Account
of Foreign Invested Companies and Certain Partnerships and the Determination of
Their Taxable Income), 1986. Accordingly, commencing taxable year 2003, results
for tax purposes are measured in terms of earnings in dollars.

Capital Gains Tax

Israeli
law generally imposes a capital gains tax on the sale of publicly traded
securities. Pursuant to changes made to the Israeli Income Tax Ordinance in
January 2006, capital gains on the sale of our ordinary shares will be subject
to Israeli capital gains tax, generally at a rate of 20% unless the holder
holds 10% or more of our voting power during the 12 months preceding the sale,
in which case it will be subject to a 25% capital gains tax.

However,
as of January 1, 2003, 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.

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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.

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. Generally, on
distributions of dividends, other than bonus shares and stock dividends, income
tax at the rate of 25% is withheld at the source (except that dividends
distributed on or after January 1, 2006 to an individual who is deemed a
non-substantial shareholder are subject to tax at the rate of 20%), unless a
different rate is provided in a treaty between Israel and the shareholders
country of residence. 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.

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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 acquisition, ownership
and disposition of our ordinary shares. This summary is based on 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 as of the date hereof and all of
which are subject to change (possibly with retroactive effect) or different
interpretations. 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:

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| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | 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 other entity taxable as a corporation for U.S. federal income
 tax purposes created or organized in or 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
 (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 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 U.S. federal alternative
minimum tax, or any aspect of state, local or non-U.S. federal tax laws or U.S.
federal tax laws other than U.S. federal income tax laws. In addition, this
summary is directed only to U.S. Holders that hold our ordinary shares as
capital assets within the meaning of Section 1221 of the Code and does not
address the considerations that may be applicable to particular classes of U.S.
Holders, including financial institutions, regulated investment companies, real
estate investment trusts, pension funds, insurance companies, broker-dealers,
tax-exempt organizations, grantor trusts, partnerships or other pass-through
entities, holders whose functional currency is not the U.S. dollar, holders who
have elected mark-to-market accounting, holders who acquired our ordinary
shares through the exercise of options or otherwise as compensation, holders
who hold our ordinary shares as part of a straddle, hedge or conversion
transaction, holders selling our ordinary shares short, holders deemed to have
sold our ordinary shares in a constructive sale, and holders, directly,
indirectly or through attribution, of 10% or more (by vote or value) of our
outstanding ordinary shares. If a partnership (including for this purpose any
entity, domestic or foreign, treated as a partnership for U.S. federal income
tax purposes) is a beneficial owner of our ordinary shares, the U.S. federal
income tax treatment of a partner in such partnership generally will depend
upon the status of the partner and the activities of the partnership. A
partnership that is a beneficial owner of our ordinary shares, and partners in
such partnership, are urged to consult their own tax advisors regarding the
U.S. federal income tax consequences of the acquisition, ownership and
disposition of our ordinary shares.

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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 acquisition, ownership and disposition of our
ordinary shares, including the effects of applicable tax treaties, state,
local, foreign or other tax laws and possible changes in the tax laws.

Distributions With Respect to Our Ordinary
Shares

For
U.S federal income tax purposes, the amount of a distribution with respect to
our ordinary shares will equal the amount of cash distributed, the fair market
value of any property distributed and the amount of any Israeli taxes withheld
on such distribution as described above under Israeli Tax Considerations  Tax
on Dividends. Other than distributions in liquidation or in redemption of our
ordinary shares that are treated as exchanges, a distribution 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 (but not below zero), and then generally as
capital gain from a deemed sale or exchange of such ordinary shares. Corporate
U.S. Holders generally will not be allowed a deduction under Section 243 of the
Code for dividends received on our ordinary shares and thus will be subject to
tax at the rate applicable to their taxable income. Currently, a noncorporate
U.S. Holders qualified dividend income generally is subject to tax at a rate
of 15%. For this purpose, qualified dividend income generally includes
dividends paid by a foreign corporation if, among other things, the
noncorporate U.S. Holder meets certain minimum holding period requirements and
either (a) the stock of such corporation 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 us will not
qualify for the 15% U.S. federal income tax rate, however, if we are treated,
for the tax year in which the dividends are paid or the preceding tax year, as
a passive foreign investment company for U.S. federal income tax purposes.
See the discussion below under the heading Passive Foreign Investment Company
Status. U.S. Holders are urged to consult their own tax advisors regarding the
U.S. federal income tax consequences of their receipt of any distributions with
respect to our ordinary shares.

A
dividend paid by us in NIS will be included in the income of U.S. Holders at
the U.S. dollar amount of the dividend, based on the spot rate of exchange in
effect on the date of receipt or deemed receipt of the dividend, regardless of
whether the payment is in fact converted into U.S. dollars. U.S. Holders will
have a tax basis in the NIS for U.S. federal income tax purposes equal to that
U.S. dollar value. Any gain or loss upon the subsequent conversion of the NIS
into U.S. dollars or other disposition of the NIS will constitute foreign
currency gain or loss taxable as ordinary income or loss and will be treated as
U.S.-source income or loss for U.S. foreign tax credit purposes.

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Dividends
received 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. Dividends
received with respect to our ordinary shares also generally will be treated as
investment income for purposes of the investment interest deduction
limitation contained in Section 163(d) of the Code, and as 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 distributions with respect to our ordinary shares which constitute
dividends under U.S. income tax law. A U.S. Holder that does not elect to claim
a foreign tax credit may instead claim a deduction for Israeli income tax
withheld, but only if the U.S. Holder elects to do so with respect to all
foreign income taxes in such year. In addition, special rules may apply to the
computation of foreign tax credits relating to qualified dividend income, as
defined above. 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 are complex and involve 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 with respect to any
dividends which may be paid with respect to our ordinary shares.

Disposition of Our Ordinary Shares

Subject
to the discussion below under Passive Foreign Investment Company Status, a
U.S. Holders sale, exchange or other taxable disposition 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 U.S. dollar value
of the amount realized and the U.S. Holders tax basis in the ordinary shares
disposed of (measured in U.S. dollars). This gain or loss will be long-term
capital gain or loss if such ordinary shares have been held or are deemed to
have been held for more than one year at the time of the disposition.
Individual U.S. Holders currently are subject to a maximum tax rate of 15% on
long-term capital gains recognized during tax years beginning on or before
December 31, 2010. If the U.S. Holders holding period on the date of the
taxable disposition is one year or less, such gain or loss will be a short-term
capital gain or loss. Short-term capital gains generally are taxed at the same
rates applicable to ordinary income. See Israeli Tax Considerations  Capital
Gains Tax for a discussion of taxation by Israel of capital gains realized on
sales of our ordinary shares. Any capital loss realized upon the taxable
disposition of our ordinary shares generally will be deductible only against
capital gains and not against ordinary income, except that noncorporate U.S.
Holders generally may deduct annually from ordinary income up to $3,000 of net
capital losses. In general, any capital gain or loss recognized by a U.S.
Holder upon the taxable disposition of our ordinary shares will be treated as
U.S.-source income or loss for U.S. foreign tax credit purposes. However, under
the tax treaty between the United States and Israel, gain derived from the
taxable disposition of ordinary shares by a U.S. Holder who is a resident of
the U.S. 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.

103

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A
U.S. Holders tax basis in its ordinary shares generally will be the U.S.
dollar purchase price paid by such U.S. Holder to acquire such ordinary shares.
The U.S. dollar cost of ordinary shares purchased with foreign currency
generally will be the U.S. dollar value of the purchase price on the date of
purchase or, in the case of our ordinary shares that are purchased by a cash
basis U.S. Holder (or an accrual basis U.S. Holder that so elects), on the
settlement date for the purchase. Such an election by an accrual basis U.S.
Holder must be applied consistently from year to year and cannot be revoked
without the consent of the U.S. Internal Revenue Service. The holding period of
each ordinary share owned by a U.S. Holder will commence 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 a taxable disposition of our ordinary shares,
the amount realized will be based on the spot rate of exchange on the
settlement date of such taxable disposition. If such U.S. Holder subsequently
converts NIS into U.S. dollars at a conversion rate other than the spot rate in
effect on the settlement date, such U.S. Holder may have a foreign currency
exchange gain or loss treated as ordinary income or loss for U.S. federal
income tax purposes. A U.S. Holder who uses the accrual method of accounting
may elect the same treatment required of cash method taxpayers with respect to
a 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 method U.S. Holder
does not elect to be treated as a cash method taxpayer (pursuant to U.S.
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 in the event of any difference
between the U.S. dollar value of the NIS on the date of the taxable disposition
and the settlement date. Any such currency gain or loss generally would be
treated as U.S.-source ordinary income or loss and would be subject to tax in
addition to any gain or loss recognized by such U.S. Holder on the 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). Passive income for this purpose
generally includes dividends, interest, rents, royalties and gains from
securities and commodities transactions.

There
is no definitive method prescribed in the Code, U.S. Treasury Regulations or
relevant administrative or judicial interpretations for determining the value
of a foreign corporations assets for purposes of the Asset Test. While the
legislative history of the U.S. Taxpayer Relief Act of 1997 (the 1997 Act)
indicates that for purposes of the Asset Test, 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, it is unclear whether other valuation methods could be employed
to determine the value of a publicly-traded foreign corporations assets for
purposes of 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, 2005, 2006 and 2007, we do not believe that we were a
PFIC during any of such tax years. It is likely, however, that under the asset
valuation method described in the legislative history of the 1997 Act, we would
have been classified as a PFIC in 2001, 2002 and 2003 primarily because (a) a
significant portion of our assets consisted of the remaining proceeds of our
two public offerings of ordinary shares in 1999, and (b) the public market
valuation of our ordinary shares during such years was relatively low. There
can be no assurance that we will not be deemed a PFIC in any future tax year.

U.S.
Holders are urged to consult their own tax advisors for guidance as to our
status as a PFIC in any tax year. For those U.S.
Holders who determine that we are a PFIC in any 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):

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| |  | Excess
 distributions by us to the 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. Thus, the U.S. Holder would be required
 to include in its gross income amounts allocated to the current tax year as
 ordinary income for that year, pay tax on amounts allocated to each prior tax
 year in which we were a PFIC at the highest rate on ordinary income in effect
 for such prior year and pay an interest charge on the resulting tax at the
 rate applicable to deficiencies of U.S. federal income tax.
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |  | The entire
 amount of any gain realized by the 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.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |  | 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 instead would 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 be a PFIC,
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 its ordinary shares through the close of the tax year in which
we cease to be a PFIC.

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A
U.S. Holder who beneficially owns shares of a PFIC must file U.S. Internal
Revenue Service Form 8621 (Return by a Shareholder of a Passive Foreign
Investment Company or Qualified Electing Fund) with the U.S. Internal Revenue
Service for each tax year in which such U.S. Holder holds shares in a PFIC.
Once properly completed, 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 its 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 made to the U.S. Holder. Any gain subsequently recognized
by the U.S. Holder upon the sale or other disposition of its 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. A
QEF Election is effective for the tax 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. A U.S. Holder
making the QEF Election must make the election on or before the due date, as
extended, for the filing of its U.S. federal 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 U.S. Internal Revenue Service 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. Upon a U.S. Holders request, we will
provide to such U.S. Holder the information required to make a QEF Election and
to make subsequent annual filings.

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 tax year, between the fair market value of its ordinary shares and the
adjusted tax basis of such shares. 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 U.S.
Internal Revenue Service.

The
implementation of many aspects of the Codes PFIC rules requires the issuance
of Treasury Regulations which in many instances have yet to be promulgated and
which may have retroactive effect when promulgated. 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 if we are treated as a PFIC.

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Information Reporting and Backup Withholding

Payments
in respect of our ordinary shares that are made in the U.S. or by certain
U.S.-related financial intermediaries may be subject to information reporting
requirements and U.S. backup withholding tax at rates equal to 28% through 2010
and 31% after 2010. The information reporting requirements will not apply,
however, to payments to certain U.S. Holders, including corporations and
tax-exempt organizations. In addition, the backup withholding tax will not
apply to a U.S. Holder that furnishes a correct taxpayer identification number
on U.S. Internal Revenue Service Form W-9 (or substitute form). The backup
withholding tax is not an additional tax. Amounts withheld under the backup
withholding tax rules may be credited against a U.S. Holders U.S. federal
income tax liability, and a U.S. Holder may obtain a refund of any excess
amounts withheld under the backup withholding tax rules by filing the
appropriate claim for refund with the U.S. Internal Revenue Service. U.S.
Holders should consult their own tax advisors regarding their qualification for
an exemption from the backup withholding tax and the procedures for obtaining
such an exemption, if applicable.

The
foregoing discussion of certain U.S. federal income tax considerations is a
general summary only and should not be considered as income tax advice or
relied upon for tax planning purposes. Accordingly, each U.S. Holder should
consult with 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 our ordinary shares.

|   |                            
|-- | ---------------------------
|F  | DIVIDENDS AND PAYING AGENTS
|   |                            
|   | Not
 applicable.           
|   |                            
|G. | STATEMENT BY EXPERTS       
|   |                            
|   | Not
 applicable.           
|   |                            
|H. | DOCUMENTS ON DISPLAY       

We
are subject to the informational requirements of the Securities Exchange Act of
1934, as amended, applicable to foreign private issuers and fulfill the
obligations with respect to such requirements by filing reports with the
Securities and Exchange Commission, or SEC. You may read and copy any document
we file, including any exhibits, with the SEC without charge at the SECs
public reference room at 100 F Street, N.E., Washington, D.C. 20549. Copies of
such material may be obtained by mail from the Public Reference Branch of the
SEC at such address, at prescribed rates. Please call the SEC at 1-800-SEC-0330
for further information on the public reference room. Certain of our SEC
filings are also available to the public at the SECs website at http://www.sec.gov.

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As
a foreign private issuer, we are exempt from the rules under the Exchange Act
prescribing the furnishing and content of proxy statements, and our officers,
directors and principal shareholders are exempt from the reporting and
short-swing profit recovery provisions contained in Section 16 of the
Exchange Act. In addition, we are not required under the Exchange Act to file
periodic reports and financial statements with the SEC as frequently or as
promptly as United States companies whose securities are registered under the
Exchange Act. We have an exemption from Nasdaqs requirement to send an annual
report to shareholders prior to our annual general meetings. We file annual
reports on Form 20-F electronically with the SEC and post a copy on our
website, www.audiocodes.com.

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|-- | ---------------------- | ----------------------------------------------------------
|I. | SUBSIDIARY INFORMATION
|   |                        |                                                           
|   | Not
 applicable.      
|   |                        |                                                           
|   | ITEM 11.               | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We are
exposed to financial market risk associated with changes in foreign currency
exchange rates. To mitigate these risks, we use derivative financial
instruments. The majority of our revenues and expenses are generated in U.S.
dollars. A portion
of our expenses, however, is denominated in NIS. In order to protect ourselves
against the volatility of future cash flows caused by changes in foreign
exchange rates, we use currency forward contracts and currency options. We
hedge the part of our forecasted expenses denominated in NIS. If our currency
forward contracts and currency options meet the definition of a hedge, and are
so designated, changes in the fair value of the contracts will be offset
against changes in the fair value of the hedged assets or liabilities through
earnings. For derivative instruments not designated as hedging instruments, the
gain or loss is recognized in current earnings during the period of change. Our
hedging program reduces, but does not eliminate, the impact of foreign currency
rate movements and due to the general economic slowdown along with the
devaluation of the dollar, our results of operations may be adversely affected.

Our
investment portfolio includes held to maturity marketable securities. The contractual cash flows of these investments are
either agencies of the U.S. government that have implied guaranty by the U.S.
government or were issued by highly rated corporations. As
of December 31, 2007, the securities in our portfolio were rated at least as A.
Securities representing about 35% of the portfolio are rated as AAA. The recent declines in interest rates
may reduce our interest income.

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| | ---------------- | ------------------------------------------------------
| | ITEM 12.         | DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES
| |                  |                                                       
| | Not
 applicable.

108

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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

Disclosure Controls and Procedures

Our management, with the participation of its chief executive officer and
chief financial officer, evaluated the effectiveness of our
disclosure controls and procedures (as defined in 13a-15(e) under the
Securities Exchange Act) as of December 31, 2007. Based on this evaluation,
our chief executive officer and chief financial officer have concluded
that, as of such date, our disclosure controls and procedures were
(i) designed to ensure that material information relating to us,
including our consolidated subsidiaries, is made known to our management,
including our chief executive officer and chief financial officer, by
others within those entities, as appropriate to allow timely decisions
regarding required disclosure, particularly during the period in which this
report was being prepared and (ii) effective, in that they provide reasonable
assurance that information required to be disclosed by us in the reports
that we file or submit under the Exchange Act is recorded, processed,
summarized and reported within the time periods specified in the SECs rules
and forms.

Managements Annual Report on Internal
Control Over Financial Reporting

Our
management, under the supervision of our Chief Executive Officer and Chief
Financial Officer, is responsible for establishing and maintaining adequate
internal control over our financial reporting, as defined in Rules 13a-15(f) of
the Exchange Act. Our internal control over financial reporting is designed to
provide reasonable assurance to our management and board of directors regarding
the reliability of financial reporting and the preparation of financial
statements for external purposes in accordance with generally accepted
accounting principles. Internal control over financial reporting includes
policies and procedures that:

|  |                                                                                                                                                                                                             
|- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | pertain to
  the maintenance of our records that in reasonable detail accurately and
  fairly reflect our transactions and asset dispositions;                                                              
|  |                                                                                                                                                                                                             
| | provide
  reasonable assurance that our transactions are recorded as necessary to
  permit the preparation of our financial statements in accordance with
  generally accepted accounting principles;       
|  |                                                                                                                                                                                                             
| | provide
  reasonable assurance that our receipts and expenditures are made only in
  accordance with authorizations of our management and board of directors (as
  appropriate); and                        
|  |                                                                                                                                                                                                             
| | provide
  reasonable assurance regarding the prevention or timely detection of
  unauthorized acquisition, use or disposition of our assets that could have a
  material effect on our financial statements.

109

---



Due
to its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements. In addition, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may
become inadequate because of changes in conditions, or that the degree of
compliance with the policies or procedures may deteriorate.

Under
the supervision and with the participation of our management, including our
principal executive officer and principal financial officer, we conducted an
evaluation of the effectiveness of our internal control over financial
reporting as of December 31, 2007 based on the framework for Internal Control -
Integrated Framework set forth by the Committee of Sponsoring Organizations of
the Treadway Commission (COSO). Based on our assessment under that framework
and the criteria established therein, our management concluded that the Companys
internal control over financial reporting were effective as of December 31,
2007.

Attestation Report of the Registered Public
Accounting Firm

This
annual report includes an attestation report of our registered public
accounting firm regarding internal control over financial reporting
on page F-3 of our audited consolidated financial statements set forth in Item 18 - Financial Statements, and is
incorporated herein by reference.

Changes in Internal Control Over Financial
Reporting

There
were no changes in our internal controls over financial reporting identified
with the evaluation thereof that occurred during the period covered by this
annual report that have materially affected, or are 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 and is independent as
defined in the applicable regulations.

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

We
have 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.

110

---



| |           |                                       
| | --------- | --------------------------------------
| | 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, 2007. The following table presents the aggregate fees
for professional audit services and other services rendered by Kost Forer
Gabbay & Kasierer in 2006 and 2007.

|                     |  |                                                 |     |      |   |     | 
|-------------------- |  | ----------------------------------------------- | --- | ---- | - | --- | 
|                     |  | Year Ended December 31
  (Amounts in thousands) |    
|                     |  |                                                 |    
|                     |  | 2006                                            |     | 2007 |  
|                     |  |                                                 |     |      |  
|                    
|Audit Fees           |  | $                                               | 191 |      | $ | 331 | 
|Audit
  Related Fees |  |                                                 | 315 |      |   | 21  | 
|Tax Fees             |  |                                                 | 129 |      |   | 94  | 
|                     |  |                                                 |     |      |   |     | 
|Total                |  | $                                               | 635 |      | $ | 446 | 
|                     |  |                                                 |     |      |   |     | 

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 services rendered for the integrated audit
over internal controls as required under Section 404 of the Sarbanes-Oxley Act applicable
in 2007, 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.

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.

111

---



The
Audit Committee pre-approves fee levels annually for the audit services.,
Non-audited services are pre-approved as required. The Chairman of the audit
committee may approve non-audit services of up to $25,000 and then request the
audit committee to ratify his decision.

During
2007, 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
| |                                                  |                     
| | Reference is
  made to pages F-1 to F-68 hereto.

| |                                                                   |         
| | ----------------------------------------------------------------- | --------
| | 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 2.00% Senior Convertible Notes due 2024.****
|              |  |                                                                                                                                                                                
|4.1           |  | AudioCodes
  Ltd. 1997 Key Employee Option Plan (C).*                                                                                                                          

112

---



|              |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|------------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit
  No. |  | Exhibit                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|              |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|              |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|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           |  | License
  Agreement between AudioCodes Ltd. and DSP Group, Inc., dated as of May 6,
  1999.*                                                                                                                                                                                                                                                                                                                                                                                     
|              |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|4.5           |  | Lease
  Agreement between AudioCodes Inc. and Spieker Properties, L.P., dated January
  26, 2000.**                                                                                                                                                                                                                                                                                                                                                                               
|              |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|4.6           |  | 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.*
|              |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|4.7           |  | AudioCodes
  Ltd. 1997 Key Employee Option Plan (D).*                                                                                                                                                                                                                                                                                                                                                                                                                             
|              |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|4.8           |  | AudioCodes
  Ltd. 1997 Key Employee Option Plan (E).*                                                                                                                                                                                                                                                                                                                                                                                                                             
|              |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|4.9           |  | AudioCodes
  Ltd. 1999 Key Employee Option Plan (F), as amended.***                                                                                                                                                                                                                                                                                                                                                                                                               
|              |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|4.10          |  | AudioCodes
  Ltd. 1997 Key Employee Option Plan, Qualified Stock Option PlanU.S.
  Employees (E).*                                                                                                                                                                                                                                                                                                                                                                               
|              |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|4.11          |  | AudioCodes
  Ltd. 1999 Key Employee Option Plan, Qualified Stock Option PlanU.S.
  Employees (F).***                                                                                                                                                                                                                                                                                                                                                                             
|              |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|4.12          |  | AudioCodes
  Ltd. 2001 Employee Stock Purchase PlanGlobal Non U.S., as amended. §                                                                                                                                                                                                                                                                                                                                                                                                
|              |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|4.13          |  | AudioCodes
  Ltd. 2001 U.S. Employee Stock Purchase Plan, as amended.§                                                                                                                                                                                                                                                                                                                                                                                                            
|              |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|4.13a         |  | AudioCodes
  Ltd. 2007 U.S. Employee Stock Purchase Plan.§§§§§§                                                                                                                                                                                                                                                                                                                                                                                                                   
|              |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|4.14          |  | Lease
  Agreement between AudioCodes Ltd. and Nortel Networks (Marketing and Sales)
  Israel Ltd., effective as of December 31, 2002.**                                                                                                                                                                                                                                                                                                                                          
|              |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|4.15          |  | Sublease
  Agreement between AudioCodes USA, Inc. and Continental Resources, Inc., dated
  December 30, 2003.§§                                                                                                                                                                                                                                                                                                                                                                   

113

---



|              |  |                                                                                                                                                                                                                                                                                                 
|------------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit
  No. |  | Exhibit                                                                                                                                                                                                                                                                                         
|              |  |                                                                                                                                                                                                                                                                                                 
|              |  |                                                                                                                                                                                                                                                                                                 
|4.16          |  | Stock
  Purchase Agreement by and among AudioCodes Ltd., AudioCodes Inc., Ai-Logix,
  Inc. and AI Technologies N.V, dated as of May 12, 2004.§§                                                                                                                                                 
|              |  |                                                                                                                                                                                                                                                                                                 
|4.17          |  | OEM Purchase
  and Sale Agreement No. 011449 between AudioCodes Ltd and Nortel Networks
  Ltd., dated as of April 28, 2003 *****§§                                                                                                                                                              
|              |  |                                                                                                                                                                                                                                                                                                 
|4.18          |  | Amendment
  No. 1 to OEM Purchase and Sale No. 011449 between AudioCodes Ltd and Nortel
  Networks Ltd., dated as of May 1, 2003 *****§§                                                                                                                                                        
|              |  |                                                                                                                                                                                                                                                                                                 
|4.19          |  | Purchase and
  Sale Agreement by and among Nortel Networks, Ltd., AudioCodes Inc. and
  AudioCodes Ltd., dated as of April 7, 2003.§§                                                                                                                                                           
|              |  |                                                                                                                                                                                                                                                                                                 
|4.20          |  | 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.****
|              |  |                                                                                                                                                                                                                                                                                                 
|4.21          |  | Amendment
  No. 2 to OEM Purchase and Sale No. 011449 between AudioCodes Ltd and Nortel Networks
  Ltd., dated as of January 1, 2005 *****§§§                                                                                                                                                   
|              |  |                                                                                                                                                                                                                                                                                                 
|4.22          |  | Amendment
  No. 3 to OEM Purchase and Sale No. 011449 between AudioCodes Ltd and Nortel
  Networks Ltd., dated as of February 15, 2005 *****§§§                                                                                                                                                 
|              |  |                                                                                                                                                                                                                                                                                                 
|4.23          |  | Amendment
  No. 5 to OEM Purchase and Sale No. 011449 between AudioCodes Ltd and Nortel
  Networks Ltd., dated as of January 1, 2005 *****§§§                                                                                                                                                   
|              |  |                                                                                                                                                                                                                                                                                                 
|4.24          |  | Amendment
  No. 6 to OEM Purchase and Sale No. 011449 between AudioCodes Ltd and Nortel
  Networks Ltd., dated as of April 1, 2005 §§§                                                                                                                                                          
|              |  |                                                                                                                                                                                                                                                                                                 
|4.25          |  | Lease Agreement
  between AudioCodes Inc. and CA-Gateway Office Limited Partnership, effective
  as of December, 2004. §§§                                                                                                                                                                      
|              |  |                                                                                                                                                                                                                                                                                                 
|4.26          |  | Amendment
  No. 4 to OEM Purchase and Sale No. 011449 between AudioCodes Ltd and Nortel
  Networks Ltd., dated as of April 28, 2005 ***** §§§§                                                                                                                                                  
|              |  |                                                                                                                                                                                                                                                                                                 
|4.27          |  | Agreement
  and Plan of Merger, dated as of May 16, 2006, among AudioCodes Ltd.,
  AudioCodes, Inc., Green Acquisition Corp., Nuera Communications, Inc. and
  Robert Wadsworth, as Sellers Representative. §§§§                                                                               
|              |  |                                                                                                                                                                                                                                                                                                 
|4.28          |  | Building and
  Tenancy Lease Agreement, dated May 11, 2007, by and between Airport City Ltd.
  and AudioCodes Ltd. §§§§§                                                                                                                                                                       

114

---



|              |  |                                                                                                                                                                                                              
|------------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit
  No. |  | Exhibit                                                                                                                                                                                                      
|              |  |                                                                                                                                                                                                              
|              |  |                                                                                                                                                                                                              
|4.29          |  | Agreement
  and Plan of Merger, dated as of July 6, 2006, by and among AudioCodes Ltd.,
  AudioCodes, Inc., Violet Acquisition Corp., Netrake Corporation and Will
  Kohler, as Sellers Representative.§§§§§
|              |  |                                                                                                                                                                                                              
|4.30          |  | Series E
  Preferred Share Purchase Agreement, dated as of November 13, 2005, by and
  between CTI Squared Ltd. and AudioCodes Ltd.§§§§§                                                                     
|              |  |                                                                                                                                                                                                              
|4.31          |  | Amended and
  Restated Second Option Agreement, dated as of October 6, 2006, by and among
  CTI Squared Ltd., AudioCodes Ltd. and each of the other parties thereto.§§§§§                                    
|              |  |                                                                                                                                                                                                              
|4.32          |  | Amendment
  No. 7 to OEM Purchase and Sale No. 011449 between AudioCodes Ltd. and Nortel
  Networks Ltd., dated as of December 15, 2006.§§§§§                                                                
|              |  |                                                                                                                                                                                                              
|4.33          |  | Endorsement and Transfer of Rights Agreement, dated
  March 29, 2007, by and between Nortel Networks (Sales and Marketing) Ltd.
  Israel and AudioCodes Ltd. §§§§§                                          
|              |  |                                                                                                                                                                                                              
|4.34          |  | Amendment
  No. 9 to OEM Purchase and Sale No. 011449 between AudioCodes Ltd. and Nortel
  Networks Ltd., dated as of October 30, 2007.#                                                                     
|              |  |                                                                                                                                                                                                              
|4.35          |  | Letter
  Agreements, dated April 30, 2008 between First International Bank of Israel,
  as lender, and AudioCodes Ltd., as borrower.                                                                        
|              |  |                                                                                                                                                                                                              
|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.                                                       
|              |  |                                                                                                                                                                                                              
|15.1          |  | Consent of
  Kost Forer Gabbay & Kasierer, a member of Ernst & Young Global.                                                                                                                                 
|              |  |                                                                                                                                                                                                              
|15.2          |  | Consent of Squar, Milner, Peterson, Miranda and Williamson, LLP.                                                                                                                                             

|  |                                                                                                              
|- | -------------------------------------------------------------------------------------------------------------
| 
|* | Incorporated
  herein by reference to Registrants Registration Statement on Form F-1 (File
  No. 333-10352).
|  |                                                                                                              
| | English
  summary of Hebrew original.                                                                        

115

---



|       |                                                                                                                                                                                                                                                                                               
|------ | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|      | 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. 333-144823).                                                                                                                                                                                
|       |                                                                                                                                                                                                                                                                                               
|**     | 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.                                                                                                                                                                                   
|       |                                                                                                                                                                                                                                                                                               
|§§§    | Incorporated
  herein by reference to Registrants Form 20-F for the fiscal year ended
  December 31, 2004.                                                                                                                                                                                   
|       |                                                                                                                                                                                                                                                                                               
|§§§§   | Incorporated
  herein by reference to Registrants Form 20-F for the fiscal year ended
  December 31, 2005.                                                                                                                                                                                   
|       |                                                                                                                                                                                                                                                                                               
|§§§§§  | Incorporated
  herein by reference to Registrants Form 20-F for the fiscal year ended
  December 31, 2006.                                                                                                                                                                                   
|       |                                                                                                                                                                                                                                                                                               
|§§§§§§ | Incorporated
  by reference to Registrants Registration Statement on Form S-8 (File No.
  333-144825).                                                                                                                                                                                       
|       |                                                                                                                                                                                                                                                                                               
|#      | 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.

116

---



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
  Falek              
| |                   | Vice
  President Finance and
| |                   | Chief
  Financial Officer   

Date: June 24, 2008

---



INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

AUDIOCODES LTD. AND
ITS SUBSIDIARIES

AS OF DECEMBER 31, 2007

IN U.S. DOLLARS

|                                                         |  |        
|-------------------------------------------------------- |  | -------
|                                                         |  | Page   
|                                                         |  |        
|                                                         |  |        
|                                                         |  |        
|Report of Independent Registered Public
 Accounting Firm |  | F-2-3  
|                                                         |  |        
|Consolidated Balance Sheets                              |  | F-4-5  
|                                                         |  |        
|Consolidated Statements of Operations                    |  | F-6    
|                                                         |  |        
|Statements of Changes in Shareholders
 Equity           |  | F-7    
|                                                         |  |        
|Consolidated Statements of Cash Flows                    |  | F-8-9  
|                                                         |  |        
|Notes to Consolidated Financial Statements               |  | F-10-47

---

NATURAL
SPEECH COMMUNICATION LTD.

AS OF
DECEMBER 31, 2007

IN U.S.
DOLLARS

|                                                            |  |        
|----------------------------------------------------------- |  | -------
|                                                            |  | Page   
|                                                            |  |        
|                                                            |  |        
|Auditors Report                                            |  | F-49   
|                                                            |  |        
|Balance Sheets                                              |  | F-50-51
|                                                            |  |        
|Statements of Operations                                    |  | F-52   
|                                                            |  |        
|Statements of Changes in
 Shareholders Equity (Deficiency) |  | F-53   
|                                                            |  |        
|Statements of Cash Flows                                    |  | F-54   
|                                                            |  |        
|Notes to Financial
 Statements                              |  | F-55-68

F-1

---



(ERNST & YOUNG LOGO)

REPORT OF
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the board of directors and Shareholders of

AudioCodes LTD. and its subsidiaries

We
have audited the accompanying consolidated balance sheets of AudioCodes Ltd.
(the Company) and its subsidiaries as of December 31, 2006 and 2007, 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,
2007. These financial statements are the responsibility of the Companys
management. Our responsibility is to express an opinion on these financial
statements based on our audits. We did not audit the financial statements of
a wholly-owned subsidiary, which statements reflect total assets of 2% as of
December 31, 2006, and total revenues of 5% for the period from July 6,
2006 through December 31, 2006. Those statements were audited by other auditors
whose report has been furnished to us, and our opinion, insofar as it relates to
the amounts included for this subsidiary, is based solely on the report of the
other auditors.

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. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.

In
our opinion and the opinion of the other auditors, the consolidated financial
statements referred to above present fairly, in all material respects, the
consolidated financial position of the Company and its subsidiaries at
December 31, 2006 and 2007, and the consolidated results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2007, in conformity with accounting principles generally accepted
in the United States.

As
discussed in Note 2r to the consolidated financial statements, in 2007 the
Company adopted FASB Interpretation No. 48, Accounting for Uncertainty in
Income Taxes  An Interpretation of FASB Statement No. 109, effective January
1, 2007. As discussed in Note 2v to the consolidated financial statements, in 2006
the Company adopted Statement of Financial Accounting Standards No. 123(R),
Share-Based Payment, as revised, effective January 1, 2006.

We
also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the Company and subsidiaries
internal control over financial reporting as of December 31, 2007, based
on criteria established in Internal Control-Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission and our report
dated June 22, 2008 expressed an unqualified opinion thereon.

|                 |                                  
|---------------- | ---------------------------------
|Tel-Aviv, Israel | KOST FORER GABBAY & KASIERER     
|June, 22,
 2008  | A Member of
 Ernst & Young Global

F-2

---



(ERNST & YOUNG LOGO)

REPORT OF INDEPENDENT REGISTERED PUBLIC
ACCOUNTING FIRM

To the Board of Directors and Shareholders of

AudioCodes LTD. and its subsidiaries

We
have audited AudioCodes Ltds (AudioCodes or the Company) internal control
over financial reporting as of December 31, 2007, based on criteria established
in Internal ControlIntegrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (the COSO criteria). AudioCodes
management is responsible for maintaining effective internal control over
financial reporting, and for its assessment of the effectiveness of internal
control over financial reporting. Our responsibility is to express an opinion
on the Companys internal control over financial reporting based on our audit.

We
conducted our audit 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
effective internal control over financial reporting was maintained in all
material respects. Our audit included obtaining an understanding of internal
control over financial reporting, assessing the risk that a material weakness
exists, testing and evaluating the design and operating effectiveness of
internal control based on the assessed risk, and performing such other
procedures as we considered necessary in the circumstances. We believe that our
audit provides a reasonable basis for our opinion.

A
Companys internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A Companys internal control
over financial reporting includes those policies and procedures that (1)
pertain to the maintenance of records that, in reasonable detail, accurately
and fairly reflect the transactions and dispositions of the assets of the
Company; (2) provide reasonable assurance that transactions are recorded as
necessary to permit preparation of financial statements in accordance with
generally accepted accounting principles, and that receipts and expenditures of
the Company are being made only in accordance with authorizations of management
and directors of the Company; and (3) provide reasonable assurance regarding
prevention or timely detection of unauthorized acquisition, use, or disposition
of the Companys assets that could have a material effect on the financial
statements.

Because
of its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may
become inadequate because of changes in conditions, or that the degree of
compliance with the policies or procedures may deteriorate.

In
our opinion, AudioCodes maintained, in all material respects, effective
internal control over financial reporting as of December 31, 2007, based on the
COSO criteria.

We
also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the consolidated balance sheets of
AudioCodes and its subsidiaries as of December 31, 2006 and 2007 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,
2007 and our report dated June 22, 2008 expressed an unqualified opinion
thereon. We did not audit the financial statements of a wholly-owned subsidiary,
which statements reflect total assets of 2% as of December 31, 2006, and
total revenues of 5% for the period from July 6, 2006 through December 31,
2006. Those statements were audited by other auditors whose report has been
furnished to us, and our opinion, insofar as it relates to the amounts included
for this subsidiary, is based solely on the report of the other auditors.

|                 |                                  
|---------------- | ---------------------------------
|Tel-Aviv, Israel | KOST FORER GABBAY & KASIERER     
|June 22,
 2008   | A Member of
 Ernst & Young Global

F-3

---



AUDIOCODES LTD. AND ITS SUBSIDIARIES

|                           
|---------------------------
|CONSOLIDATED BALANCE SHEETS
|                           
|U.S. dollars in thousands  

|                                                                                                                          |  |              |         |      |   |         | 
|------------------------------------------------------------------------------------------------------------------------- |  | ------------ | ------- | ---- | - | ------- | 
|                                                                                                                          |  | December 31, |        
|                                                                                                                          |  |              |        
|                                                                                                                          |  | 2006         |         | 2007 |  
|                                                                                                                          |  |              |         |      |  
|ASSETS                                                                                                                    |  |              |         |      |   |         | 
|                                                                                                                          |  |              |         |      |   |         | 
|CURRENT ASSETS:                                                                                                           |  |              |         |      |   |         | 
|Cash and cash equivalents                                                                                                 |  | $            | 25,171  |      | $ | 75,063  | 
|Short-term bank deposits and structured
 notes                                                                            |  |              | 28,658  |      |   | 18,065  | 
|Short-term marketable securities and
 accrued interest                                                                    |  |              | 29,422  |      |   | 17,244  | 
|Trade receivables (net of allowance for
 doubtful accounts of $854 and $521
 at December 31, 2006 and 2007, respectively) |  |              | 30,501  |      |   | 25,604  | 
|Other receivables and prepaid expenses                                                                                    |  |              | 3,309   |      |   | 6,592   | 
|Deferred tax assets                                                                                                       |  |              | 1,282   |      |   | 1,001   | 
|Inventories                                                                                                               |  |              | 16,093  |      |   | 18,736  | 
|                                                                                                                          |  |              |         |      |   |         | 
|                                                                                                                          |  |              |         |      |   |         | 
|Total current assets                                                                                                      |  |              | 134,436 |      |   | 162,305 | 
|                                                                                                                          |  |              |         |      |   |         | 
|                                                                                                                          |  |              |         |      |   |         | 
|LONG-TERM ASSETS:                                                                                                         |  |              |         |      |   |         | 
|Long-term bank deposits and structured
 notes                                                                             |  |              | 30,435  |      |   | 32,670  | 
|Long-term marketable securities                                                                                           |  |              | 19,942  |      |   |        | 
|Investment in companies                                                                                                   |  |              | 3,999   |      |   | 1,343   | 
|Deferred tax assets                                                                                                       |  |              | 2,460   |      |   | 1,057   | 
|Severance pay funds                                                                                                       |  |              | 7,231   |      |   | 9,799   | 
|                                                                                                                          |  |              |         |      |   |         | 
|                                                                                                                          |  |              |         |      |   |         | 
|Total long-term assets                                                                                                    |  |              | 64,067  |      |   | 44,869  | 
|                                                                                                                          |  |              |         |      |   |         | 
|                                                                                                                          |  |              |         |      |   |         | 
|PROPERTY AND EQUIPMENT, NET                                                                                               |  |              | 7,847   |      |   | 7,094   | 
|                                                                                                                          |  |              |         |      |   |         | 
|                                                                                                                          |  |              |         |      |   |         | 
|INTANGIBLE ASSETS, DEFERRED CHARGES AND
 OTHER, NET                                                                       |  |              | 21,853  |      |   | 19,007  | 
|                                                                                                                          |  |              |         |      |   |         | 
|                                                                                                                          |  |              |         |      |   |         | 
|GOODWILL                                                                                                                  |  |              | 108,853 |      |   | 111,212 | 
|                                                                                                                          |  |              |         |      |   |         | 
|                                                                                                                          |  |              |         |      |   |         | 
|Total assets                                                                                                              |  | $            | 337,056 |      | $ | 344,487 | 
|                                                                                                                          |  |              |         |      |   |         | 

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

F-4

---



AUDIOCODES LTD. AND ITS SUBSIDIARIES

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

|                                                                                                                                                                                                                                                                                             |  |              |         |      |   |         |  
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------ | ------- | ---- | - | ------- | -
|                                                                                                                                                                                                                                                                                             |  | December 31, |        
|                                                                                                                                                                                                                                                                                             |  |              |        
|                                                                                                                                                                                                                                                                                             |  | 2006         |         | 2007 |  
|                                                                                                                                                                                                                                                                                             |  |              |         |      |  
|LIABILITIES AND SHAREHOLDERS EQUITY                                                                                                                                                                                                                                                         |  |              |         |      |   |         |  
|                                                                                                                                                                                                                                                                                             |  |              |         |      |   |         |  
|CURRENT LIABILITIES:                                                                                                                                                                                                                                                                         |  |              |         |      |   |         |  
|Trade payables                                                                                                                                                                                                                                                                               |  | $            | 7,522   |      | $ | 8,849   |  
|Deferred tax liabilities                                                                                                                                                                                                                                                                     |  |              | 1,321   |      |   |        |  
|Other payables and accrued expenses                                                                                                                                                                                                                                                          |  |              | 28,139  |      |   | 28,780  |  
|                                                                                                                                                                                                                                                                                             |  |              |         |      |   |         |  
|                                                                                                                                                                                                                                                                                             |  |              |         |      |   |         |  
|Total current liabilities                                                                                                                                                                                                                                                                    |  |              | 36,982  |      |   | 37,629  |  
|                                                                                                                                                                                                                                                                                             |  |              |         |      |   |         |  
|                                                                                                                                                                                                                                                                                             |  |              |         |      |   |         |  
|LONG-TERM LIABILITIES:                                                                                                                                                                                                                                                                       |  |              |         |      |   |         |  
|Deferred tax liabilities                                                                                                                                                                                                                                                                     |  |              | 6,459   |      |   |        |  
|Accrued severance pay                                                                                                                                                                                                                                                                        |  |              | 7,915   |      |   | 11,168  |  
|Senior convertible notes                                                                                                                                                                                                                                                                     |  |              | 121,015 |      |   | 121,198 |  
|                                                                                                                                                                                                                                                                                             |  |              |         |      |   |         |  
|                                                                                                                                                                                                                                                                                             |  |              |         |      |   |         |  
|Total long-term liabilities                                                                                                                                                                                                                                                                  |  |              | 135,389 |      |   | 132,366 |  
|                                                                                                                                                                                                                                                                                             |  |              |         |      |   |         |  
|                                                                                                                                                                                                                                                                                             |  |              |         |      |   |         |  
|COMMITMENTS AND CONTINGENT LIABILITIES                                                                                                                                                                                                                                                       |  |              |         |      |   |         |  
|                                                                                                                                                                                                                                                                                             |  |              |         |      |   |         |  
|SHAREHOLDERS EQUITY:                                                                                                                                                                                                                                                                        |  |              |         |      |   |         |  
|Share capital -                                                                                                                                                                                                                                                                              |  |              |         |      |   |         |  
|Ordinary shares of NIS 0.01 par value -
 Authorized: 100,000,000 at December 31, 2006 and 2007; Issued:
 46,051,867 shares at December 31, 2006 and 47,031,691 shares at
 December 31, 2007; Outstanding: 42,109,728 shares at December 31,
 2006 and 43,089,552 shares at December 31, 2007 |  |              | 131     |      |   | 133     |  
|Additional paid-in capital                                                                                                                                                                                                                                                                   |  |              | 149,205 |      |   | 161,970 |  
|Treasury stock                                                                                                                                                                                                                                                                               |  |              | (11,320 | )    |   | (11,320 | )
|Accumulated other comprehensive income                                                                                                                                                                                                                                                       |  |              | 122     |      |   | 1,047   |  
|Retained earnings                                                                                                                                                                                                                                                                            |  |              | 26,547  |      |   | 22,662  |  
|                                                                                                                                                                                                                                                                                             |  |              |         |      |   |         |  
|                                                                                                                                                                                                                                                                                             |  |              |         |      |   |         |  
|Total shareholders equity                                                                                                                                                                                                                                                                   |  |              | 164,685 |      |   | 174,492 |  
|                                                                                                                                                                                                                                                                                             |  |              |         |      |   |         |  
|                                                                                                                                                                                                                                                                                             |  |              |         |      |   |         |  
|Total liabilities and shareholders equity                                                                                                                                                                                                                                                   |  | $            | 337,056 |      | $ | 344,487 |  
|                                                                                                                                                                                                                                                                                             |  |              |         |      |   |         |  

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

F-5

---



AUDIOCODES LTD. AND ITS SUBSIDIARIES

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

|                                               |  |                         |         |      |   |         |  |   |         |  
|---------------------------------------------- |  | ----------------------- | ------- | ---- | - | ------- |  | - | ------- | -
|                                               |  | Year ended December 31, |        
|                                               |  |                         |        
|                                               |  | 2005                    |         | 2006 |   | 2007    | 
|                                               |  |                         |         |      |   |         | 
|                                               |  |                         |         |      |   |         |  |   |         |  
|Revenues                                       |  | $                       | 115,827 |      | $ | 147,353 |  | $ | 158,235 |  
|Cost of revenues                               |  |                         | 46,993  |      |   | 61,242  |  |   | 69,185  |  
|                                               |  |                         |         |      |   |         |  |   |         |  
|                                               |  |                         |         |      |   |         |  |   |         |  
|Gross profit                                   |  |                         | 68,834  |      |   | 86,111  |  |   | 89,050  |  
|                                               |  |                         |         |      |   |         |  |   |         |  
|                                               |  |                         |         |      |   |         |  |   |         |  
|Operating expenses:                            |  |                         |         |      |   |         |  |   |         |  
|Research and development, net                  |  |                         | 24,415  |      |   | 35,416  |  |   | 40,706  |  
|Selling and marketing                          |  |                         | 25,944  |      |   | 37,664  |  |   | 42,900  |  
|General and administrative                     |  |                         | 6,004   |      |   | 8,766   |  |   | 9,637   |  
|                                               |  |                         |         |      |   |         |  |   |         |  
|                                               |  |                         |         |      |   |         |  |   |         |  
|Total operating expenses                       |  |                         | 56,363  |      |   | 81,846  |  |   | 93,243  |  
|                                               |  |                         |         |      |   |         |  |   |         |  
|                                               |  |                         |         |      |   |         |  |   |         |  
|Operating income (loss)                        |  |                         | 12,471  |      |   | 4,265   |  |   | (4,193  | )
|Financial income, net                          |  |                         | 2,457   |      |   | 3,817   |  |   | 2,670   |  
|                                               |  |                         |         |      |   |         |  |   |         |  
|                                               |  |                         |         |      |   |         |  |   |         |  
|Income (loss) before taxes on income           |  |                         | 14,928  |      |   | 8,082   |  |   | (1,523  | )
|Taxes on income, net                           |  |                         | 799     |      |   | 289     |  |   | 1,265   |  
|Equity in losses of affiliated companies,
 net |  |                         | 693     |      |   | 916     |  |   | 1,097   |  
|                                               |  |                         |         |      |   |         |  |   |         |  
|                                               |  |                         |         |      |   |         |  |   |         |  
|Net income (loss)                              |  | $                       | 13,436  |      | $ | 6,877   |  | $ | (3,885  | )
|                                               |  |                         |         |      |   |         |  |   |         |  
|                                               |  |                         |         |      |   |         |  |   |         |  
|Basic net earnings (loss) per share            |  | $                       | 0.33    |      | $ | 0.16    |  | $ | (0.09   | )
|                                               |  |                         |         |      |   |         |  |   |         |  
|                                               |  |                         |         |      |   |         |  |   |         |  
|Diluted net earnings (loss) per share          |  | $                       | 0.31    |      | $ | 0.16    |  | $ | (0.09   | )
|                                               |  |                         |         |      |   |         |  |   |         |  
|                                               |  |                         |         |      |   |         |  |   |         |  
|                                               |  |                         |         |      |   |         |  |   |         |  
|                                               |  |                         |         |      |   |         |  |   |         |  

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

F-6

---



|                                               
|-----------------------------------------------
|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 January1, 2005                                                         |  | $               | 126 |                                | $ | 126,700          |   | $                               | (11,320 | )                                            | $ | (108                | ) | $                                     | 353   |                                | $ | 6,234  |   |   |        |   | $ | 121,985 |  
|                                                                                     |  |                 |     |                                |   |                  |   |                                 |         |                                              |   |                     |   |                                       |       |                                |   |        |   |   |        |   |   |         |  
|Issuance of shares upon exercise of
  options and employee stock purchase plan       |  |                 | 2   |                                |   | 3,916            |   |                                 |        |                                              |   |                    |   |                                       |      |                                |   |       |   |   |        |   |   | 3,918   |  
|Amortization of deferred stock
  compensation                                        |  |                 |    |                                |   |                 |   |                                 |        |                                              |   | 36                  |   |                                       |      |                                |   |       |   |   |        |   |   | 36      |  
|Comprehensive income, net:                                                           |  |                 |     |                                |   |                  |   |                                 |         |                                              |   |                     |   |                                       |       |                                |   |        |   |   |        |   |   |         |  
|Unrealized loss on forward contracts, net                                            |  |                 |    |                                |   |                 |   |                                 |        |                                              |   |                    |   |                                       | (269  | )                              |   |       |   | $ | (269   | ) |   | (269    | )
|Net income                                                                           |  |                 |    |                                |   |                 |   |                                 |        |                                              |   |                    |   |                                       |      |                                |   | 13,436 |   |   | 13,436 |   |   | 13,436  |  
|                                                                                     |  |                 |     |                                |   |                  |   |                                 |         |                                              |   |                     |   |                                       |       |                                |   |        |   |   |        |   |   |         |  
|Total comprehensive income, net                                                      |  |                 |     |                                |   |                  |   |                                 |         |                                              |   |                     |   |                                       |       |                                |   |        |   | $ | 13,167 |   |   |         |  
|                                                                                     |  |                 |     |                                |   |                  |   |                                 |         |                                              |   |                     |   |                                       |       |                                |   |        |   |   |        |   |   |         |  
|Balance as of December 31, 2005                                                      |  |                 | 128 |                                |   | 130,616          |   |                                 | (11,320 | )                                            |   | (72                 | ) |                                       | 84    |                                |   | 19,670 |   |   |        |   |   | 139,106 |  
|                                                                                     |  |                 |     |                                |   |                  |   |                                 |         |                                              |   |                     |   |                                       |       |                                |   |        |   |   |        |   |   |         |  
|Issuance of shares upon exercise of
  options and employee stock purchase plan       |  |                 | 3   |                                |   | 9,178            |   |                                 |        |                                              |   |                    |   |                                       |      |                                |   |       |   |   |        |   |   | 9,181   |  
|Stock compensation related to options
  granted to employees                         |  |                 |    |                                |   | 8,707            |   |                                 |        |                                              |   |                    |   |                                       |      |                                |   |       |   |   |        |   |   | 8,707   |  
|Excess tax benefit from net operating
  loss utilization                             |  |                 |    |                                |   | 776              |   |                                 |        |                                              |   |                    |   |                                       |      |                                |   |       |   |   |        |   |   | 776     |  
|Reclassification of deferred stock
  compensation due to implementation of SFAS 123R |  |                 |    |                                |   | (72              | ) |                                 |        |                                              |   | 72                  |   |                                       |      |                                |   |       |   |   |        |   |   |         |  
|Comprehensive income, net:                                                           |  |                 |     |                                |   |                  |   |                                 |         |                                              |   |                     |   |                                       |       |                                |   |        |   |   |        |   |   |         |  
|Unrealized gain on forward contracts, net                                            |  |                 |    |                                |   |                 |   |                                 |        |                                              |   |                    |   |                                       | 38    |                                |   |       |   | $ | 38     |   |   | 38      |  
|Net income                                                                           |  |                 |    |                                |   |                 |   |                                 |        |                                              |   |                    |   |                                       |      |                                |   | 6,877  |   |   | 6,877  |   |   | 6877    |  
|                                                                                     |  |                 |     |                                |   |                  |   |                                 |         |                                              |   |                     |   |                                       |       |                                |   |        |   |   |        |   |   |         |  
|Total comprehensive income, net                                                      |  |                 |     |                                |   |                  |   |                                 |         |                                              |   |                     |   |                                       |       |                                |   |        |   | $ | 6,915  |   |   |         |  
|                                                                                     |  |                 |     |                                |   |                  |   |                                 |         |                                              |   |                     |   |                                       |       |                                |   |        |   |   |        |   |   |         |  
|Balance as of December 31, 2006                                                      |  |                 | 131 |                                |   | 149,205          |   |                                 | (11,320 | )                                            |   |                    |   |                                       | 122   |                                |   | 26,547 |   |   |        |   |   | 164,685 |  
|                                                                                     |  |                 |     |                                |   |                  |   |                                 |         |                                              |   |                     |   |                                       |       |                                |   |        |   |   |        |   |   |         |  
|Issuance of shares upon exercise of
  options and employee stock purchase plan       |  |                 | 2   |                                |   | 4,798            |   |                                 |        |                                              |   |                    |   |                                       |      |                                |   |       |   |   |        |   |   | 4,800   |  
|Stock compensation related to options
  granted to employees                         |  |                 |    |                                |   | 7,967            |   |                                 |        |                                              |   |                    |   |                                       |      |                                |   |       |   |   |        |   |   | 7,967   |  
|Comprehensive income, net:                                                           |  |                 |     |                                |   |                  |   |                                 |         |                                              |   |                     |   |                                       |       |                                |   |        |   |   |        |   |   |         |  
|Unrealized gains on foreign currency cash
  flow hedges                              |  |                 |    |                                |   |                 |   |                                 |        |                                              |   |                    |   |                                       | 925   |                                |   |       |   | $ | 925    |   |   | 925     |  
|Net loss                                                                             |  |                 |    |                                |   |                 |   |                                 |        |                                              |   |                    |   |                                       |      |                                |   | (3,885 | ) |   | (3,885 | ) |   | (3,885  | )
|                                                                                     |  |                 |     |                                |   |                  |   |                                 |         |                                              |   |                     |   |                                       |       |                                |   |        |   |   |        |   |   |         |  
|Total comprehensive loss, net                                                        |  |                 |     |                                |   |                  |   |                                 |         |                                              |   |                     |   |                                       |       |                                |   |        |   | $ | (2,960 | ) |   |         |  
|                                                                                     |  |                 |     |                                |   |                  |   |                                 |         |                                              |   |                     |   |                                       |       |                                |   |        |   |   |        |   |   |         |  
|Balance as of December 31, 2007                                                      |  | $               | 133 |                                | $ | 161,970          |   | $                               | (11,320 | )                                            | $ |                    |   | $                                     | 1,047 |                                | $ | 22,662 |   |   |        |   | $ | 174,492 |  
|                                                                                     |  |                 |     |                                |   |                  |   |                                 |         |                                              |   |                     |   |                                       |       |                                |   |        |   |   |        |   |   |         |  

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

F-7

---



AUDIOCODES LTD. AND ITS SUBSIDIARIES

|                                     
|-------------------------------------
|CONSOLIDATED STATEMENTS OF CASH FLOWS
|                                     
|U.S. dollars in thousands            

|                                                                                                    |  |                         |          |      |   |         |   |   |         |  
|--------------------------------------------------------------------------------------------------- |  | ----------------------- | -------- | ---- | - | ------- | - | - | ------- | -
|                                                                                                    |  | Year ended December 31, |         
|                                                                                                    |  |                         |         
|                                                                                                    |  | 2005                    |          | 2006 |   | 2007    |  
|                                                                                                    |  |                         |          |      |   |         |  
|Cash flows from operating activities:                                                               |  |                         |          |      |   |         |   |   |         |  
|Net income (loss)                                                                                   |  | $                       | 13,436   |      | $ | 6,877   |   | $ | (3,885  | )
|Adjustments required to reconcile net
  income (loss) to net cash provided by operating activities: |  |                         |          |      |   |         |   |   |         |  
|Depreciation and amortization                                                                       |  |                         | 3,369    |      |   | 5,543   |   |   | 7,789   |  
|Amortization of marketable securities
  premiums and accretion of discounts, net                    |  |                         | 143      |      |   | 225     |   |   | 39      |  
|Equity in losses of affiliated companies,
  net                                                     |  |                         | 693      |      |   | 916     |   |   | 1,097   |  
|Stock-based compensation expenses                                                                   |  |                         | 36       |      |   | 8,707   |   |   | 7,967   |  
|Amortization of senior convertible notes
  discount and deferred charges                            |  |                         | 198      |      |   | 199     |   |   | 203     |  
|Increase in accrued interest on marketable
  securities, bank deposits and structured notes         |  |                         | (736     | )    |   | (130    | ) |   | (519    | )
|Decrease (increase) in deferred tax assets,
  net                                                   |  |                         | (2,033   | )    |   | (1,001  | ) |   | 2,390   |  
|Decrease (increase) in trade receivables,
  net                                                     |  |                         | (3,520   | )    |   | (9,751  | ) |   | 5,014   |  
|Decrease (increase) in other receivables
  and prepaid expenses                                     |  |                         | 57       |      |   | 1,457   |   |   | (1,504  | )
|Increase in inventories                                                                             |  |                         | (1,503   | )    |   | (1,954  | ) |   | (2,643  | )
|Increase (decrease) in trade payables                                                               |  |                         | 1,233    |      |   | (2,671  | ) |   | 1,263   |  
|Increase (decrease) in other payables and
  accrued expenses                                        |  |                         | 1,914    |      |   | (2,005  | ) |   | (5,181  | )
|Increase in accrued severance pay, net                                                              |  |                         | 41       |      |   | 203     |   |   | 356     |  
|Other                                                                                               |  |                         | (12      | )    |   | 15      |   |   |        |  
|                                                                                                    |  |                         |          |      |   |         |   |   |         |  
|                                                                                                    |  |                         |          |      |   |         |   |   |         |  
|Net cash provided by operating activities                                                           |  |                         | 13,316   |      |   | 6,630   |   |   | 12,386  |  
|                                                                                                    |  |                         |          |      |   |         |   |   |         |  
|                                                                                                    |  |                         |          |      |   |         |   |   |         |  
|Cash flows from investing activities:                                                               |  |                         |          |      |   |         |   |   |         |  
|Investments in affiliated companies                                                                 |  |                         | (1,318   | )    |   | (3,453  | ) |   | (1,003  | )
|Short-term loan to unrelated Company                                                                |  |                         | (350     | )    |   |        |   |   |        |  
|Purchase of property and equipment                                                                  |  |                         | (2,393   | )    |   | (3,067  | ) |   | (2,629  | )
|Proceeds from sale of property and
  equipment                                                      |  |                         | 96       |      |   |        |   |   |        |  
|Investment in short-term and long-term bank
  deposits                                              |  |                         | (33,969  | )    |   | (20,000 | ) |   | (29,065 | )
|Proceeds from sale of short-term bank
  deposits                                                    |  |                         | 3,969    |      |   | 51,300  |   |   | 28,700  |  
|Investment in structured notes                                                                      |  |                         | (20,000  | )    |   |        |   |   |        |  
|Proceeds from structured notes called by
  the issuer                                               |  |                         | 10,000   |      |   |        |   |   | 10,000  |  
|Investment in short-term and long-term
  marketable securities                                      |  |                         | (59,060  | )    |   |        |   |   |        |  
|Proceeds from marketable securities held to
  maturity                                              |  |                         |         |      |   | 9,000   |   |   | 31,600  |  
|Proceeds from sale of
  held-to-maturity marketable securities                                      |  |                         |         |      |   | 979     |   |   |        |  
|Additional payment for the acquisition of
  AudioCodes USA Inc.                                     |  |                         | (10,000  | )    |   |        |   |   |        |  
|Payment for acquisition of Nuera
  Communication Inc. (1)                                           |  |                         |         |      |   | (82,520 | ) |   |        |  
|Payment for acquisition of Netrake
  Corporation. (2)                                               |  |                         |         |      |   | (13,836 | ) |   |        |  
|Payment for acquisition of CTI Squared
  Ltd (CTI2) (3)                                           |  |                         |         |      |   |        |   |   | (4,897  | )
|                                                                                                    |  |                         |          |      |   |         |   |   |         |  
|                                                                                                    |  |                         |          |      |   |         |   |   |         |  
|Net cash provided by (used in) investing
  activities                                               |  |                         | (113,025 | )    |   | (61,597 | ) |   | 32,706  |  
|                                                                                                    |  |                         |          |      |   |         |   |   |         |  
|                                                                                                    |  |                         |          |      |   |         |   |   |         |  
|Cash flows from financing activities:                                                               |  |                         |          |      |   |         |   |   |         |  
|Issuance costs for senior convertible
notes                                                         |  |                         | (84      | )    |   |        |   |   |        |  
|Proceeds from issuance of shares upon
  exercise of options and employee stock purchase plan        |  |                         | 3,918    |      |   | 9,181   |   |   | 4,800   |  
|                                                                                                    |  |                         |          |      |   |         |   |   |         |  
|                                                                                                    |  |                         |          |      |   |         |   |   |         |  
|Net cash provided by financing activities                                                           |  |                         | 3,834    |      |   | 9,181   |   |   | 4,800   |  
|                                                                                                    |  |                         |          |      |   |         |   |   |         |  
|                                                                                                    |  |                         |          |      |   |         |   |   |         |  
|Increase (decrease) in cash and cash
  equivalents                                                  |  |                         | (95,875  | )    |   | (45,786 | ) |   | 49,892  |  
|Cash and cash equivalents at the beginning
  of the year                                            |  |                         | 166,832  |      |   | 70,957  |   |   | 25,171  |  
|                                                                                                    |  |                         |          |      |   |         |   |   |         |  
|                                                                                                    |  |                         |          |      |   |         |   |   |         |  
|Cash and cash equivalents at the end of the
  year                                                  |  | $                       | 70,957   |      | $ | 25,171  |   | $ | 75,063  |  
|                                                                                                    |  |                         |          |      |   |         |   |   |         |  

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

F-8

---



AUDIOCODES LTD. AND ITS SUBSIDIARIES

|                                     
|-------------------------------------
|CONSOLIDATED STATEMENTS OF CASH FLOWS
|                                     
|U.S. dollars in thousands            

|    |                                                                                                                      |  |                         |       |      |   |        |   |   |        |  
|--- | -------------------------------------------------------------------------------------------------------------------- |  | ----------------------- | ----- | ---- | - | ------ | - | - | ------ | -
|    |                                                                                                                      |  | Year ended December 31, |      
|    |                                                                                                                      |  |                         |      
|    |                                                                                                                      |  | 2005                    |       | 2006 |   | 2007   |  
|    |                                                                                                                      |  |                         |       |      |   |        |  
|(1) | Payment for acquisition of Nuera Communication Inc.                                                                  |  |                         |       |      |   |        |   |   |        |  
|    | Net fair value of assets acquired and
  liabilities assumed of Nuera at the date of acquisition (see also Note 1b):  |  |                         |       |      |   |        |   |   |        |  
|    | Working capital, net (excluding cash and
  cash equivalents)                                                         |  | $                       |      |      | $ | (6,728 | ) | $ |       |  
|    | Technology                                                                                                           |  |                         |      |      |   | 6,020  |   |   |       |  
|    | Backlog                                                                                                              |  |                         |      |      |   | 750    |   |   |       |  
|    | Customer relationship                                                                                                |  |                         |      |      |   | 8,001  |   |   |       |  
|    | Trade name                                                                                                           |  |                         |      |      |   | 466    |   |   |       |  
|    | Deferred tax liability                                                                                               |  |                         |      |      |   | (6,176 | ) |   |       |  
|    | Existing contracts                                                                                                   |  |                         |      |      |   | 204    |   |   |       |  
|    | Deferred tax assets                                                                                                  |  |                         |      |      |   | 1,201  |   |   |       |  
|    | Goodwill                                                                                                             |  |                         |      |      |   | 78,782 |   |   |       |  
|    |                                                                                                                      |  |                         |       |      |   |        |   |   |        |  
|    |                                                                                                                      |  |                         |       |      |   |        |   |   |        |  
|    |                                                                                                                      |  | $                       |      |      | $ | 82,520 |   | $ |       |  
|    |                                                                                                                      |  |                         |       |      |   |        |   |   |        |  
|    |                                                                                                                      |  |                         |       |      |   |        |   |   |        |  
|(2) | Payment for acquisition of Netrake
  Corporation.                                                                    |  |                         |       |      |   |        |   |   |        |  
|    | Net fair value of assets acquired and
  liabilities assumed of Netrake at the date of acquisition (see also Note 1c) |  |                         |       |      |   |        |   |   |        |  
|    | Working capital, net (excluding cash and
  cash equivalents)                                                         |  | $                       |      |      | $ | (2     | ) | $ |       |  
|    | Core technology                                                                                                      |  |                         |      |      |   | 5,688  |   |   |       |  
|    | Backlog                                                                                                              |  |                         |      |      |   | 87     |   |   |       |  
|    | Deferred tax liability                                                                                               |  |                         |      |      |   | (2,310 | ) |   |       |  
|    | Goodwill                                                                                                             |  |                         |      |      |   | 10,373 |   |   |       |  
|    |                                                                                                                      |  |                         |       |      |   |        |   |   |        |  
|    |                                                                                                                      |  |                         |       |      |   |        |   |   |        |  
|    |                                                                                                                      |  | $                       |      |      | $ | 13,836 |   | $ |       |  
|    |                                                                                                                      |  |                         |       |      |   |        |   |   |        |  
|    |                                                                                                                      |  |                         |       |      |   |        |   |   |        |  
|(3) | Payment for acquisition of CTI Squared Ltd.                                                                          |  |                         |       |      |   |        |   |   |        |  
|    | Net fair value of assets acquired and
  liabilities assumed of CTI2 at the date of acquisition (see
  also Note 1d): |  |                         |       |      |   |        |   |   |        |  
|    | Working capital, net (excluding cash and
  cash equivalents)                                                         |  | $                       |      |      | $ |       |   | $ | (7,519 | )
|    | Technology                                                                                                           |  |                         |      |      |   |       |   |   | 1,530  |  
|    | Backlog                                                                                                              |  |                         |      |      |   |       |   |   | 41     |  
|    | Goodwill                                                                                                             |  |                         |      |      |   |       |   |   | 10,845 |  
|    |                                                                                                                      |  |                         |       |      |   |        |   |   |        |  
|    |                                                                                                                      |  |                         |       |      |   |        |   |   |        |  
|    |                                                                                                                      |  | $                       |      |      | $ |       |   | $ | 4,897  |  
|    |                                                                                                                      |  |                         |       |      |   |        |   |   |        |  
|    |                                                                                                                      |  |                         |       |      |   |        |   |   |        |  
|(4) | Supplemental disclosure of cash flow
  activities:                                                                   |  |                         |       |      |   |        |   |   |        |  
|    | Cash paid during the year for income
taxes                                                                           |  | $                       | 760   |      | $ | 1,237  |   | $ | 403    |  
|    |                                                                                                                      |  |                         |       |      |   |        |   |   |        |  
|    |                                                                                                                      |  |                         |       |      |   |        |   |   |        |  
|    | Cash paid during the year for interest                                                                               |  | $                       | 2,500 |      | $ | 2,500  |   | $ | 2,500  |  
|    |                                                                                                                      |  |                         |       |      |   |        |   |   |        |  

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

F-9

---



AUDIOCODES LTD. AND ITS SUBSIDIARIES

|                                                          
|----------------------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                
|                                                          
|U.S. dollars in thousands, except share and per share data

|         |        
|-------- | -------
|NOTE 1:- | GENERAL

| |    |                                                                                                                                                                                                                                                                                                          
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | a. | Business
 overview:                                                                                                                                                                                                                                                                                      
| |    |                                                                                                                                                                                                                                                                                                          
| |    | AudioCodes
 Ltd. (the Company) and its subsidiaries (together the Group) designs,
 develops and markets products for voice, data and video over IP networks to
 service providers and channels (such as distributors), OEMs, network
 equipment providers and systems integrators.                   
| |    |                                                                                                                                                                                                                                                                                                          
| |    | The Company
 operates through its wholly-owned subsidiaries in the United States, United
 Kingdom, France, Germany, Italy, Russia, Argentina, Brazil, India, Singapore,
 Hong-Kong, Japan, Korea and Mexico.                                                                                             
| |    |                                                                                                                                                                                                                                                                                                          
| | b. | Acquisition
 of Nuera Communications Inc. (renamed: AudioCodes California Inc.):                                                                                                                                                                                                                         
| |    |                                                                                                                                                                                                                                                                                                          
| |    | On July 6,
 2006, the Group acquired all of the outstanding common stock of Nuera
 Communications Inc, a leading provider of Voice over Internet Protocol (VoIP)
 infrastructure solutions for broadband and long distance with an extensive client
 base in North America as well as in Asia and Europe.
| |    |                                                                                                                                                                                                                                                                                                          
| |    | The Group
 paid $82,520 in cash at the closing of the transaction including acquisition
 costs in the amount of $2,376.                                                                                                                                                                                  
| |    |                                                                                                                                                                                                                                                                                                          
| |    | Nuera
 Communications Inc. became a wholly-owned subsidiary of AudioCodes Inc. and
 accordingly, its results of operations have been included in the consolidated
 financial statements of the Group since the acquisition date.                                                                         
| |    |                                                                                                                                                                                                                                                                                                          
| |    | This
 acquisition was accounted for under the purchase method of accounting in
 accordance with Statement of Financial Accounting Standard No. 141 Business
 Combinations (SFAS 141).                                                                                                                  

F-10

---



AUDIOCODES LTD. AND ITS SUBSIDIARIES

|                                                          
|----------------------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                
|                                                          
|U.S. dollars in thousands, except share and per share data

|         |                
|-------- | ---------------
|NOTE 1:- | GENERAL (Cont.)

| |                                                                                                                                                                                                       
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Based upon
 an independent valuation of tangible and intangible assets acquired, the
 Group has allocated the total acquisition cost of Nuera Communication Inc.s
 assets and liabilities as follows:

|                                                |  |              |         |  
|----------------------------------------------- |  | ------------ | ------- | -
|                                                |  | July 6, 2006 |        
|                                                |  |              |        
|                                                |  |              |         |  
|Trade receivables                               |  | $            | 2,213   |  
|Inventories                                     |  |              | 931     |  
|Other receivables and prepaid expenses          |  |              | 356     |  
|Deferred tax asset                              |  |              | 1,201   |  
|Property and equipment                          |  |              | 673     |  
|                                                |  |              |         |  
|                                                |  |              |         |  
|Total tangible
 assets acquired                 |  |              | 5,374   |  
|                                                |  |              |         |  
|                                                |  |              |         |  
|Technology (five years useful life)             |  |              | 6,020   |  
|Backlog (one year useful life)                  |  |              | 750     |  
|Customer relationship (nine years useful
 life) |  |              | 8,001   |  
|Existing contracts (three years useful
 life)   |  |              | 204     |  
|Trade name (three years useful life)            |  |              | 466     |  
|Goodwill                                        |  |              | 78,782  |  
|                                                |  |              |         |  
|                                                |  |              |         |  
|Total intangible
 assets acquired               |  |              | 94,223  |  
|                                                |  |              |         |  
|                                                |  |              |         |  
|Total tangible and
 intangible assets acquired  |  |              | 99,597  |  
|                                                |  |              |         |  
|                                                |  |              |         |  
|Trade payables                                  |  |              | (1,292  | )
|Deferred tax liability                          |  |              | (6,176  | )
|Other current liabilities and accrued
 expenses |  |              | (9,609  | )
|                                                |  |              |         |  
|                                                |  |              |         |  
|Total liabilities
 assumed                      |  |              | (17,077 | )
|                                                |  |              |         |  
|                                                |  |              |         |  
|Net assets acquired                             |  | $            | 82,520  |  
|                                                |  |              |         |  

| |                                                                                                                                                                                                                                                                                                                                                                           
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 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 2n).
| |                                                                                                                                                                                                                                                                                                                                                                           
| | The value
 assigned to tangible assets, intangible assets and liabilities has been determined
 as follows:                                                                                                                                                                                                                                                                
| |                                                                                                                                                                                                                                                                                                                                                                           
| | Current
 assets and liabilities are recorded at their carrying amounts. The carrying
 amounts of current assets and liabilities were reasonable proxies for their
 fair value due to their short-term maturity. Property and equipment are
 presented at current replacement cost. The fair value of intangible assets
 was determined using the income approach.         

F-11

---



AUDIOCODES LTD. AND ITS SUBSIDIARIES

|                                                          
|----------------------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                
|                                                          
|U.S. dollars in thousands, except share and per share data

|         |                 |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|-------- | --------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 1:- | GENERAL (Cont.)
|         |                 |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|         | c.              | Acquisition
  of Netrake Corporation. (renamed: AudioCodes Texas Inc.):                                                                                                                                                                                                                                                                                                                                                                                                                   
|         |                 |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|         |                 | On August
  14, 2006, the Group acquired all of the outstanding common stock of Netrake
  Corporation, a leading provider of Session Border Controller (SBC) and
  Security Gateway solutions. SBCS enable connectivity, policies and security
  for real-time applications such as VoIP and video when traversing IP to IP
  networks. Security Gateways enable secure real-time session across wifi,
  broadband and wireless networks in Field Mobile Convergence (FMC)
  deployments.
|         |                 |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|         |                 | The Group
  paid $13,836 in cash at the closing of the transaction including acquisition
  costs in the amount of $649.                                                                                                                                                                                                                                                                                                                                                                   
|         |                 |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|         |                 | Netrake
  Corporation became a wholly-owned subsidiary of AudioCodes Inc. and
  accordingly, its results of operations have been included in the consolidated
  financial statements of the Group since the acquisition date.                                                                                                                                                                                                                                                             
|         |                 |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|         |                 | This
  acquisition was accounted for under the purchase method of accounting in
  accordance with SFAS No. 141.                                                                                                                                                                                                                                                                                                                                                                           

F-12

---



AUDIOCODES LTD. AND ITS SUBSIDIARIES

|                                                          
|----------------------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                
|                                                          
|U.S. dollars in thousands, except share and per share data

|         |                 |                                                                                                                                                                                                      
|-------- | --------------- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 1:- | GENERAL (Cont.)
|         |                 |                                                                                                                                                                                                      
|         |                 | Based upon
  an independent valuation of tangible and intangible assets acquired, the
  Group has allocated the total acquisition cost of Netrake Corporations
  assets and liabilities, as follows:

| |                                                  |  |                   |        |  
| | ------------------------------------------------ |  | ----------------- | ------ | -
| |                                                  |  | August 14,
  2006 |       
| |                                                  |  |                   |       
| |                                                  |  |                   |        |  
| | Trade
  receivables                              |  | $                 | 554    |  
| | Inventories                                      |  |                   | 1,646  |  
| | Other
  receivables and prepaid expenses         |  |                   | 311    |  
| |                                                  |  |                   |        |  
|
| |                                                  |  |                   | 2,511  |  
| | Property and
  equipment                         |  |                   | 528    |  
| |                                                  |  |                   |        |  
|
| | Total tangible
  assets acquired                 |  |                   | 3,039  |  
| |                                                  |  |                   |        |  
|
| | Technology
  (five years useful life)            |  |                   | 5,688  |  
| | Backlog (two
  years useful life)                |  |                   | 87     |  
| | Goodwill                                         |  |                   | 10,373 |  
| |                                                  |  |                   |        |  
|
| | Total intangible
  assets acquired               |  |                   | 16,148 |  
| |                                                  |  |                   |        |  
|
| | Total tangible
  and intangible assets acquired  |  |                   | 19,187 |  
| |                                                  |  |                   |        |  
|
| | Trade
  payables                                 |  |                   | (1,127 | )
| | Deferred tax
  liability                         |  |                   | (2,310 | )
| | Other
  current liabilities and accrued expenses |  |                   | (1,914 | )
| |                                                  |  |                   |        |  
|
| | Total
  liabilities assumed                      |  |                   | (5,351 | )
| |                                                  |  |                   |        |  
|
| | Net assets
  acquired                            |  | $                 | 13,836 |  
| |                                                  |  |                   |        |  

| |  |                                                                                                                                                                                                                                                                                                                                                                       
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | 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 2n).                               
| |  |                                                                                                                                                                                                                                                                                                                                                                       
| |  | The value
  assigned to tangible assets, intangible assets and liabilities has been
  determined as follows:                                                                                                                                                                                                                                                          
| |  |                                                                                                                                                                                                                                                                                                                                                                       
| |  | Current
  assets and liabilities are recorded at their carrying amounts. The carrying
  amounts of current assets and liabilities were reasonable proxies for their
  fair value due to their short-term maturity. Property and equipment are
  presented at current replacement cost. The fair value of intangible assets
  was determined using the income approach.

F-13

---



|                                                           
|-----------------------------------------------------------
|AUDIOCODES LTD. AND ITS SUBSIDIARIES                       
|                                                           
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in
 thousands, except share and per share data

|         |                 |                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|-------- | --------------- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 1:- | GENERAL (Cont.)
|         |                 |                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|         | d.              | Acquisition
 of CTI Squared Ltd.:                                                                                                                                                                                                                                                                                                                                                                                                                                         
|         |                 |                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|         |                 | On April 1,
 2007, the Group acquired the remaining outstanding common stock of CTI
 Squared Ltd (CTI2), a leading provider of enhanced messaging and
 communications platforms deployed globally by service providers and
 enterprises. CTI2s platforms integrate data and voice messaging services
 over internet, intranet, PSTN, cellular, cable and enterprise networks. Prior
 to this acquisition, the Group had an investment in CTI2 in the
 amount of $1,565.
|         |                 |                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|         |                 | In
 consideration for the acquisition the Group paid $4,897 in cash at the
 closing of the transaction in April 2007 and committed to pay additional
 $5,000 as of April, 2008. In February 2008 the Group paid the additional
 amount of $5,000.                                                                                                                                                                                                                         
|         |                 |                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|         |                 | CTI2
 became a wholly-owned subsidiary of the Company and accordingly, its results
 of operations have been included in the consolidated financial statements of
 the Group since the acquisition date.                                                                                                                                                                                                                                                                   
|         |                 |                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|         |                 | This
 acquisition was accounted for under the purchase method of accounting in
 accordance with SFAS No. 141.                                                                                                                                                                                                                                                                                                                                                             

|                                                |  |                 |        |  
|----------------------------------------------- |  | --------------- | ------ | -
|                                                |  | April 2, 
 2007 |       
|                                                |  |                 |       
|                                                |  |                 |        |  
|Trade
 receivables                              |  | $               | 117    |  
|Other
 receivables and prepaid expenses         |  |                 | 134    |  
|Property and
 equipment                         |  |                 | 10     |  
|                                                |  |                 |        |  
|                                                |  |                 |        |  
|Total
 tangible assets acquired                 |  |                 | 261    |  
|                                                |  |                 |        |  
|                                                |  |                 |        |  
|Technology
 (six years useful life)             |  |                 | 1,530  |  
|Backlog (one
 year useful life)                 |  |                 | 41     |  
|Goodwill                                        |  |                 | 10,845 |  
|                                                |  |                 |        |  
|                                                |  |                 |        |  
|Total
 intangible assets acquired               |  |                 | 12,416 |  
|                                                |  |                 |        |  
|                                                |  |                 |        |  
|Total
 tangible and intangible assets acquired  |  |                 | 12,677 |  
|                                                |  |                 |        |  
|                                                |  |                 |        |  
|Trade
 payables                                 |  |                 | (64    | )
|Other
 current liabilities and accrued expenses |  |                 | (822   | )
|Accrued severance
 pay, net                     |  |                 | (329   | )
|                                                |  |                 |        |  
|                                                |  |                 |        |  
|Total
 liabilities assumed                      |  |                 | (1,215 | )
|                                                |  |                 |        |  
|                                                |  |                 |        |  
|Net assets
 acquired                            |  | $               | 11,462 |  
|                                                |  |                 |        |  

F-14

---



|                                                           
|-----------------------------------------------------------
|AUDIOCODES LTD. AND ITS SUBSIDIARIES                       
|                                                           
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in
 thousands, except share and per share data

|         |                 |                                                                                                                                                                                                                                                                                                                                                                  
|-------- | --------------- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 1:- | GENERAL (Cont.)
|         |                 |                                                                                                                                                                                                                                                                                                                                                                  
|         |                 | Based upon
 an independent valuation of tangible and intangible assets acquired, the
 Group has allocated the total acquisition cost of CTI2s assets
 and liabilities, as follows:                                                                                                                                                                              
|         |                 |                                                                                                                                                                                                                                                                                                                                                                  
|         |                 | 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 2n).                               
|         |                 |                                                                                                                                                                                                                                                                                                                                                                  
|         |                 | The value
 assigned to tangible assets, intangible assets and liabilities has been
 determined as follows:                                                                                                                                                                                                                                                       
|         |                 |                                                                                                                                                                                                                                                                                                                                                                  
|         |                 | Current
 assets and liabilities are recorded at their carrying amounts. The carrying
 amounts of current assets and liabilities were reasonable proxies for their
 fair value due to their short-term maturity. Property and equipment are
 presented at current replacement cost. The fair value of intangible assets
 was determined using the income approach.
|         |                 |                                                                                                                                                                                                                                                                                                                                                                  
|         |                 | The
 following unaudited pro forma information does not purport to represent what
 the Groups results of operations would have been had the acquisition of CTI2
 been consummated on January 1, 2006, nor does it purport to represent the
 results of operations of the Group for any future period.                                                           

|                            |  |                         |         |      |   |         |  
|--------------------------- |  | ----------------------- | ------- | ---- | - | ------- | -
|                            |  | Year ended December 31, |        
|                            |  |                         |        
|                            |  | 2006                    |         | 2007 |  
|                            |  |                         |         |      |  
|                            |  |                         |         |      |   |         |  
|Revenues                    |  | $                       | 148,323 |      | $ | 158,349 |  
|                            |  |                         |         |      |   |         |  
|                            |  |                         |         |      |   |         |  
|Net income
 (loss)          |  | $                       | 4,742   |      | $ | (4,698  | )
|                            |  |                         |         |      |   |         |  
|                            |  |                         |         |      |   |         |  
|Basic net
 loss per share   |  | $                       | 0.11    |      | $ | (0.11   | )
|                            |  |                         |         |      |   |         |  
|                            |  |                         |         |      |   |         |  
|Diluted net
 loss per share |  | $                       | 0.11    |      | $ | (0.11   | )
|                            |  |                         |         |      |   |         |  

| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | e. | The Group is
 dependent upon sole source suppliers for certain key components used in its
 products, including certain digital signal processing chips. Although there
 are 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.
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| | f. | As to a
 major customer data, see Note 16b.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    

F-15

---



AUDIOCODES LTD. AND ITS SUBSIDIARIES

|                                                          
|----------------------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                
|                                                          
|U.S. dollars in thousands, except share and per share data

|         |                                
|-------- | -------------------------------
|NOTE 2:- | SIGNIFICANT ACCOUNTING POLICIES

| |                                                                                                                                                            |                                                                                                                                                                                                                                                                                                                                                                                                      
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | The
 consolidated financial statements have been prepared in accordance with
 generally accepted accounting principles in the United States (U.S. GAAP).
| |                                                                                                                                                            |                                                                                                                                                                                                                                                                                                                                                                                                      
| | a.                                                                                                                                                         | Use of
 estimates:                                                                                                                                                                                                                                                                                                                                                                                   
| |                                                                                                                                                            |                                                                                                                                                                                                                                                                                                                                                                                                      
| |                                                                                                                                                            | The
 preparation of financial statements in conformity with generally accepted
 accounting principles requires management to make estimates and assumptions
 that affect the amounts reported in the financial statements and accompanying
 notes. Actual results could differ from those estimates.                                                                                                 
| |                                                                                                                                                            |                                                                                                                                                                                                                                                                                                                                                                                                      
| | b.                                                                                                                                                         | Financial
 statements in U.S. dollars:                                                                                                                                                                                                                                                                                                                                                               
| |                                                                                                                                                            |                                                                                                                                                                                                                                                                                                                                                                                                      
| |                                                                                                                                                            | A majority
 of the Companys revenues is generated in dollars. In addition, most of the
 Companys costs are denominated and determined in U.S. dollars and in New
 Israeli Shekels. The Companys management believes that the dollar is the
 currency in the primary economic environment in which the Company operates.
 Thus, the functional and reporting currency of the Company is the dollar.
| |                                                                                                                                                            |                                                                                                                                                                                                                                                                                                                                                                                                      
| |                                                                                                                                                            | Accordingly,
 monetary accounts maintained in currencies other than the dollar are
 remeasured into U.S. dollars in accordance with SFAS No. 52, Foreign Currency
 Translation. All transaction gains and losses of the remeasured monetary
 balance sheet items are reflected in the statements of operations as
 financial income or expenses, as appropriate.                                   
| |                                                                                                                                                            |                                                                                                                                                                                                                                                                                                                                                                                                      
| | c.                                                                                                                                                         | Principles
 of consolidation:                                                                                                                                                                                                                                                                                                                                                                        
| |                                                                                                                                                            |                                                                                                                                                                                                                                                                                                                                                                                                      
| |                                                                                                                                                            | The
 consolidated financial statements include the accounts of the Company and its
 wholly-owned subsidiaries. Intercompany transactions and balances, including
 profits from intercompany sales not yet realized outside the Company, have
 been eliminated upon consolidation.                                                                                                                    
| |                                                                                                                                                            |                                                                                                                                                                                                                                                                                                                                                                                                      
| | d.                                                                                                                                                         | Cash
 equivalents:                                                                                                                                                                                                                                                                                                                                                                                   
| |                                                                                                                                                            |                                                                                                                                                                                                                                                                                                                                                                                                      
| |                                                                                                                                                            | Cash
 equivalents are short-term highly liquid investments that are readily
 convertible into cash with original maturities of three months or less, at
 the date acquired.                                                                                                                                                                                                                          
| |                                                                                                                                                            |                                                                                                                                                                                                                                                                                                                                                                                                      
| | e.                                                                                                                                                         | Short-term
 bank deposits:                                                                                                                                                                                                                                                                                                                                                                           
| |                                                                                                                                                            |                                                                                                                                                                                                                                                                                                                                                                                                      
| |                                                                                                                                                            | Short-term
 bank deposits are deposits with maturities of more than three months but less
 than one year. The deposits are in U.S. dollars and bear interest at an
 average rate of 5.18% and 4.57% for 2006 and 2007, respectively. Short-term
 deposits are presented at their cost. The accrued interest is included in
 other receivables and prepaid expenses.                                  

F-16

---



AUDIOCODES LTD. AND ITS SUBSIDIARIES

|                                                           
|-----------------------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands,
 except share and per share data

|         |                                         | 
|-------- | --------------------------------------- | 
|NOTE 2:- | SIGNIFICANT ACCOUNTING POLICIES (Cont.)
|         |                                        

| | f. | Marketable
 securities:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| |    | The Company
 accounts for investments in debt securities in accordance with SFAS No. 115,
 Accounting for Certain Investments in Debt and Equity Securities.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| |    | Management
 determines the appropriate classification of its investments in marketable
 debt securities at the time of purchase and evaluates such determinations at
 each balance sheet date. Debt securities are classified as held-to-maturity
 since the Company has the intent and ability to hold the securities to
 maturity and, accordingly, debt securities are stated at amortized cost.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| |    | The
 amortized cost of held-to-maturity securities is adjusted for amortization of
 premiums and accretion of discounts to maturity. Such amortization and
 interest are included in the consolidated statement of income as financial
 income or expenses, as appropriate. The accrued interest on short-term and
 long-term marketable securities is included in the balance of short-term
 marketable securities.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| |    | FASB Staff
 Position (FSP) No. 115-1, The Meaning of Other-Than-Temporary Impairment
 and Its Application to Certain Investment (FSP 115-1) and SAB Topic 5M
 Other Than Temporary Impairment Of Certain Investments In Debt And Equity Securities
 provides guidance for determining when an investment is considered impaired,
 whether impairment is other-than temporary, and measurement of an impairment
 loss. An investment is considered impaired if the fair value of the
 investment decreased below its cost in an other-than temporary manner. If,
 after consideration of all available evidence to evaluate the realizable
 value of its investment, impairment is determined to be other than -
 temporary, then an impairment loss should be recognized equal to the
 difference between the investments cost and its fair value. FSP 115-1
 nullifies certain provisions of Emerging Issues Task Force (EITF) Issue No.
 03-1, The Meaning of Other-Than-Temporary Impairment and Its Application to
 Certain Investments (EITF 03-1) while retaining the disclosure
 requirements of EITF 03-1 which the Company adopted in 2003.
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| | g. | Inventories:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| |    | Inventories
 are stated at the lower of cost or market value. Cost is determined as
 follows:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| |    | Raw
 materials - using the moving average method.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| |    | Finished
 products - using the moving average method with the addition of direct
 manufacturing costs.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| |    | The Group
 periodically evaluates 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
 are taken based on slow moving items, technological obsolescence, excess
 inventories, discontinued products and for market prices lower than cost.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       

F-17

---



AUDIOCODES LTD. AND ITS SUBSIDIARIES

|                                                          
|----------------------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                
|                                                          
|U.S. dollars in thousands, except share and per share data

|         |                                         | 
|-------- | --------------------------------------- | 
|NOTE 2:- | SIGNIFICANT ACCOUNTING POLICIES (Cont.)

| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | h. | Long-term
 bank deposits:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| |    | Bank
 deposits with maturities of more than one year are included in long-term
 investments and presented at their cost including accrued interest. The
 deposits are in U.S. dollars and bear interest at an average rate of 5.10%
 for 2006 and 2007. Long-term deposits are presented at their cost. Accrued
 interest is included in other receivables and prepaid expenses.                                                                                                                                                                                                   
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| | i. | Structured
 notes:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| |    | The Group
 accounts for investments in structured notes in accordance with Emerging
 Issues Task Force (EITF) Issue No. 96-12, Recognition of Interest Income
 and Balance Sheet Classification of Structure Notes. Management determines
 the appropriate classification of its investments in debt securities at the
 time of purchase and reevaluates such determinations at each balance sheet
 date. Debt securities are classified as held-to-maturity when the Group has
 the intent and ability to hold these securities to maturity and are stated at
 amortized cost.
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| |    | As of
 December 31, 2007 the Company did not have any structured notes.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| | j. | Investment
 in companies:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| |    | The Company
 accounts for its investments in companies in which it has the ability to
 exercise significant influence over the operating and financial policies,
 using the equity method of accounting in accordance with the requirements of
 Accounting Principle Board (APB) No. 18, The Equity Method of Accounting
 for Investments in Common Stock. If the Company does not have the ability to
 exercise significant influence over operating and financial policies of these
 companies, the investment in these companies are stated at cost.                        
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| |    | Investment
 in companies represents investments in Ordinary shares, Preferred shares and
 convertible loans. The Company applies EITF No. 99-10, Percentage Used to
 Determine the Amount of Equity Method Losses. Accordingly, losses of such
 companies are recognized based on the ownership level of the particular
 security held by the investor.                                                                                                                                                                                                                          
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| |    | The
 Companys investments are reviewed for impairment whenever events or changes
 in circumstances indicate that the carrying amount of the investment may not
 be recoverable, in accordance with APB No. 18. As of December 31, 2006 and
 2007, based on managements most recent analyses, no impairment losses have
 been identified.                                                                                                                                                                                                                                         

F-18

---



|                                                           
|-----------------------------------------------------------
|AUDIOCODES LTD. AND ITS SUBSIDIARIES                       
|                                                           
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in
 thousands, except share and per share data

|         |                                         |                                                                                                                                                                                                                    
|-------- | --------------------------------------- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|         |                                        
|NOTE 2:- | SIGNIFICANT
ACCOUNTING POLICIES (Cont.)
|         |                                         |                                                                                                                                                                                                                    
|         | k.                                      | Property and
 equipment:                                                                                                                                                                                           
|         |                                         |                                                                                                                                                                                                                    
|         |                                         | Property and equipment are
 stated at cost, net of accumulated depreciation. Depreciation is calculated
 by the straight-line method over the estimated useful lives of the assets, at
 the following annual rates:

|                                    |                                                                   
|----------------------------------- | ------------------------------------------------------------------
|                                    | %                                                                 
|                                    |                                                                   
|                                    |                                                                   
|Computers
 and peripheral equipment | 33                                                                
|Office
 furniture and equipment     | 6 - 20 (mainly 15%)                                               
|Leasehold
 improvements             | Over the shorter of the term of the lease or the life of the asset

| |    |                                                                                                                                                                                                                                                                                                                                                                  
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 1. | Intangible
 assets and deferred charges:                                                                                                                                                                                                                                                                                                                         
| |    |                                                                                                                                                                                                                                                                                                                                                                  
| |    | Intangible
 assets are amortized over their useful life using a method of amortization
 that reflects the pattern in which the economic benefits of the intangible
 assets are consumed or otherwise used up, in accordance with SFAS No. 142. Amortization is calculated by the
 straight-line method over the estimated useful lives of the assets as
 follows:

|                                   |  |       
|---------------------------------- |  | ------
|                                   |  | Years 
|                                   |  |       
|                                   |  |       
|Acquired technology                |  | 5 - 10
|Customer relationship              |  | 9     
|Backlog                            |  | 1 - 2 
|Trade name                         |  | 3     
|Existing contracts for maintenance |  | 3     

| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |    | Cost
 incurred in respect of issuance of senior convertible notes are deferred and
 amortized using the effective interest method and classified as a component
 of interest expense, over the period from issuance to maturity, which is 20
 years, in accordance with APB No. 21 Interest on Receivables and Payables.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| | m. | Impairment
 of long-lived assets:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| |    | The Groups
 long-lived assets and identifiable intangibles which are subject to
 amortization are reviewed for impairment in accordance with SFAS No. 144
 Accounting for the Impairment or Disposal of Long-Lived Assets, whenever
 events or changes in circumstances indicate that the carrying amount of an
 asset may not be recoverable. Recoverability of assets to be held and used is
 measured by a comparison of the carrying amount of an asset to the
 undiscounted future cash flows expected to be generated by the assets. If
 such assets are considered to be impaired, the impairment to be recognized is
 measured by the amount by which the carrying amount of the assets exceeds the
 fair value of the assets. As of December 31, 2006 and 2007, no impairment
 losses have been identified.

F-19

---



|                                                           
|-----------------------------------------------------------
|AUDIOCODES LTD. AND ITS SUBSIDIARIES                       
|                                                           
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in
 thousands, except share and per share data

|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|-------- | --------------------------------------- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 2:- | SIGNIFICANT ACCOUNTING POLICIES (Cont.)
|         |                                        
|         | n.                                      | Goodwill:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|         |                                         | Goodwill represents an excess of costs over the fair value of the net
 assets of businesses acquired under SFAS No. 142.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|         |                                         | 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.                                                                                                                                                                                                                                                   
|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|         |                                         | Fair value
 is determined using market capitalizations. The Company elected to perform
 its analysis of goodwill impairment during the fourth quarter of each year.
 The test was done in the forth quarter of 2007 based on the Groups single
 operating segment and reporting unit structure. As of December 31, 2006
 and 2007, no impairment losses had been identified.                                                                                                                                                                                                                                                         
|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|         | o.                                      | Revenue
 recognition:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|         |                                         | The Group
 generates its revenues primarily from the sale of products, through a direct
 sales force and sales representatives. The Groups products are delivered to
 its customers, which include original equipment manufacturers, network
 equipment providers, systems integrators and distributors in the
 telecommunications and networking industries, all of whom are considered
 end-users.                                                                                                                                                                                                                                 
|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|         |                                         | Revenues
 from products are recognized in accordance with Staff Accounting Bulleting
 (SAB) No. 104, Revenue Recognition in Financial Statements, when the
 following criteria are met: persuasive evidence of an arrangement exists,
 delivery of the product has occurred, the fee is fixed or determinable, and
 collectibility is probable. The Group has no obligation to customers after
 the date on which products are delivered other than pursuant to warranty
 obligations and right of return.                                                                                                                        
|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|         |                                         | The Group
 generally grants to its customers a 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. The Group maintains
 a provision for product returns and exchanges based on its experience with
 historical sales returns, analysis of credit memo data and other known
 factors, in accordance with SFAS No. 48, Revenue Recognition When Right of
 Return Exists. The provision was deducted from revenues and amounted to
 $545, $636 and $559 as of December 31, 2005, 2006 and 2007, respectively.
|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|         |                                         | 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.                                                                                                                                                                                                                                                                                                                                                                                                                                        

F-20

---



|                                                           
|-----------------------------------------------------------
|AUDIOCODES LTD. AND ITS SUBSIDIARIES                       
|                                                           
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in
 thousands, except share and per share data

|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|-------- | --------------------------------------- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 2:- | SIGNIFICANT ACCOUNTING POLICIES (Cont.)
|         |                                        
|         | p.                                      | Warranty
 costs:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|         |                                         | The Group
 generally provides a warranty period of 12 months, at no extra charge. The
 Group estimates the costs that may be incurred under its basic limited
 warranty and records a liability in the amount of such costs at the time
 product revenue is recognized. Factors that affect the Groups warranty
 liability include the number of installed units, historical and anticipated
 rates of warranty claims, and cost per claim. The Group periodically assesses
 the adequacy of its recorded warranty liability and adjusts the amount as
 necessary. A tabular reconciliation of the changes in the Companys aggregate
 product warranty liability was not provided due to immateriality.                                              
|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|         | q.                                      | Research and
 development costs:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|         |                                         | Research and
 development costs, net of government grants received, are charged to the
 statement of operations as incurred.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|         | r.                                      | Income
 taxes:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|         |                                         | The Group
 accounts for income taxes in accordance with SFAS No. 109, Accounting for
 Income Taxes. This Statement prescribes the use of the asset and liability
 method whereby account balances of deferred tax assets and liabilities are
 determined based on differences between financial reporting and tax bases of
 assets and liabilities and are measured using the enacted tax rates and laws
 that will be in effect when the differences are expected to reverse. The
 Group provides a valuation allowance, if necessary, to reduce deferred tax
 assets to their estimated realizable value.                                                                                                                                          
|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|         |                                         | In June
 2006, the FASB issued FIN 48, Accounting for Uncertainty in Income Taxesan
 interpretation of FASB Statement No. 109 (FIN 48). FIN 48 clarifies
 the accounting for uncertainty in income taxes recognized under SFAS
 No. 109. FIN 48 prescribes a recognition threshold and measurement
 attribute for financial statement recognition and measurement of a tax
 position taken or expected to be taken in a tax return and also provides
 guidance on various related matters such as derecognition, interest and
 penalties, and disclosure. On January 1, 2007, the Company adopted FIN
 48. The initial application of FIN 48 to the Companys tax positions did not
 have a material effect on the Companys Shareholders Equity.
|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|         | s.                                      | Concentrations
 of credit risk:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|         |                                         | Financial
 instruments that potentially subject the Group to concentrations of credit
 risk consist principally of cash and cash equivalents, bank deposits,
 structured notes, marketable securities and trade receivables.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           

F-21

---



|                                                           
|-----------------------------------------------------------
|AUDIOCODES LTD. AND ITS SUBSIDIARIES                       
|                                                           
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in
 thousands, except share and per share data

|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|-------- | --------------------------------------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 2:- | SIGNIFICANT ACCOUNTING POLICIES (Cont.)
|         |                                        
|         |                                         | The majority
 of the Groups cash and cash equivalents and bank deposits are invested in
 U.S. dollar instruments with major banks in Israel and the United States.
 Such investments in the United States may be in excess of insured limits and
 are not insured in other jurisdictions. Management believes that the
 financial institutions that hold the Groups investments are financially
 sound and, accordingly, minimal credit risk exists with respect to these
 financial investments.                                                                                                 
|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|         |                                         | Marketable
 securities include investments in debentures of corporations, U.S. government
 and agencies. Management believes that those corporations and agencies are
 financially sound, the portfolio is well diversified, and accordingly,
 minimal credit risk exists with respect to these marketable debt securities.                                                                                                                                                                                                                                                                         
|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|         |                                         | As a result
 of the recent turmoil in capital markets the Company tightened its control
 and monitoring over its marketable securities portfolio in order to minimize
 potential risks stemming from the current capital markets environment. Such
 measures included among others: the Companys investment policy approved by
 the Investment Committee that limits the amount the Company may invest in any
 one type of investment or issuer and the grade of the security with the
 intent of, reducing credit risk concentrations.                                                            
|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|         |                                         | The trade
 receivables of the Group are derived from sales to customers located
 primarily in the Americas, the Far East, Israel and Europe. The Group
 performs ongoing credit evaluations of its customers and to date has not
 experienced any material losses with respect to its trade receivables. An
 allowance for doubtful accounts is determined with respect to those amounts
 that the Group has determined to be doubtful of collection. The Group usually
 does not require collateral on trade receivables because most of its sales
 are to large and well-established companies.   
|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|         | t.                                      | Senior
 convertible notes:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|         |                                         | The Company
 presents the outstanding principal amount of its senior convertible notes as
 a long-term liability, in accordance with APB No. 14, Accounting for
 Convertible Debt and Debt Issued with Stock Purchase Warrants. The debt is
 classified as a long-term liability until the date of conversion on which it
 would be reclassified to equity, or at within one year of the first
 contractual redemption date, on which it would be reclassified as a
 short-term liability. Accrued interest on the senior convertible notes is
 included in other payables and accrued expenses.
|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|         |                                         | The Initial
 Purchasers discount is recorded as a discount to the debt and amortized
 according to the interest method over the term of the senior convertible
 notes in accordance with EITF Issue No. 00-27, Application of Issue No. 98-5
 to Certain Convertible Industries, which is 20 years.                                                                                                                                                                                                                                                                                               

F-22

---



|                                                          
|----------------------------------------------------------
|AUDIOCODES LTD. AND ITS SUBSIDIARIES                      
|                                                          
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                
|                                                          
|U.S. dollars in thousands, except share and per share data

|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|-------- | --------------------------------------- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 2:- | SIGNIFICANT ACCOUNTING POLICIES (Cont.)
|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|         | u.                                      | Basic and
  diluted net earnings per share:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|         |                                         | Basic net
  earnings per share are computed based on the weighted average number of
  Ordinary shares outstanding during each year. Diluted net earnings per share
  are computed based on the weighted average number of Ordinary shares
  outstanding during each year, plus potential dilutive Ordinary shares
  considered outstanding during the year, in accordance with SFAS No. 128,
  Earnings Per Share.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|         |                                         | Senior
  convertible notes and certain outstanding stock options and warrants have
  been excluded from the calculation of the diluted net earnings per Ordinary
  share since such securities are anti-dilutive for all years presented. The
  total weighted average number of shares related to the senior convertible
  notes and outstanding options and warrants that have been excluded from the
  calculations of diluted net earnings per share was 8,598,556, 9,924,624 and
  11,765,438 for the years ended December 31, 2005, 2006 and 2007,
  respectively.                                                                                                                                                                                                                                                                                                                                            
|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|         | v.                                      | Equity-based
  compensation expenses:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|         |                                         | On January
  1, 2006, the Company adopted SFAS No. 123 (revised 2004), Share-Based
  Payment (SFAS No. 123(R)) which requires the measurement and recognition
  of compensation expense based on estimated fair values for all share-based
  payment awards made to employees and directors. SFAS No. 123(R) supersedes
  Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to
  Employees (APB No. 25), for periods beginning in fiscal year 2006. In
  March 2005, the Securities and Exchange Commission issued Staff Accounting
  Bulletin No. 107 (SAB 107) relating to SFAS No. 123(R). The Company has
  applied the provisions of SAB No. 107 in its adoption of SFAS No. 123(R).                                                                                                                                                                                           
|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|         |                                         | The Company
  adopted SFAS No. 123(R) using the modified prospective transition method,
  which requires the application of the accounting standard starting from
  January 1, 2006, the first day of the Companys fiscal year 2006. Under that
  transition method, compensation cost recognized in the years ended December
  31, 2006 and 2007, includes: (a) compensation cost for all share-based
  payments granted prior to, but not yet vested as of January 1, 2006, based on
  the grant date fair value estimated in accordance with the original
  provisions of SFAS No. 123, and (b) compensation cost for all share-based
  payments granted subsequent to January 1, 2006, based on the grant-date fair
  value estimated in accordance with the provisions of SFAS No. 123(R). Results
  for prior periods have not been restated in accordance with the modified
  prospective transition method.
|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|         |                                         | The Company
  recognizes compensation expenses for the value of its awards based on the
  accelerated method over the requisite service period of each of the awards,
  net of estimated forfeitures. SFAS No. 123(R) requires forfeitures to be
  estimated at the time of grant and revised, if necessary, in subsequent
  periods if actual forfeitures differ from those estimates. Estimated
  forfeitures are based on actual historical pre-vesting forfeitures.                                                                                                                                                                                                                                                                                                                                                                                                                                             

F-23

---



|                                                          
|----------------------------------------------------------
|AUDIOCODES LTD. AND ITS SUBSIDIARIES                      
|                                                          
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                
|                                                          
|U.S. dollars in thousands, except share and per share data

|         |                                        
|-------- | ---------------------------------------
|NOTE 2:- | SIGNIFICANT ACCOUNTING POLICIES (Cont.)

| |                                                                                                                                                                                                                                                                   
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Pro forma
  information regarding the Groups net income and net earnings per share is
  required by SFAS No. 123 and has been determined as if the Group had
  accounted for its employee stock options under the fair value method
  prescribed by SFAS No. 123.
| |                                                                                                                                                                                                                                                                   
| | The fair
  value for these options was estimated at the date of grant using the Black
  and Scholes option pricing model and amortized over the vesting period. Fair
  values were estimated using the following weighted-average assumptions:                    

|                      |          
|--------------------- | ---------
|                      | 2005     
|                      |          
|                      |          
|Dividend
  yield      | 0%       
|Expected
  volatility | 75%      
|Risk-free
  interest  | 4%       
|Expected
  life       | 4.5 years

| |                                                                                                                                                                                        
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | The
  Black-Scholes pricing-model was used to estimate the fair value of the
  Employee Stock Purchase Plan (ESPP) compensation. Assumptions are not
  provided due to immateriality.
| |                                                                                                                                                                                        
| | Pro forma
  information under SFAS No. 123 is as follows:                                                                                                                              

|                                                                                                                                 |  |                                  |        |  
|-------------------------------------------------------------------------------------------------------------------------------- |  | -------------------------------- | ------ | -
|                                                                                                                                 |  | Year ended
  December 31,
  2005 |       
|                                                                                                                                 |  |                                  |       
|                                                                                                                                 |  |                                  |        |  
|Net income as reported                                                                                                           |  | $                                | 13,436 |  
|Add: stock-based compensation expenses
  determined under the intrinsic value based method included in the reported
  net income |  |                                  | 36     |  
|Deduct: stock-based compensation expenses
  determined under the fair value based method for all awards                          |  |                                  | (8,869 | )
|                                                                                                                                 |  |                                  |        |  
|                                                                                                                                 |  |                                  |        |  
|Pro forma net income                                                                                                             |  | $                                | 4,603  |  
|                                                                                                                                 |  |                                  |        |  
|                                                                                                                                 |  |                                  |        |  
|Basic net earnings per share as reported                                                                                         |  | $                                | 0.33   |  
|                                                                                                                                 |  |                                  |        |  
|Diluted net earnings per share as reported                                                                                       |  | $                                | 0.31   |  
|                                                                                                                                 |  |                                  |        |  
|                                                                                                                                 |  |                                  |        |  
|Pro forma basic net earning per share                                                                                            |  | $                                | 0.11   |  
|                                                                                                                                 |  |                                  |        |  
|Pro forma diluted net earning per share                                                                                          |  | $                                | 0.11   |  
|                                                                                                                                 |  |                                  |        |  

| |                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | The Group
  applies SFAS No. 123 and EITF No. 96-18, Accounting for Equity Instruments
  That Are Issued to Other Than Employees for Acquiring or in Conjunction with
  Selling, Goods or Services, with respect to options and warrants issued to
  non-employees. SFAS No. 123 requires the use of option valuation models to
  measure the fair value of the options and warrants at the measurement date.                                       
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| | As of
  December 31, 2007, the total unrecognized estimated compensation cost related
  to non-vested stock options granted prior to that date was $8,003, which is
  expected to be recognized over a weighted-average period of 1.5 years. The
  total intrinsic value of stock options exercised during 2007 was $613. The
  Company recorded cash received from the exercise of stock options of $1,189
  during the year ended December 31, 2007.

F-24

---



|                                                            
|------------------------------------------------------------
|AUDIOCODES LTD. AND ITS SUBSIDIARIES                        
|                                                            
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                  
|                                                            
|U.S. dollars in
  thousands, except share and per share data

|         |                                        
|-------- | ---------------------------------------
|NOTE 2:- | SIGNIFICANT ACCOUNTING POLICIES (Cont.)

| |                                                                                                                                                                                                                                                                                                                                            
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | The
  weighted-average estimated fair value of employee stock options granted
  during the years ended December 31, 2006 and 2007, was $5.81 and $3.23 per
  share, respectively, using the Black-Scholes option pricing formula. Fair
  values were estimated using the following weighted-average assumptions (annualized
  percentages):

|                      |  |                            |           |      |  |           | 
|--------------------- |  | -------------------------- | --------- | ---- |  | --------- | 
|                      |  | Year ended 
  December 31, |          
|                      |  |                            |          
|                      |  | 2006                       |           | 2007 | 
|                      |  |                            |           |      | 
|                      |  |                            |           |      |  |           | 
|Dividend
  yield      |  |                            | 0%        |      |  | 0%        | 
|Expected
  volatility |  |                            | 61.9%     |      |  | 54.7%     | 
|Risk-free
  interest  |  |                            | 4.6%      |      |  | 4.6%      | 
|Expected
  life       |  |                            | 4.8 years |      |  | 4.8 years | 
|Forfeiture
  rate     |  |                            | 5.1%      |      |  | 7.0%      | 

| |                                                                                                                                                                                                                                                    
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | The dividend yield
  assumption is based on the Companys historical experience and expectation of
  no future dividend payouts and may be subject to substantial change in the
  future.                                                          
| |                                                                                                                                                                                                                                                    
| | The Company used its
  historical volatility in accordance with SFAS No. 123(R). The computation of
  volatility uses historical volatility derived from the Companys exchange
  traded shares.                                                   
| |                                                                                                                                                                                                                                                    
| | The risk-free interest
  rate assumption is the implied yield currently available on United States
  treasury zero-coupon issues with a remaining term equal to the expected life
  of the Companys options.                                      
| |                                                                                                                                                                                                                                                    
| | The Company determined the
  expected life of the options according to the simplified method based on the
  average of vesting and the contractual term of the Companys stock options.                                                            
| |                                                                                                                                                                                                                                                    
| | The Companys compensation
  cost for the years ended December 31, 2006 and 2007 totaled $8,707 and
  $7,967, respectively.                                                                                                                        
| |                                                                                                                                                                                                                                                    
| | The total equity-based
  compensation expense relating to all of the Companys equity-based awards
  recognized for the twelve months ended December 31, 2006 and 2007 was
  included in items of the consolidated statements of income as follows:

|                                           |  |                          |       |      |   |       | 
|------------------------------------------ |  | ------------------------ | ----- | ---- | - | ----- | 
|                                           |  | Year ended
  December 31 |      
|                                           |  |                          |      
|                                           |  | 2006                     |       | 2007 |  
|                                           |  |                          |       |      |  
|                                          
|Cost of
  revenues                         |  | $                        | 620   |      | $ | 613   | 
|Research and
  development, net            |  |                          | 3,053 |      |   | 3,011 | 
|Selling and
  Marketing expenses           |  |                          | 3,628 |      |   | 3,476 | 
|General and
  administrative expenses      |  |                          | 1,406 |      |   | 867   | 
|                                           |  |                          |       |      |   |       | 
|                                           |  |                          |       |      |   |       | 
|Total
  equity-based compensation expenses |  | $                        | 8,707 |      | $ | 7,967 | 
|                                           |  |                          |       |      |   |       | 

F-25

---



|                                                            
|------------------------------------------------------------
|AUDIOCODES LTD. AND ITS SUBSIDIARIES                        
|                                                            
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                  
|                                                            
|U.S. dollars in
  thousands, except share and per share data

|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|-------- | --------------------------------------- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 2:- | SIGNIFICANT ACCOUNTING POLICIES (Cont.)
|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|         | w.                                      | Severance
  pay:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|         |                                         | The Groups
  liability for severance pay for Israeli employees is calculated pursuant to
  Israels Severance Pay Law, based on the most recent salary of the employees
  multiplied by the number of years of employment as of the balance sheet date.
  Employees are entitled to one months salary for each year of employment, or
  a portion thereof. The Groups liability for all of its Israeli employees is
  fully provided for by monthly deposits with severance pay funds, insurance
  policies and by an accrual.                                                                                                                 
|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|         |                                         | The
  deposited funds include profits accumulated up to the balance sheet date. The
  deposited funds may be withdrawn only upon the fulfillment of the obligation
  pursuant to Israels Severance Pay Law or labor agreements. The value of the
  deposited funds is based on the cash surrendered value of these policies and
  includes immaterial profits.                                                                                                                                                                                                                                                                                   
|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|         |                                         | Severance
  pay expenses for the years ended December 31, 2005, 2006 and 2007, amounted
  to approximately $1,514, $1,766 and $2,409, respectively.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|         | x.                                      | Employees
  benefit plan                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|         |                                         | During 2007,
  the Company merged its separate 401(k) defined contribution plans into one
  plan covering employees in the U.S. All eligible employees may elect to
  contribute a portion of their annual compensation to the plan through salary
  deferrals, subject to the IRS limit of $15.5 during 2007 ($20.5 including
  catch-up contributions for participants age 50 or over). The Company matches
  employee contributions to the plan up to a limit of 3.75% of their eligible
  compensation, subject to IRS limits. In 2005, 2006 and 2007, the Company
  matched contributions in the amount of $236, $271 and $361, respectively.
|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|         | y.                                      | Advertising
  expenses:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|         |                                         | Advertising
  expenses are charged to the statements of income as incurred. Advertising
  expenses for the years ended December 31, 2005, 2006 and 2007, amounted to
  $371, $402 and $350, respectively.                                                                                                                                                                                                                                                                                                                                                                                                                                         
|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|         | z.                                      | Fair value
  of financial instruments:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|         |                                         | The
  following methods and assumptions were used by the Group in estimating its
  fair value disclosures for financial instruments:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|         |                                         | The carrying
  amounts of cash and cash equivalents, trade receivables and trade payables
  approximate their fair value due to the short-term maturity of such
  instruments.                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|         |                                         | The carrying
  amounts of bank deposits are estimated by discounting the future cash flows
  using current interest rates for deposits of similar terms and maturities.
  The carrying amount of long-term deposits approximates their fair value.                                                                                                                                                                                                                                                                                                                                                                                                

F-26

---



|                                                            
|------------------------------------------------------------
|AUDIOCODES LTD. AND ITS SUBSIDIARIES                        
|                                                            
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                  
|                                                            
|U.S. dollars in
  thousands, except share and per share data

|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|-------- | --------------------------------------- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 2:- | SIGNIFICANT ACCOUNTING POLICIES (Cont.)
|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|         |                                         | The fair
  value of marketable securities is based on quoted prices and do not differ
  significantly from the carrying amount (see Note 4).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|         |                                         | The fair
  value of senior convertible notes is based on quoted market values in the
  amount of $107, 500.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|         |                                         | The fair
  value of foreign currency contracts (used for hedging purposes) is estimated
  by obtaining current quotes from banks.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|         | aa.                                     | Derivative
  instruments:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|         |                                         | Statement of
  Financial Accounting Standard No. 133, Accounting for Derivative Instruments
  and Hedging Activities (SFAS No. 133), requires companies to recognize all
  of its derivative instruments as either assets or liabilities in the
  statement of financial position at fair value.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|         |                                         | For those
  derivative instruments that are designated and qualify as hedging
  instruments, a Company must designate the hedging instrument, based upon the
  exposure being hedged, as a fair value hedge, cash flow hedge or a hedge of a
  net investment in a foreign operation.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|         |                                         | For
  derivative instruments that are designated and qualify as a cash flow hedge
  (i.e., hedging the exposure to variability in expected future cash flows that
  is attributable to a particular risk), the effective portion of the gain or
  loss on the derivative instrument is reported as a component of other
  comprehensive income and reclassified into earnings in the same period or
  periods during which the hedged transaction affects earnings. The remaining gain
  or loss on the derivative instrument in excess of the cumulative change in
  the present value of future cash flows of the hedged item, if any, is
  recognized in current earnings during the period of change. For derivative
  instruments not designated as hedging instruments, the gain or loss is
  recognized in current earnings during the period of change.
|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|         |                                         | Cash flow
  hedging strategy - To hedge against the risk of overall changes in cash flows
  resulting from forecasted foreign currency salary payments during the year,
  the Company hedges portions of its forecasted expenses denominated in NIS
  with currency forwards and options. These option contracts are designated as
  cash flow hedges, as defined by SFAS No. 133 and Derivative
  Implementation Group No. G20, Cash Flow Hedges: Assessing and Measuring the
  Effectiveness of a Purchased option Used in a Cash Flow Hedge (DIG 20) and
  are all effective.                                                                                                                                                                                                                                                                           
|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|         |                                         | During 2007,
  the Company recorded accumulated other comprehensive income in the amount of
  $925 from its currency forward and option transactions with respect to
  payroll expenses expected to be incurred during 2008. Such amount will be
  recorded into earnings during 2008.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|         | ab.                                     | Reclassification:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|         |                                         | Certain
  amounts in prior years financial statements have been reclassified to
  conform to the current years presentation.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 

F-27

---



AUDIOCODES LTD. AND ITS SUBSIDIARIES

|                                                          
|----------------------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                
|                                                          
|U.S. dollars in thousands, except share and per share data

|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|-------- | --------------------------------------- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 2:- | SIGNIFICANT ACCOUNTING POLICIES (Cont.)
|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|         | ac.                                     | Impact of
  recently issued accounting standards:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|         |                                         | In September
  2006, the Financial Accounting Standards Board (FASB) issued SFAS No. 157,
  Fair Value Measurements (SFAS No. 157). This Standard defines fair value,
  establishes a framework for measuring fair value in generally accepted accounting
  principles and expands disclosures about fair value measurements. The
  provisions of SFAS No. 157 are effective for the Company beginning January 1,
  2008. The FASB issued a FASB Staff Position (FSP 157-2) to defer the
  effective date of SFAS No. 157 for one year for all nonfinancial assets and
  nonfinancial liabilities, except for those items that are recognized or
  disclosed at fair value in the financial statements on a recurring basis. The
  Company does not expect the adoption of SFAS No. 157 will have material
  impact on its consolidated financial statements.                                                                                                                                                                                                                                                                                           
|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|         |                                         | In February
  2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial
  Assets and Financial Liabilities (SFAS No. 159). SFAS No. 159 permits
  companies to choose to measure certain financial instruments and other items
  at fair value. The standard requires that unrealized gains and losses are
  reported in earnings for items measured using the fair value option. SFAS No.
  159 is effective for the Company beginning in the first quarter of fiscal
  year 2008. The company has determined that the adoption of SFAS 159 will not
  have an impact on its consolidated financial statements since it has not
  elected the fair value option for any of its existing assets or liabilities
  as of FAS 159 effective date.                                                                                                                                                                                                                                                                                                                                                                                                
|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|         |                                         | In December
  2007, the FASB issued SFAS No. 141 (revised 2007), Business Combinations
  (SFAS 141R). SFAS 141R establishes principles and requirements for how an
  acquirer recognizes and measures in its financial statements the identifiable
  assets acquired, the liabilities assumed, any non controlling interest in the
  acquiree and the goodwill acquired. SFAS 141R also establishes disclosure
  requirements to enable the evaluation of the nature and financial effects of
  the business combination. SFAS 141R is effective for fiscal years beginning
  after December 15, 2008. Earlier adoption is prohibited. The adoption of SFAS
  141R might have a material effect if and when the Company enters into a
  business combination after December 31, 2008.                                                                                                                                                                                                                                                                                                                                                                     
|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|         |                                         | In December
  2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated
  Financial Statements, an amendment of ARB No. 51. SFAS No. 160 establishes
  accounting and reporting standards that require that the ownership interests
  in subsidiaries held by parties other than the parent be clearly identified,
  labeled, and presented in the consolidated statement of financial position
  within equity, but separate from the parents equity; the amount of
  consolidated net income attributable to the parent and to the noncontrolling
  interest be clearly identified and presented on the face of the consolidated
  statement of income; and changes in a parents ownership interest while the
  parent retains its controlling financial interest in its subsidiary be
  accounted for consistently. SFAS No. 160 is effective for fiscal years, and
  interim periods within those fiscal years, beginning on or after December 15,
  2008. The adoption of the provisions of Statement No. 160 is not anticipated
  to materially impact the Companys consolidated financial position and
  results of operations.

F-28

---



AUDIOCODES LTD. AND ITS SUBSIDIARIES

|                                                          
|----------------------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                
|                                                          
|U.S. dollars in thousands, except share and per share data

|         |                                                               |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|-------- | ------------------------------------------------------------- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 2:- | SIGNIFICANT ACCOUNTING POLICIES (Cont.)                      
|         |                                                              
|         |                                                               | In December,
  2007 the SEC staff issued Staff Accounting Bulletin No. 110 (SAB 110), which,
  effective January 1, 2008, amends and replaces SAB 107, Share-Based Payment.
  SAB 110 expresses the views of the SEC staff regarding the use of a
  simplified method in developing an estimate of the expected term of plain
  vanilla share options in accordance with FASB Statement No. 123(R),
  Share-Based Payment. Under the simplified method, the expected term is
  calculated as the midpoint between the vesting date and the end of the
  contractual term of the option.
|         |                                                               |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|         |                                                               | The use of
  the simplified method, which was first described in Staff Accounting
  Bulletin No. 107, was scheduled to expire on December 31, 2007. SAB 110
  extends the use of the simplified method for plain vanilla awards in
  certain situations. The SEC staff does not expect the simplified method to
  be used when sufficient information regarding exercise behavior, such as
  historical exercise data or exercise information from external sources,
  becomes available.                                                                                            
|         |                                                               |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|NOTE 3:- | BANK DEPOSITS AND STRUCTURED NOTES                           
|         |                                                              
|         | Bank
  deposits and structured notes are composed as follows:

|                                           |  |                           |      |      |  |      |   |      |        |  |   |        | 
|------------------------------------------ |  | ------------------------- | ---- | ---- |  | ---- | - | ---- | ------ |  | - | ------ | 
|                                           |  | December 31,             
|                                           |  |                          
|                                           |  | 2006                      |      | 2007 |  | 2006 |   | 2007 |       
|                                           |  |                           |      |      |  |      |   |      |       
|                                           |  | Weighted average interest |      |      |  |      |  
|                                           |  |                           |      |      |  |      |  
|                                           |  |                           |      |      |  |      |   |      |        |  |   |        | 
|Short-term bank deposits (in U.S. dollars) |  |                           | 5.18 | %    |  | 4.57 | % | $    | 10,700 |  | $ | 18,065 | 
|Structured notes (1)                       |  |                           |     |      |  |     |   |      | 17,958 |  |   |       | 
|                                           |  |                           |      |      |  |      |   |      |        |  |   |        | 
|                                           |  |                           |      |      |  |      |   |      |        |  |   |        | 
|                                           |  |                           |      |      |  |      |   |      | 28,658 |  |   | 18,065 | 
|                                           |  |                           |      |      |  |      |   |      |        |  |   |        | 
|Long-term bank deposits (in U.S. dollars)  |  |                           | 5.10 | %    |  | 5.10 | % |      | 20,287 |  |   | 32,670 | 
|Structured notes (2)                       |  |                           | 5.51 | %    |  |     |   |      | 10,148 |  |   |       | 
|                                           |  |                           |      |      |  |      |   |      |        |  |   |        | 
|                                           |  |                           |      |      |  |      |   |      |        |  |   |        | 
|                                           |  |                           |      |      |  |      |   |      | 30,435 |  |   | 32,670 | 
|                                           |  |                           |      |      |  |      |   |      |        |  |   |        | 
|                                           |  |                           |      |      |  |      |   |      |        |  |   |        | 
|                                           |  |                           |      |      |  |      |   | $    | 59,093 |  | $ | 50,735 | 
|                                           |  |                           |      |      |  |      |   |      |        |  |   |        | 

| |     |                                                                                                                                                                                                                                                                                                                                                                   
| | --- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | (1) | As of
  December 31, 2006, the Group had callable structured notes at par value
  totaling $18,000 for settlement during 2007 from several banks. 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
  ranged from 2.5% to 4.5% the structured notes bear interest at the rate of
  3.2% to 4.5% per annum. On all other days, the structured notes do not bear
  any interest. As of December 31, 2006, investments in structured notes
  approximated their market value.

F-29

---



AUDIOCODES LTD. AND ITS SUBSIDIARIES

|                                                           
|-----------------------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in
 thousands, except share and per share data

|         |                                           
|-------- | ------------------------------------------
|NOTE 3:- | BANK DEPOSITS AND STRUCTURED NOTES (Cont.)

| |     |                                                                                                                                                                                                                                                                                                                                                                          
| | --- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | (2) | As of
 December 31, 2006, the Group had callable structured notes at par value
 totaling $10,000 for settlement during 2010. Under the arrangements with the
 bank, whether or not the structured notes bear interest depends upon the six
 month LIBOR rate.                                                                                                            
| |     |                                                                                                                                                                                                                                                                                                                                                                          
| |     | For each day
 in which the relevant LIBOR rate is below an agreed annual fixed rate, which
 ranged from 5.25% to 6% the structured notes bear interest at the rate of
 5.75% per annum. On all other days, the structured notes bear interest at the
 rate of 2.5%. As of December 31, 2006, investments in structured notes
 securities approximated their market value.
| |     |                                                                                                                                                                                                                                                                                                                                                                          
| |     | During 2007,
 structured note at par amount of $10,000 was called by the bank.                                                                                                                                                                                                                                                                                           
| |     |                                                                                                                                                                                                                                                                                                                                                                          
| |     | As of
 December 31, 2007, the Company did not have any structured notes.                                                                                                                                                                                                                                                                                                 

|         |                                                                       
|-------- | ----------------------------------------------------------------------
|NOTE 4:- | MARKETABLE SECURITIES AND ACCRUED INTEREST                            
|         |                                                                       
|         | The
 following is a summery of held to maturity marketable securities.

|                                    |  |               |        |                     |   |               |  |               |        |                     |   |               |  |   |    |  |   |        | 
|----------------------------------- |  | ------------- | ------ | ------------------- | - | ------------- |  | ------------- | ------ | ------------------- | - | ------------- |  | - | -- |  | - | ------ | 
|                                    |  | December 31,  |       
|                                    |  |               |       
|                                    |  | 2006          |        | 2007                |  
|                                    |  |               |        |                     |  
|                                    |  | Amortizedcost |        | Netunrealizedlosses |   | Market
 Value |  | Amortizedcost |        | Netunrealizedlosses |   | Market
 Value | 
|                                    |  |               |        |                     |   |               |  |               |        |                     |   |               | 
|Corporate
 debentures:              |  |               |        |                     |   |               |  |               |        |                     |   |               |  |   |    |  |   |        | 
|Maturing
 within one year           |  | $             | 19,682 |                     | $ | 84            |  | $             | 19,598 |                     | $ | 12,985        |  | $ | 21 |  | $ | 12,964 | 
|Maturing
 within one to three years |  |               | 12,943 |                     |   | 126           |  |               | 12,817 |                     |   |              |  |   |   |  |   |       | 
|                                    |  |               |        |                     |   |               |  |               |        |                     |   |               |  |   |    |  |   |        | 
|                                    |  |               |        |                     |   |               |  |               |        |                     |   |               |  |   |    |  |   |        | 
|                                    |  |               | 32,625 |                     |   | 210           |  |               | 32,415 |                     |   | 12,985        |  |   | 21 |  |   | 12,964 | 
|                                    |  |               |        |                     |   |               |  |               |        |                     |   |               |  |   |    |  |   |        | 
|                                    |  |               |        |                     |   |               |  |               |        |                     |   |               |  |   |    |  |   |        | 
|U.S.
 Government and agencies debts |  |               |        |                     |   |               |  |               |        |                     |   |               |  |   |    |  |   |        | 
|Maturing
 within one year           |  |               | 9,000  |                     |   | 49            |  |               | 8,951  |                     |   | 4,000         |  |   |   |  |   | 4,000  | 
|Maturing
 within one to three years |  |               | 6,999  |                     |   | 48            |  |               | 6,951  |                     |   |              |  |   |   |  |   |       | 
|                                    |  |               |        |                     |   |               |  |               |        |                     |   |               |  |   |    |  |   |        | 
|                                    |  |               |        |                     |   |               |  |               |        |                     |   |               |  |   |    |  |   |        | 
|                                    |  |               | 15,999 |                     |   | 97            |  |               | 15,902 |                     |   | 4,000         |  |   |   |  |   | 4,000  | 
|                                    |  |               |        |                     |   |               |  |               |        |                     |   |               |  |   |    |  |   |        | 
|Accrued
 interest                   |  |               | 740    |                     |   |              |  |               | 740    |                     |   | 259           |  |   |   |  |   | 259    | 
|                                    |  |               |        |                     |   |               |  |               |        |                     |   |               |  |   |    |  |   |        | 
|                                    |  |               |        |                     |   |               |  |               |        |                     |   |               |  |   |    |  |   |        | 
|                                    |  | $             | 49,364 |                     | $ | 307           |  | $             | 49,057 |                     | $ | 17,244        |  | $ | 21 |  | $ | 17,223 | 
|                                    |  |               |        |                     |   |               |  |               |        |                     |   |               |  |   |    |  |   |        | 

| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | The
 unrealized losses on the Companys investments in all types of securities are
 due to interest rate increases. The contractual cash flows of these
 investments are either guaranteed by the U.S. government or an agency of the
 U.S. government or were issued by highly rated corporations. Accordingly, it
 is expected that the securities would not be settled at a price less than the
 amortized cost of the Companys investment. Since the Company has the ability
 and intent to hold these investments until a recovery of fair value, which
 may be until maturity, the Company does not consider these investments to be
 other-than-temporarily impaired as of December 31, 2007.

F-30

---



AUDIOCODES LTD. AND ITS SUBSIDIARIES

|                                                           
|-----------------------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in
 thousands, except share and per share data

|         |            
|-------- | -----------
|NOTE 5:- | INVENTORIES

|                  |  |              |        |      |   |        | 
|----------------- |  | ------------ | ------ | ---- | - | ------ | 
|                  |  | December 31, |       
|                  |  |              |       
|                  |  | 2006         |        | 2007 |  
|                  |  |              |        |      |  
|                  |  |              |        |      |   |        | 
|Raw materials     |  | $            | 5,431  |      | $ | 9,879  | 
|Finished products |  |              | 10,662 |      |   | 8,857  | 
|                  |  |              |        |      |   |        | 
|                  |  |              |        |      |   |        | 
|                  |  | $            | 16,093 |      | $ | 18,736 | 
|                  |  |              |        |      |   |        | 

| |                                                                                                                                                 
| | ------------------------------------------------------------------------------------------------------------------------------------------------
| | In the years
 ended December 31, 2005, 2006 and 2007, the Group wrote-off inventory in a
 total amount of $1,800, $1,900 and $700, respectively.

|         |                        
|-------- | -----------------------
|NOTE 6:- | INVESTMENT IN COMPANIES

| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | a. | Through
 December 31, 2007, the Group had invested an aggregate of $4,600 in Natural
 Speech Communication Ltd., a privately-held Company engaged in speech
 recognition, which is in a development stage, in order for the Company to
 achieve substantive technological milestone. As of December 31, 2007,
 the Group owned 45.2% of the outstanding share capital of this Company and
 41.5% of the share capital of this Company on a fully diluted basis.

|                  |  |              |     |      |   |     | 
|----------------- |  | ------------ | --- | ---- | - | --- | 
|                  |  | December 31, |    
|                  |  |              |    
|                  |  | 2006         |     | 2007 |  
|                  |  |              |     |      |  
|                  |  |              |     |      |   |     | 
|Equity, net (1)   |  | $            | 33  |      | $ | 435 | 
|Convertible loans |  |              | 558 |      |   |    | 
|                  |  |              |     |      |   |     | 
|                  |  |              |     |      |   |     | 
|Total investments |  | $            | 591 |      | $ | 435 | 
|                  |  |              |     |      |   |     | 

| |     |                        
| | --- | -----------------------
| | (1) | Net equity
 as follows:

|                               |  |   |        |   |   |        |  
|------------------------------ |  | - | ------ | - | - | ------ | -
|Net equity as of purchase date |  | $ | 93     |   | $ | 93     |  
|Unamortized goodwill           |  |   | 3,511  |   |   | 4,972  |  
|Accumulated net losses         |  |   | (3,571 | ) |   | (4,630 | )
|                               |  |   |        |   |   |        |  
|                               |  |   |        |   |   |        |  
|                               |  | $ | 33     |   | $ | 435    |  
|                               |  |   |        |   |   |        |  

| |                                                                                   
| | ----------------------------------------------------------------------------------
| | During 2006
 and 2007 the investees net loss was $1,780 and $1,736, respectively.

F-31

---



AUDIOCODES LTD. AND ITS SUBSIDIARIES

|                                                            
|------------------------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                  
|                                                            
|U.S. dollars in
  thousands, except share and per share data

|         |                                
|-------- | -------------------------------
|NOTE 6:- | INVESTMENT IN COMPANIES (Cont.)

| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | b. | In July
  2005, the Company signed a share purchase agreement with another unrelated
  privately-held Company and certain of its shareholders to acquire 19.5% of
  its Ordinary shares for a total purchase price in the amount of $707. During
  2006 and 2007, the Company made convertible loans in the aggregate amount of
  $272 to this Company. The loans bear interest at the rate of 9% per annum and
  are convertible into shares. The loans are payable during 2008. As of
  December 31, 2007, the Company owned 19.5% of the investees outstanding
  share capital and 17.4% of the investees share capital on a diluted basis
  without taking into account shares that may be issued upon conversion of the
  loans. As of December 31, 2006 and 2007 no impairment was identified.

| |                                |  |              |      |      |   |       |  
| | ------------------------------ |  | ------------ | ---- | ---- | - | ----- | -
| |                                |  | December 31, |     
| |                                |  |              |     
| |                                |  | 2006         |      | 2007 |  
| |                                |  |              |      |      |  
| |                                |  |              |      |      |   |       |  
| | Net equity as of purchase date |  | $            | (106 | )    | $ | (106  | )
| | Unamortized goodwill           |  |              | 985  |      |   | 1,085 |  
| | Accumulated net loss           |  |              | (33  | )    |   | (71   | )
| |                                |  |              |      |      |   |       |  
| |                                |  |              |      |      |   |       |  
| | Total investment               |  | $            | 846  |      | $ | 908   |  
| |                                |  |              |      |      |   |       |  

| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | c. | In December
  2006, the Company made a convertible loan in the amount of $1,000 to another
  unrelated privately-held Company. The loan bears interest at LIBOR+2% per
  annum and was due and payable in December 2007. In addition, the Company
  received warrants valid until the consummation of an exit transaction to
  purchase in consideration for 40% of the principal amount ($400), in
  consideration of $941.91 per share. In December, 2007 the Company requested
  repayment of loan. The Company received part of the loan and expects to
  receive the remaining balance of the loan during 2008.

|         |                       
|-------- | ----------------------
|NOTE 7:- | PROPERTY AND EQUIPMENT

| |                                      |              |      |        |      |   |        | 
| | ------------------------------------ | ------------ | ---- | ------ | ---- | - | ------ | 
| |                                      | December 31, |     
| |                                      |              |     
| |                                      |              | 2006 |        | 2007 |  
| |                                      |              |      |        |      |  
| |                                      |              |      |        |      |   |        | 
| | Cost:                                |              |      |        |      |   |        | 
| | Computers and peripheral
  equipment |              | $    | 14,022 |      | $ | 16,073 | 
| | Office furniture and
  equipment     |              |      | 8,079  |      |   | 8,515  | 
| | Motor vehicles                       |              |      | 48     |      |   |       | 
| | Leasehold improvements               |              |      | 1,561  |      |   | 1,731  | 
| |                                      |              |      |        |      |   |        | 
| |                                      |              |      |        |      |   |        | 
| |                                      |              |      | 23,710 |      |   | 26,319 | 
| |                                      |              |      |        |      |   |        | 
| | Accumulated depreciation:            |              |      |        |      |   |        | 
| | Computers and peripheral
  equipment |              |      | 10,868 |      |   | 12,848 | 
| | Office furniture and
  equipment     |              |      | 4,429  |      |   | 5,733  | 
| | Motor vehicles                       |              |      | 48     |      |   |       | 
| | Leasehold improvements               |              |      | 518    |      |   | 644    | 
| |                                      |              |      |        |      |   |        | 
| |                                      |              |      |        |      |   |        | 
| |                                      |              |      | 15,863 |      |   | 19,225 | 
| |                                      |              |      |        |      |   |        | 
| |                                      |              |      |        |      |   |        | 
| | Depreciated cost                     |              | $    | 7,847  |      | $ | 7,094  | 
| |                                      |              |      |        |      |   |        | 

| |                                                                                                                                    
| | -----------------------------------------------------------------------------------------------------------------------------------
| | Depreciation
  expenses amounted to $2,509, $2,920 and $3,392 for the years ended December
  31, 2005, 2006 and 2007, respectively.

F-32

---



AUDIOCODES LTD. AND ITS SUBSIDIARIES

|                                                            
|------------------------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                  
|                                                            
|U.S. dollars in
  thousands, except share and per share data

|         |                                              
|-------- | ---------------------------------------------
|NOTE 8:- | INTANGIBLE ASSETS, DEFERRED CHARGES AND OTHER

| |    |                                      |  |              |        |      |   |        | 
| | -- | ------------------------------------ |  | ------------ | ------ | ---- | - | ------ | 
| |    |                                      |  | December 31, |       
| |    |                                      |  |              |       
| |    |                                      |  | 2006         |        | 2007 |  
| |    |                                      |  |              |        |      |  
| |    |                                      |  |              |        |      |   |        | 
| | a. | Cost:                                |  |              |        |      |   |        | 
| |    | Acquired technology                  |  | $            | 15,982 |      | $ | 17,512 | 
| |    | Customer relationship                |  |              | 8,001  |      |   | 8,001  | 
| |    | Trade name                           |  |              | 466    |      |   | 466    | 
| |    | Existing contracts for
  maintenance |  |              | 204    |      |   | 204    | 
| |    | Backlog                              |  |              | 837    |      |   | 878    | 
| |    | Deferred charges                     |  |              | 478    |      |   | 478    | 
| |    | Other                                |  |              | 200    |      |   | 200    | 
| |    |                                      |  |              |        |      |   |        | 
| |    |                                      |  |              |        |      |   |        | 
| |    |                                      |  |              | 26,168 |      |   | 27,739 | 
| |    |                                      |  |              |        |      |   |        | 
| |    | Accumulated amortization:            |  |              |        |      |   |        | 
| |    | Acquired technology                  |  |              | 3,322  |      |   | 6,146  | 
| |    | Customer relationship                |  |              | 445    |      |   | 1,333  | 
| |    | Trade name                           |  |              | 78     |      |   | 234    | 
| |    | Existing contracts for
  maintenance |  |              | 34     |      |   | 102    | 
| |    | Backlog                              |  |              | 391    |      |   | 852    | 
| |    | Deferred charges                     |  |              | 45     |      |   | 65     | 
| |    |                                      |  |              |        |      |   |        | 
| |    |                                      |  |              |        |      |   |        | 
| |    |                                      |  |              | 4,315  |      |   | 8,732  | 
| |    |                                      |  |              |        |      |   |        | 
| |    |                                      |  |              |        |      |   |        | 
| |    | Amortized cost                       |  | $            | 21,853 |      | $ | 19,007 | 
| |    |                                      |  |              |        |      |   |        | 

| |    |                                                                                                                                                       
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------
| | b. | Amortization
  expenses amounted to $860, $2,623 and $4,397 for the years ended December 31,
  2005, 2006 and 2007, respectively.                     
| |    |                                                                                                                                                       
| | c. | Amortization
  expenses related to deferred charges amounted to $22, $20 and $20 for the
  years ended December 31, 2005, 2006 and 2007, respectively.
| |    |                                                                                                                                                       
| | d. | Expected amortization expenses for the years ended December 31:                                                                                       

|     |  |   |       | 
|---- |  | - | ----- | 
|2008 |  | $ | 3,860 | 
|2009 |  | $ | 3,281 | 
|2010 |  | $ | 2,938 | 
|2011 |  | $ | 2,337 | 
|2012 |  | $ | 1,735 | 

F-33

---



|                                                            
|------------------------------------------------------------
|AUDIOCODES LTD. AND ITS SUBSIDIARIES                        
|                                                            
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                  
|                                                            
|U.S. dollars in
  thousands, except share and per share data

|         |                                    
|-------- | -----------------------------------
|NOTE 9:- | OTHER PAYABLES AND ACCRUED EXPENSES

|                               |  |              |        |      |   |        | 
|------------------------------ |  | ------------ | ------ | ---- | - | ------ | 
|                               |  | December 31, |       
|                               |  |              |       
|                               |  | 2006         |        | 2007 |  
|                               |  |              |        |      |  
|                               |  |              |        |      |   |        | 
|Employees and payroll accruals |  | $            | 11,614 |      | $ | 8,047  | 
|Royalties provision            |  |              | 2,067  |      |   | 1,786  | 
|Government authorities         |  |              | 873    |      |   | 420    | 
|Accrued expenses               |  |              | 10,857 |      |   | 15,506 | 
|Deferred revenues              |  |              | 1,753  |      |   | 1,594  | 
|Others                         |  |              | 975    |      |   | 1,427  | 
|                               |  |              |        |      |   |        | 
|                               |  |              |        |      |   |        | 
|                               |  | $            | 28,139 |      | $ | 28,780 | 
|                               |  |              |        |      |   |        | 

|          |                         
|--------- | ------------------------
|NOTE 10:- | SENIOR CONVERTIBLE NOTES

| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | In November
  2004, the Company issued an aggregate of $125,000 (including the exercise of
  the option as described below) 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.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| | 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 $1 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, 2007, the Notes are presented
  as a long-term liability.
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| | The Notes
  also contain a provision for a make-whole premium to be paid by the Company
  to holders of the Notes in the event of certain changes in control that could
  occur during the life of the Notes. The premium is payable in the form of
  cash, the Companys Ordinary shares, or the same form of consideration used
  to pay for the shares of the Companys Ordinary shares in connection with the
  transaction constituting the change in control. The premium declines over
  time and is based upon the price of the Companys Ordinary shares as of the
  effective date of the change in control. As of December 31, 2006 and 2007 the
  Company did not record a separate derivative in the financial statements due
  to immateriality.                                                                                                                                                                                                                                     
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| | The additional
  amount that the Company can be required to pay in respect of the withholding
  taxes was recorded as a liability.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   

F-34

---



|                                                            
|------------------------------------------------------------
|AUDIOCODES LTD. AND ITS SUBSIDIARIES                        
|                                                            
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                  
|                                                            
|U.S. dollars in
  thousands, except share and per share data

|          |                                       
|--------- | --------------------------------------
|NOTE 11:- | COMMITMENTS
AND CONTINGENT LIABILITIES

| |    |                                                                                                                             
| | -- | ----------------------------------------------------------------------------------------------------------------------------
| | a. | Lease
  commitments:                                                                                                        
| |    |                                                                                                                             
| |    | The Groups
  facilities are rented under several lease agreements in Israel and the U.S.
  for periods ending in 2013.     
| |    |                                                                                                                             
| |    | Future
  minimum rental commitments under non-cancelable operating leases for the
  years ended December 31, are as follows:

|           |  |  |   |        | 
|---------- |  |  | - | ------ | 
|2008       |  |  | $ | 4,967  | 
|2009       |  |  |   | 4,910  | 
|2010       |  |  |   | 4,442  | 
|2011       |  |  |   | 1,160  | 
|2012       |  |  |   | 1,082  | 
|Thereafter |  |  |   | 1,026  | 
|           |  |  |   |        | 
|           |  |  |   |        | 
|           |  |  | $ | 17,587 | 
|           |  |  |   |        | 

| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |    | Rent
  expenses for the years ended December 31, 2005, 2006 and 2007, were
  approximately $2,938, $3,087 and $4,471 respectively.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| | b. | Other
  commitments:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| |    | The Company
  is obligated under certain agreements with its suppliers to purchase goods
  and under an agreement with its manufacturing subcontractor to purchase
  excess inventory. Non- cancelable obligations as of December 31, 2007, were
  approximately $3,000:                                                                                                                                                                                                                                                                                                                                                           
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| | c. | Royalty
  commitment to the Office of the Chief Scientist of Israel (OCS):                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| |    | Under the
  research and development agreements of the Company with the OCS and pursuant
  to applicable laws, the Company is required to pay royalties at the rate of
  3%-4.5% of sales of products developed with funds provided by the OCS, up to
  an amount equal to 100% of the OCS research and development grants received,
  linked to the U.S. dollar plus interest on the unpaid amount received based
  on the 12-month LIBOR rate applicable to dollar deposits. The Company is
  obligated to repay the Israeli Government for the grants received only to the
  extent that there are sales of the funded products.
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| |    | As of
  December 31, 2007, the Company has a contingent obligation to pay royalties
  in the amount of approximately $ 3,519.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| | d. | Royalty
  commitments to third parties:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| |    | Previously,
  the Group has entered into technology licensing fee agreements with third
  party. Under the agreements, the Group agreed to pay the third parties
  royalties until 2008, based on 0.75%-0.9% of the Groups total consolidated
  revenues.                                                                                                                                                                                                                                                                                                                                                                         

F-35

---



AUDIOCODES LTD. AND ITS SUBSIDIARIES

|                                                          
|----------------------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                
|                                                          
|U.S. dollars in thousands, except share and per share data

|          |                                               
|--------- | ----------------------------------------------
|NOTE 11:- | COMMITMENTS AND CONTINGENT LIABILITIES (Cont.)

| |    |                                                                                                                                                                                                                                                                                                                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |    | Periodically,
 the Group may be subject to patent infringement claims that arise in the
 ordinary course of its business activities. The Group estimates and records
 liabilities for those contingent claims for which it believes future
 expenditures will be required and for which such expenditures can be
 reasonably estimated.
| |    |                                                                                                                                                                                                                                                                                                                                        
| | e. | Legal
 proceedings                                                                                                                                                                                                                                                                                                                     
| |    |                                                                                                                                                                                                                                                                                                                                        
| |    | 1.                                                                                                                                                                                                                                                                                                                                      | In January
 2005, prior to the acquisition of Nuera, the Company was notified that one of
 Nueras customers had been named as a defendant in a patent infringement suit
 involving similar technology. In the suit, the plaintiff alleged that the
 customer uses devices to offer services that infringe upon a patent the
 plaintiff owns. The customer has sought indemnification from Nuera pursuant
 to the terms of a purchase agreement between Nuera and the customer relating
 to the allegedly infringing technology at issue.                                                                       
| |    |                                                                                                                                                                                                                                                                                                                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| |    | 2.                                                                                                                                                                                                                                                                                                                                      | Prior to the
 acquisition of Nuera by the Company, eight former employees of a French
 subsidiary of Nuera filed a labor grievance against the subsidiary claiming
 they were unfairly terminated. The French subsidiary filed for bankruptcy in
 2004 and, in 2005, the court appointed liquidator sought to hold Nuera liable
 for the obligations of its French subsidiary. In June 2006, the court ruled
 in favor of Nuera that it was not liable for the obligations of its French
 subsidiary. In March 2007, the liquidator appealed the judgment and in April
 2008 the appeal was denied by the court.
| |    |                                                                                                                                                                                                                                                                                                                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| |    | As of
 December 31, 2007, based on the estimate of the Companys management and a
 legal opinion, sufficient amount has been reserved.                                                                                                                                                                                                 

|          |                     
|--------- | --------------------
|NOTE 12:- | SHAREHOLDERS
EQUITY

| |    |                                                                                                                                                                                                        
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | a. | Treasury
 stock:                                                                                                                                                                                       
| |    |                                                                                                                                                                                                        
| |    | Through
 January, 2001 the Company had a share repurchase program pursuant to which
 the Company was authorized to purchase up to an aggregate amount of 4,000,000
 of its outstanding Ordinary shares.
| |    |                                                                                                                                                                                                        
| |    | As of
 December 31, 2006 and 2007, the Company had purchased 3,942,139 of its
 outstanding Ordinary shares, at a weighted average price per share of $2.87.                                            

F-36

---



AUDIOCODES LTD. AND ITS SUBSIDIARIES

|                                                          
|----------------------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                
|                                                          
|U.S. dollars in thousands, except share and per share data

|          |                             
|--------- | ----------------------------
|NOTE 12:- | SHAREHOLDERS EQUITY (Cont.)

| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | b. | Warrants
 issued to consultants:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| |    | During 2001,
 the Company issued warrants to consultants to purchase 50,000 Ordinary shares
 of NIS 0.01 par value at an exercise price of $18.82 per share, expiring
 seven years from the date of grant.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| |    | As of
 December 31, 2006 and 2007, 34,000 and 4,000 warrants to consultants are
 outstanding and exercisable at a weighted average exercise price of $18.82
 and $18.82, respectively.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| | c. | Employee
 Stock Purchase Plan:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| |    | In May 2001
 and in July 2007, the Companys Board of Directors adopted the Employee Stock
 Purchase Plan (the Purchase Plan), and amended the Purchase Plan in July
 2007. As amended, the Purchase Plan provides for the issuance of a maximum of
 6,500,000 Ordinary shares. As of December 31, 2007, 4,324,136 shares are
 still available for future issuance. Eligible employees can have up to 15% of
 their wages, up to certain maximums, used to purchase Ordinary shares. The
 Purchase Plan is implemented with purchases every six months occurring on
 January 31 and July 31 of each year. The price of the Ordinary shares
 purchased under the Purchase Plan is equal to 85% of the lower of the fair
 market value of the Ordinary shares on the commencement date of each offering
 period or on the semi-annual purchase date. The Purchase Plan is considered a
 compensatory plan. Therefore the Company recorded compensation expense in
 accordance to SFAS 123R
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| |    | During the years ended December 31, 2005, 2006 and
 2007, 257,746, 323,303 and 649,853 shares, respectively, were issued under
 the Purchase Plan for aggregate considerations of $2,134, $2,665 and $3,619,
 respectively.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| | d. | Employee
 Stock Option Plans:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| |    | Under the
 Companys 1997 and 1999 Stock Option Plans (the Plans), options to purchase
 Ordinary shares may be granted to officers, directors, employees and
 consultants of the Group.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| |    | The total number
 of shares authorized for grant of options under the Plans is 17,041,864. As
 of December 31, 2007, 2,090,870 shares are still available for future option
 grants.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      

F-37

---



AUDIOCODES LTD. AND ITS SUBSIDIARIES

|                                                          
|----------------------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                
|                                                          
|U.S. dollars in thousands, except share and per share data

|          |                             
|--------- | ----------------------------
|NOTE 12:- | SHAREHOLDERS EQUITY (Cont.)

| |  |                                                                                                                                                                                                                                                                                                                                                                                   
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Stock
 options granted under the Plans are exercisable usually at the fair market
 value of the Ordinary shares at the date of grant and usually expire seven or
 ten years from the date of grant. The options generally vest over four or
 five years from the date of grant. Any options that are forfeited or
 cancelled before expiration become available for future grants.
| |  |                                                                                                                                                                                                                                                                                                                                                                                   
| |  | The
 following is a summary of the Groups stock option activity and related
 information for the years ended December 31, 2005, 2006 and 2007:                                                                                                                                                                                                                                   

|                                    |  |                         |           |                                    |   |                                                              |  |                             |     |  |   |        | 
|----------------------------------- |  | ----------------------- | --------- | ---------------------------------- | - | ------------------------------------------------------------ |  | --------------------------- | --- |  | - | ------ | 
|                                    |  | Year ended December 31, |          
|                                    |  |                         |          
|                                    |  | 2007                    |          
|                                    |  |                         |          
|                                    |  | Amount
 of options      |           | Weighted
 average
 exercise
 price |   | Weighted
 average
 remaining
 contractual
  term (in
 years) |  | Aggregate
 intrinsic
 value |    
|                                    |  |                         |           |                                    |   |                                                              |  |                             |    
|                                    |  |                         |           |                                    |   |                                                              |  |                             |    
|Outstanding at beginning of
 year   |  |                         | 7,981,826 |                                    | $ | 9.92                                                         |  |                             | 3.8 |  | $ | 22,353 | 
|Changes during the year:            |  |                         |           |                                    |   |                                                              |  |                             |     |  |   |        | 
|Granted                             |  |                         | 1,254,375 |                                    | $ | 6.31                                                         |  |                             |     |  |   |        | 
|Exercised                           |  |                         | (329,971  | )                                  | $ | 3.60                                                         |  |                             |     |  |   |        | 
|Forfeited                           |  |                         | (905,970  | )                                  | $ | 10.31                                                        |  |                             |     |  |   |        | 
|Expired                             |  |                         | (613,000  | )                                  | $ | 29.80                                                        |  |                             |     |  |   |        | 
|                                    |  |                         |           |                                    |   |                                                              |  |                             |     |  |   |        | 
|Options outstanding at end
 of year |  |                         | 7,387,260 |                                    | $ | 7.85                                                         |  |                             | 3.7 |  | $ | 3,583  | 
|                                    |  |                         |           |                                    |   |                                                              |  |                             |     |  |   |        | 
|Vested and expected to vest         |  |                         | 6,870,152 |                                    | $ | 7.85                                                         |  |                             | 3.7 |  | $ | 3,332  | 
|                                    |  |                         |           |                                    |   |                                                              |  |                             |     |  |   |        | 
|Options exercisable at end
 of year |  |                         | 4,492,490 |                                    | $ | 7.19                                                         |  |                             | 2.5 |  | $ | 3,580  | 
|                                    |  |                         |           |                                    |   |                                                              |  |                             |     |  |   |        | 

| |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | The
 weighted-average grant-date fair value of options granted during the year
 ended December 31, 2007 was $3.23. The aggregate intrinsic value in the table
 above represents the total intrinsic value (the difference between the
 Companys closing stock price on the last trading day of the fiscal year and
 the exercise price, multiplied by the number of in-the-money options) that
 would have been received by the option holders had all option holders
 exercised their options on the last trading day of the fiscal year. This
 amount changes based on the fair market value of the Companys shares.
| |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| |  | Total
 intrinsic value of options exercised for the twelve months ended December 31,
 2005, 2006 and 2007 was $3,373, $4,790 and $613 respectively. As of December
 31, 2007, there was $8,003 of total unrecognized compensation cost related to
 non-vested share-based compensation arrangements granted under the Companys
 stock option plans. That cost is expected to be recognized over a
 weighted-average period of 1.5 years.                                                                                                                                                                               
| |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| |  | Cash
 received from exercise of options for the years ended December 31, 2005, 2006
 and 2007 were approximately $1,800, $6,515 and $1,189 respectively.                                                                                                                                                                                                                                                                                                                                                                                                                                                                

F-38

---



AUDIOCODES LTD. AND ITS SUBSIDIARIES

|                                                            
|------------------------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                  
|                                                            
|U.S. dollars in
  thousands, except share and per share data

|          |                              |                                                                                                                      | 
|--------- | ---------------------------- | -------------------------------------------------------------------------------------------------------------------- | 
|NOTE 12:- | SHAREHOLDERS EQUITY (Cont.)
|          |                              |                                                                                                                     
|          |                              | The options
  outstanding as of December 31, 2007, have been separated into ranges of
  exercise prices, as follows:

|                      |  |                                             |  |                                         |  |                                   |  |                                             |      |                                                        |  |  |   |       |  | 
|--------------------- |  | ------------------------------------------- |  | --------------------------------------- |  | --------------------------------- |  | ------------------------------------------- | ---- | ------------------------------------------------------ |  |  | - | ----- |  | 
|Range ofexerciseprice |  | Options 
  outstandingas ofDecember 31,2007 |  | Weightedaverageremainingcontractuallife |  | Weighted average 
  exerciseprice |  | Options 
  exercisableas ofDecember 31,2007 |      | Weightedaverageexercise price 
  of exercisableoptions | 
|                      |  |                                             |  |                                         |  |                                   |  |                                             |      |                                                        | 
|(Years)               | 
|                      | 
|$  0.61               |  |                                             |  | 96,000                                  |  |                                   |  |                                             | 0.30 |                                                        |  |  | $ | 0.61  |  | 
|$  1.1                |  |                                             |  | 127,800                                 |  |                                   |  |                                             | 0.51 |                                                        |  |  | $ | 1.10  |  | 
|$  1.73-2.51          |  |                                             |  | 440,568                                 |  |                                   |  |                                             | 1.87 |                                                        |  |  | $ | 2.28  |  | 
|$  2.67-4             |  |                                             |  | 405,734                                 |  |                                   |  |                                             | 1.23 |                                                        |  |  | $ | 3.10  |  | 
|$  4.1-6.49           |  |                                             |  | 1,810,150                               |  |                                   |  |                                             | 4.21 |                                                        |  |  | $ | 5.22  |  | 
|$  6.51-9.24          |  |                                             |  | 996,558                                 |  |                                   |  |                                             | 3.05 |                                                        |  |  | $ | 7.55  |  | 
|$  9.32-14.76         |  |                                             |  | 3,457,950                               |  |                                   |  |                                             | 4.39 |                                                        |  |  | $ | 10.90 |  | 
|$  15.94-20.38        |  |                                             |  | 52,500                                  |  |                                   |  |                                             | 4.00 |                                                        |  |  | $ | 15.94 |  | 
|                      |  |                                             |  |                                         |  |                                   |  |                                             |      |                                                        | 
|                      |  |                                             |  |                                         |  |                                   |  |                                             |      |                                                        |  |  |   |       |  | 
|                      |  |                                             |  | 7,387,260                               |  |                                   |  |                                             |      |                                                        |  |  | $ | 7.85  |  | 
|                      |  |                                             |  |                                         |  |                                   |  |                                             |      |                                                        | 

| |    |                                                                                                                                                                                                                          
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | e. | During 2007,
  the Company decided on an exceptional and ex-gratia basis to extend the
  validity of certain options granted to employees by a period of 2 years and
  re-priced the exercise price to certain employees.
| |    |                                                                                                                                                                                                                          
| |    | The Company
  accounted for these changes as modifications in accordance with FAS 123R. The
  Company calculated the incremental value of these modifications and recorded
  compensation cost in a total amount of $283.
| |    |                                                                                                                                                                                                                          
| | f. | Dividends:                                                                                                                                                                                                               
| |    |                                                                                                                                                                                                                          
| |    | In the event
  that cash dividends are declared in the future, such dividends will be paid
  in NIS. The Company does not intend to pay cash dividends in the foreseeable
  future. (See also Note 13a.)                 
| |    |                                                                                                                                                                                                                          

F-39

---



AUDIOCODES LTD. AND ITS SUBSIDIARIES

|                                                            
|------------------------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                  
|                                                            
|U.S. dollars in
  thousands, except share and per share data

|          |                
|--------- | ---------------
|NOTE 13:- | TAXES ON INCOME

| |    |                     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| | -- | ------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | a. | Israeli
  taxation:
| |    |                    
| |    | 1.                  | Measurement of taxable
  income:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| |    |                     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| |    |                     | The Company
  has elected to measure its taxable income and file its tax return under the
  Israeli Income Tax Regulations (Principles Regarding the Management of Books
  of Account of Foreign Invested Companies and Certain Partnerships and the
  Determination of Their Taxable Income), 1986. Accordingly, results for tax
  purposes are measured in terms of earnings in dollars.                                                                                                                                                                                                                                                                                          
| |    |                     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| |    |                     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| |    |                     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| |    | 2.                  | Tax benefits
  under the Law for the Encouragement of Capital Investments, 1959 (the
  Investment Law):                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| |    |                     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| |    |                     | The
  Companys production facilities have been granted the status of an Approved
  Enterprise in accordance with the Investment Law under four separate investment
  programs. According to the provisions of such Israeli Investment Law, the
  Company has been granted the Alternative Benefit Plan, under which the main
  benefits are tax exempt and reduced tax rates.                                                                                                                                                                                                                                                                                                  
| |    |                     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| |    |                     | Therefore,
  the Companys income derived from Approved Enterprise will be entitled to a
  tax exemption for a period of two to four years and to an additional period
  of five to eight years of reduced tax rates of 10% - 25% (based on the
  percentage of foreign ownership). The duration of tax benefits of reduced tax
  rates is subject to a limitation of the earlier of 12 years from commencement
  of production, or 14 years from the approval date. The Company utilized tax
  benefits from the first program in 1998 and is no longer eligible for
  benefits in 2007. Tax benefits from the remaining programs are scheduled to
  gradually expire through 2013.
| |    |                     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| |    |                     | As of
  December 31, 2007, retained earnings included approximately $540 in
  tax-exempt income earned by the Companys Approved Enterprise. The
  Companys Board of Directors has decided not to declare dividends out of such
  tax-exempt income. Accordingly, no deferred income taxes have been provided
  on income attributable to the Companys Approved Enterprise.                                                                                                                                                                                                                                                                                                   
| |    |                     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| |    |                     | Tax-exempt
  income attributable to the Approved Enterprise cannot be distributed to
  shareholders without subjecting the Company to taxes except upon complete
  liquidation of the Company. If such retained tax-exempt income is distributed
  in a manner other than upon the complete liquidation of the Company, it would
  be taxed at the corporate tax rate applicable to such profits as if the
  Company had not elected the alternative tax benefits (currently between 10% -
  25%) and an income tax liability of approximately up to $135 would be
  incurred by the Company.                                                                                     

F-40

---



AUDIOCODES LTD. AND ITS SUBSIDIARIES

|                                                            
|------------------------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                  
|                                                            
|U.S. dollars in
  thousands, except share and per share data

|          |                         |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|--------- | ----------------------- | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 13:- | TAXES ON INCOME (Cont.)
|          |                         |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|          |                         |    | The
  entitlement to the above benefits is conditional upon the Company fulfilling
  the conditions stipulated by the above Investment Law, regulations published
  thereunder and the certificate of approval for the specific investments in
  Approved Enterprises. In the event of failure to comply with these conditions,
  the benefits may be canceled and the Company may be required to refund the
  amount of the benefits, in whole or in part, including interest. As of
  December 31, 2007, management believes that the Company is in compliance with
  all of the aforementioned conditions.                                                                                                                                                           
|          |                         |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|          |                         |    | 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.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|          |                         |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|          |                         |    | On April 1,
  2005, an amendment to the Investment Law came into effect (the Amendment)
  that has significantly changed the provisions of the Investment Law. The
  Amendment limits the scope of enterprises that may be approved by the
  Investment Center by setting criteria for the approval of a facility as a
  Privileged Enterprise including a provision generally requiring that at least
  25% of the Privileged Enterprises income will be derived from export.
  Additionally, the Amendment enacted major changes in the manner in which tax
  benefits are awarded under the Investment Law so that companies no longer
  require Investment Center approval in order to qualify for tax benefits.                                                   
|          |                         |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|          |                         |    | However, the
  Investment Law provides that terms and benefits included in any certificate
  of approval already granted will remain subject to the provisions of the
  Investment Law as they were on the date of such approval. Therefore, the
  Companys existing Approved Enterprises will generally not be subject to
  the provisions of the Amendment. As a result of the Amendment, tax-exempt
  income generated under the provisions of the Investment Law, as amended, will
  subject the Company to taxes upon distribution or liquidation and the Company
  may be required to record a deferred tax liability with respect to such
  tax-exempt income. As of December 31, 2007, there was no taxable income
  attributable to the Privileged Enterprise.
|          |                         |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|          |                         | 3. | Net operating loss
  carryforward:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|          |                         |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|          |                         |    | As of
  December 31, 2007, the Company has accumulated losses for tax purposes in the
  amount of approximately $76,000, which can be carried forward and offset
  against taxable income in the future for an indefinite period.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|          |                         |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|          |                         | 4. | Tax benefits under the Law
  for the Encouragement of Industry (Taxation), 1969:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|          |                         |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|          |                         |    | The Company
  currently qualifies as an Industrial Company under the above law and as
  such is entitled to certain tax benefits, including accelerated depreciation
  and the deduction of public offering expenses in three equal annual payments.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    

F-41

---



AUDIOCODES LTD. AND ITS SUBSIDIARIES

|                                                          
|----------------------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                
|                                                          
|U.S. dollars in thousands, except share and per share data

|          |                         |                                                                |                                                                                                                                                                                                                                                            
|--------- | ----------------------- | -------------------------------------------------------------- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 13:- | TAXES ON INCOME (Cont.)
|          |                         |                                                                |                                                                                                                                                                                                                                                            
|          |                         | 5.                                                             | Tax rates:                                                                                                                                                                                                                                                 
|          |                         |                                                               
|          |                         |                                                                | Under an
  amendment to the Israeli Income Tax Ordinance enacted on July 25, 2005, a
  gradual decrease in the corporate tax rate in Israel will be in effect as
  follows: in 2007 - 29%, in 2008 - 27%, in 2009 - 26% and in 2010 and
  thereafter - 25%.
|          |                         |                                                               
|          | b.                      | Income (loss)
  before taxes on income comprised as following:

|         |  |                         |   |        |  |      |   |       |  |  |   |        |   |  |  | 
|-------- |  | ----------------------- | - | ------ |  | ---- | - | ----- |  |  | - | ------ | - |  |  | 
|         |  | Year ended December 31, |  
|         |  |                         |   |       
|         |  | 2005                    |   | 2006   |  | 2007 |  
|         |  |                         |   |        |  |      |   |       |  | 
|         |  |                         |   |        |  |      |   |       |  | 
|Domestic |  |                         | $ | 7,387  |  |      | $ | 6,683 |  |  | $ | 3,131  |  
|Foreign  |  |                         |   | 7,541  |  |      |   | 1,399 |  |  |   | (4,654 | )
|         |  |                         |   |        |  |      |   |       |  |  |   |        |  
|        
|         |  |                         | $ | 14,928 |  |      | $ | 8,082 |  |  | $ | (1,523 | )
|         |  |                         |   |        |  |      |   |       |  |  |   |        |  

| |    |                                            
| | -- | -------------------------------------------
| | c. | Taxes on
  income are comprised as follows:

|               |  |                         |   |        |   |      |   |        |   |  |   |        |   |  |  | 
|-------------- |  | ----------------------- | - | ------ | - | ---- | - | ------ | - |  | - | ------ | - |  |  | 
|               |  | Year ended December 31, |  
|               |  |                         |   |       
|               |  | 2005                    |   | 2006   |   | 2007 |  
|               |  |                         |   |        |   |      |   |        |   | 
|               |  |                         |   |        |   |      |   |        |   | 
|Current taxes  |  |                         | $ | 3,167  |   |      | $ | 1,290  |   |  | $ | (1,125 | )
|Deferred taxes |  |                         |   | (2,368 | ) |      |   | (1,001 | ) |  |   | 2,390  |  
|               |  |                         |   |        |   |      |   |        |   |  |   |        |  
|              
|               |  |                         | $ | 799    |   |      | $ | 289    |   |  | $ | 1,265  |  
|               |  |                         |   |        |   |      |   |        |   |  |   |        |  

|         |  |                         |   |        |   |      |      |     |  |       |   |        |   |  |  | 
|-------- |  | ----------------------- | - | ------ | - | ---- | ---- | --- |  | ----- | - | ------ | - |  |  | 
|         |  | Year ended December 31, |  
|         |  |                         |   |       
|         |  | 2005                    |   | 2006   |   | 2007 |     
|         |  |                         |   |        |   |      |      |     |  |      
|        
|Domestic |  |                         | $ | 2,167  |   |      | $    | 846 |  |       | $ | (1,575 | )
|Foreign  |  |                         |   | (1,368 | ) |      | (557 | )   |  | 2,840 |  
|         |  |                         |   |        |   |      |      |     |  |       |   |        |  
|        
|         |  |                         | $ | 799    |   |      | $    | 289 |  |       | $ | 1,265  |  
|         |  |                         |   |        |   |      |      |     |  |       |   |        |  

F-42

---



AUDIOCODES LTD. AND ITS SUBSIDIARIES

|                                                          
|----------------------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                
|                                                          
|U.S. dollars in thousands, except share and per share data

|          |                         |                                                                                                                                                                                                                                                                                                                   
|--------- | ----------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 13:- | TAXES ON INCOME (Cont.)
|          |                        
|          | d.                      | 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, |  
|                                                     |  |              |   |         |  
|                                                     |  | 2006         |   | 2007    |  
|                                                     |  |              |   |         |   |  |  |   |        
|Deferred tax assets:                                 |  |              |   |         |  
|Net operating loss carry
  forward                   |  |              | $ | 44,645  |   |  |  | $ | 58,513  |   | 
|Reserves and allowances                              |  |              |   | 7,879   |   |  |  |   | 5,823   |   | 
|                                                     |  |              |   |         |   |  |  |   |         |   | 
|                                                     |  |              |   |         |   |  |  |   |         |   | 
|Deferred tax assets before valuation allowance       |  |              |   | 52,524  |   |  |  |   | 64,336  |   | 
|Valuation allowance                                  |  |              |   | (48,782 | ) |  |  |   | (62,278 | ) | 
|                                                     |  |              |   |         |   |  |  |   |         |   | 
|                                                     |  |              |   |         |   |  |  |   |         |   | 
|Deferred tax assets                                  |  |              | $ | 3,742   |   |  |  | $ | 2,058   |   | 
|Deferred tax liability, related to intangible assets |  |              | $ | (7,780  | ) |  |  | $ |        |   | 
|                                                     |  |              |   |         |   |  |  |   |         |   | 
|                                                     |  |              |   |         |   |  |  |   |         |   | 
|Deferred tax asset (liabilities), net                |  |              | $ | (4,038  | ) |  |  | $ | 2,058   |   | 
|                                                     |  |              |   |         |   |  |  |   |         |   | 
|                                                     |  |              |   |         |   |  |  |   |         |   | 
|Foreign:                                             |  |              |   |         |   |  |  |   |         |   | 
|Current deferred tax assets                          |  |              | $ | 1,282   |   |  |  | $ | 1,001   |   | 
|Current deferred tax
  liability                     |  |              |   | (1,321  | ) |  |  |   |        |   | 
|Non current deferred tax
  asset                     |  |              |   | 2,460   |   |  |  |   | 1,057   |   | 
|Non current deferred tax
  liability                 |  |              |   | (6,459  | ) |  |  |   |        |   | 
|                                                     |  |              |   |         |   |  |  |   |         |   | 
|                                                     |  |              |   |         |   |  |  |   |         |   | 
|                                                     |  |              | $ | (4,038  | ) |  |  | $ | 2,058   |   | 
|                                                     |  |              |   |         |   |  |  |   |         |   | 

| |                                                                                                                                                                                                                                                                                                                             
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | The Companys
  U.S. subsidiaries have estimated total available carry forward tax losses of
  approximately $80,000 to offset against future taxable income between 2015
  and 2024. As of December 31, 2007, the Company recorded a deferred tax asset
  of $2,058 relating to the available net carry forward tax losses.
| |                                                                                                                                                                                                                                                                                                                             
| | Utilization
  of U.S. net operating losses may be subject to substantial annual limitations
  due to the change in ownership provisions of the Internal Revenue Code of
  1986 and similar state provisions. The annual limitation may result in the
  expiration of net operating losses before utilization.             

F-43

---



AUDIOCODES LTD. AND ITS SUBSIDIARIES

|                                                            
|------------------------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                  
|                                                            
|U.S. dollars in
  thousands, except share and per share data

|          |                         |                                                                                                                                                                                                                                        
|--------- | ----------------------- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 13:- | TAXES ON INCOME (Cont.)
|          |                         |                                                                                                                                                                                                                                        
|          | e.                      | Reconciliation
  of the theoretical tax expenses:                                                                                                                                                                                      
|          |                         |                                                                                                                                                                                                                                        
|          |                         | A reconciliation
  between the theoretical tax expense, assuming all income is taxed at the
  statutory tax rate applicable to income of the Company and the actual tax
  expense as reported in the statement of income is as follows:

|                                                                                            |  |                         |        |      |   |        |   |   |        |  
|------------------------------------------------------------------------------------------- |  | ----------------------- | ------ | ---- | - | ------ | - | - | ------ | -
|                                                                                            |  | Year ended December 31, |       
|                                                                                            |  |                         |       
|                                                                                            |  | 2005                    |        | 2006 |   | 2007   |  
|                                                                                            |  |                         |        |      |   |        |  
|Income (loss) before taxes,
  as reported in the consolidated statements of operations      |  | $                       | 14,928 |      | $ | 8,082  |   | $ | (1,523 | )
|                                                                                            |  |                         |        |      |   |        |   |   |        |  
|                                                                                           
|Statutory tax rate                                                                          |  |                         | 34     | %    |   | 31     | % |   | 29     | %
|                                                                                            |  |                         |        |      |   |        |   |   |        |  
|                                                                                            |  |                         |        |      |   |        |   |   |        |  
|Theoretical tax expenses
  (benefits) on the above amount at the Israeli statutory tax rate |  |                         | 5,076  |      |   | 2,505  |   |   | (442   | )
|Income taxed at rate other
  than the Israeli statutory tax rate (1)                        |  |                         | (3,543 | )    |   | (4,672 | ) |   | 655    |  
|Non-deductible expenses
  including equity based compensation expenses                      |  |                         | 1,663  |      |   | 4,008  |   |   | 2,432  |  
|Deferred taxes on losses for
  which a valuation allowance was provided                     |  |                         | (2,813 | )    |   | (261   | ) |   | 3,333  |  
|Utilization of operation
  losses carry forward                                             |  |                         | (2,291 | )    |   | (1,232 | ) |   | (3,355 | )
|Taxes in respect to prior
  years                                                           |  |                         |       |      |   | (66    | ) |   | (1,588 | )
|State and Federal taxes                                                                     |  |                         | 826    |      |   | 425    |   |   | 689    |  
|Inter-company charges                                                                       |  |                         | 1,725  |      |   | (299   | ) |   | (430   | )
|Other individually immaterial
  income tax item                                             |  |                         | 156    |      |   | (119   | ) |   | (29    | )
|                                                                                            |  |                         |        |      |   |        |   |   |        |  
|                                                                                            |  |                         |        |      |   |        |   |   |        |  
|Actual tax expense                                                                          |  | $                       | 799    |      | $ | 289    |   | $ | 1,265  |  
|                                                                                            |  |                         |        |      |   |        |   |   |        |  
|                                                                                            |  |                         |        |      |   |        |   |   |        |  
|(1) Per share amounts (basic)
  of the tax benefit resulting from the exemption             |  | $                       | 0.09   |      | $ | 0.11   |   | $ | 0.02   |  
|                                                                                            |  |                         |        |      |   |        |   |   |        |  
|Per share amounts (diluted) of
  the tax benefit
  resulting from the exemption             |  | $                       | 0.08   |      | $ | 0.11   |   | $ | 0.02   |  
|                                                                                            |  |                         |        |      |   |        |   |   |        |  

F-44

---



AUDIOCODES LTD. AND ITS SUBSIDIARIES

|                                                            
|------------------------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                  
|                                                            
|U.S. dollars in
  thousands, except share and per share data

|          |                         |                                                                                                                                                                                                                                                                                                                                                                                                 
|--------- | ----------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 13:- | TAXES ON INCOME (Cont.)
|          |                         |                                                                                                                                                                                                                                                                                                                                                                                                 
|          | f.                      | The Company
  adopted the provisions of FIN 48 on January 1, 2007. Prior to 2007 the
  Company used the provisions of SFAS 5 to determine tax contingencies. As of
  January 1, 2007 there was no difference in the Companys tax contingencies
  under the provisions of FIN 48. As a result, there was no effect on the
  Companys shareholders equity upon the Companys adoption of FIN 48.
|          |                         |                                                                                                                                                                                                                                                                                                                                                                                                 
|          |                         | A
  reconciliation of the beginning and ending amount of unrecognized tax
  benefits is as follows:                                                                                                                                                                                                                                                                                             

|                                                        |  |   |     | 
|------------------------------------------------------- |  | - | --- | 
|Gross unrecognized tax benefits as of January 1, 2007   |  | $ | 275 | 
|                                                        |  |   |     | 
|Increase in tax position for current year               |  |   | 13  | 
|                                                        |  |   |     | 
|                                                        |  |   |     | 
|Gross unrecognized tax benefits as of December 31, 2007 |  | $ | 288 | 
|                                                        |  |   |     | 

| |  |                                                                                                                                                                                                                                                                          
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | The Company
  recognizes interest and penalties related to unrecognized tax benefits in tax
  expenses. The liability for unrecognized tax benefits included accrued
  interest and penalties of $130
  and $113 at December 31, 2007 and
  January 1, 2007, respectively

|          |                                                  
|--------- | -------------------------------------------------
|NOTE 14:- | BASIC AND DILUTED NET EARNINGS (LOSS) PER
  SHARE

|                                                                                                               |  |                         |            |      |   |            |  |   |            |  
|-------------------------------------------------------------------------------------------------------------- |  | ----------------------- | ---------- | ---- | - | ---------- |  | - | ---------- | -
|                                                                                                               |  | Year ended December 31, |           
|                                                                                                               |  |                         |           
|                                                                                                               |  | 2005                    |            | 2006 |   | 2007       | 
|                                                                                                               |  |                         |            |      |   |            | 
|Numerator:                                                                                                     |  |                         |            |      |   |            |  |   |            |  
|                                                                                                               |  |                         |            |      |   |            |  |   |            |  
|Net income (loss) available to
  shareholders of Ordinary Shares                                               |  | $                       | 13,436     |      | $ | 6,877      |  | $ | (3,885     | )
|                                                                                                               |  |                         |            |      |   |            |  |   |            |  
|Denominator:                                                                                                   |  |                         |            |      |   |            |  |   |            |  
|                                                                                                               |  |                         |            |      |   |            |  |   |            |  
|Denominator for basic earnings
  per share - weighted average number of Ordinary shares, net of treasury stock |  |                         | 40,295,591 |      |   | 41,716,626 |  |   | 42,699,307 |  
|Effect of dilutive securities:                                                                                 |  |                         |            |      |   |            |  |   |            |  
|Employee stock options and ESPP                                                                                |  |                         | 2,790,110  |      |   | 1,972,767  |  |   | *)        |  
|Senior convertible notes                                                                                       |  |                         | *)        |      |   | *)        |  |   | *)        |  
|                                                                                                               |  |                         |            |      |   |            |  |   |            |  
|Denominator for diluted net
  earnings per share - adjusted weighted average number of shares                  |  | $                       | 43,085,701 |      | $ | 43,689,393 |  | $ | 42,699,307 |  
|                                                                                                               |  |                         |            |      |   |            |  |   |            |  

| |    |              
| | -- | -------------
| | *) | Antidilutive.

F-45

---



|                                                           
|-----------------------------------------------------------
|AUDIOCODES LTD. AND ITS SUBSIDIARIES                       
|                                                           
|NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in
 thousands, except share and per share data

|          |                       
|--------- | ----------------------
|NOTE 15:- | FINANCIAL
 INCOME, NET

|                                                                                |  |                          |        |      |   |        |   |   |        |  
|------------------------------------------------------------------------------- |  | ------------------------ | ------ | ---- | - | ------ | - | - | ------ | -
|                                                                                |  | Year ended
 December 31, |       
|                                                                                |  |                          |       
|                                                                                |  | 2005                     |        | 2006 |   | 2007   |  
|                                                                                |  |                          |        |      |   |        |  
|                                                                                |  |                          |        |      |   |        |   |   |        |  
|Financial expenses:                                                             |  |                          |        |      |   |        |   |   |        |  
|Interest                                                                        |  | $                        | (3,357 | )    | $ | (2,961 | ) | $ | (2,582 | )
|Amortization of marketable
 securities premiums and accretion of discounts, net |  |                          | (143   | )    |   | (224   | ) |   | (40    | )
|Others                                                                          |  |                          | (146   | )    |   | (240   | ) |   | (617   | )
|                                                                                |  |                          |        |      |   |        |   |   |        |  
|                                                                                |  |                          |        |      |   |        |   |   |        |  
|                                                                                |  |                          | (3,646 | )    |   | (3,425 | ) |   | (3,239 | )
|                                                                                |  |                          |        |      |   |        |   |   |        |  
|Financial income:                                                               |  |                          |        |      |   |        |   |   |        |  
|Interest and others                                                             |  |                          | 6,103  |      |   | 7,242  |   |   | 5,909  |  
|                                                                                |  |                          |        |      |   |        |   |   |        |  
|                                                                                |  |                          |        |      |   |        |   |   |        |  
|                                                                                |  | $                        | 2,457  |      | $ | 3,817  |   | $ | 2,670  |  
|                                                                                |  |                          |        |      |   |        |   |   |        |  

|          |                                           
|--------- | ------------------------------------------
|NOTE 16:- | MAJOR CUSTOMERS AND GEOGRAPHIC INFORMATION

| |    |                                                                                                                                                                                                                                                                                                                                                                                 
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | a. | Summary
 information about geographic areas:                                                                                                                                                                                                                                                                                                                                    
| |    |                                                                                                                                                                                                                                                                                                                                                                                 
| |    | The Group
 manages its business on a basis of one reportable segment (see Note 1 for a
 brief description of the Groups business). The data is presented in
 accordance with SFAS No. 131, Disclosure About Segments of an Enterprise and
 Related Information. Revenues in the table below are attributed to
 geographical areas based on the location of the end customers.
| |    |                                                                                                                                                                                                                                                                                                                                                                                 
| |    | The
 following presents total revenues for the years ended December 31, 2005, 2006
 and 2007 and long-lived assets as of December 31, 2005, 2006 and 2007.                                                                                                                                                                                                                      

|          |  |                 |         |                      |   |                 |  |                      |         |                 |   |                    |  |   |         |  |   |         | 
|--------- |  | --------------- | ------- | -------------------- | - | --------------- |  | -------------------- | ------- | --------------- | - | ------------------ |  | - | ------- |  | - | ------- | 
|          |  | 2005            |         | 2006                 |   | 2007            | 
|          |  |                 |         |                      |   |                 | 
|          |  | Total
 revenues |         | Long-
 lived
 assets |   | Total
 revenues |  | Long-
 lived
 assets |         | Total
 revenues |   | Long-
 livedassets | 
|          |  |                 |         |                      |   |                 |  |                      |         |                 |   |                    | 
|          |  |                 |         |                      |   |                 |  |                      |         |                 |   |                    |  |   |         |  |   |         | 
|Israel    |  | $               | 12,235  |                      | $ | 6,248           |  | $                    | 12,411  |                 | $ | 11,463             |  | $ | 10,604  |  | $ | 23,261  | 
|Americas  |  |                 | 66,622  |                      |   | 22,193          |  |                      | 83,352  |                 |   | 127,079            |  |   | 89,614  |  |   | 113,894 | 
|Europe    |  |                 | 22,434  |                      |   | 7               |  |                      | 32,704  |                 |   | 6                  |  |   | 40,305  |  |   | 105     | 
|Far
 East |  |                 | 14,536  |                      |   | 4               |  |                      | 18,886  |                 |   | 5                  |  |   | 17,712  |  |   | 53      | 
|          |  |                 |         |                      |   |                 |  |                      |         |                 |   |                    |  |   |         |  |   |         | 
|          |  |                 |         |                      |   |                 |  |                      |         |                 |   |                    |  |   |         |  |   |         | 
|          |  | $               | 115,827 |                      | $ | 28,452          |  | $                    | 147,353 |                 | $ | 138,553            |  | $ | 158,235 |  | $ | 137,313 | 
|          |  |                 |         |                      |   |                 |  |                      |         |                 |   |                    |  |   |         |  |   |         | 

| |    |                                                          
| | -- | ---------------------------------------------------------
| | b. | Major
 customers data as a percentage of total revenues:

|           |  |                          |    |      |  |      |   |  |    |  
|---------- |  | ------------------------ | -- | ---- |  | ---- | - |  | -- | -
|           |  | Year ended
 December 31, |   
|           |  |                          |   
|           |  | 2005                     |    | 2006 |  | 2007 |  
|           |  |                          |    |      |  |      |  
|           |  |                          |    |      |  |      |   |  |    |  
|Customer A |  |                          | 16 | %    |  | 15   | % |  | 17 | %

F-46

---



|                                                           
|-----------------------------------------------------------
|AUDIOCODES LTD. AND ITS SUBSIDIARIES                       
|                                                           
|NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in
 thousands, except share and per share data

|          |                                                   
|--------- | --------------------------------------------------
|NOTE 16:- | MAJOR CUSTOMERS AND GEOGRAPHIC INFORMATION (Cont.)

| |    |                                                                                                             
| | -- | ------------------------------------------------------------------------------------------------------------
| | c. | Product
 lines:                                                                                             
| |    |                                                                                                             
| |    | Total
 revenues from external customers divided on the basis of the Companys
 product lines are as follows:

|           |  |                          |         |      |   |         |  |   |         | 
|---------- |  | ------------------------ | ------- | ---- | - | ------- |  | - | ------- | 
|           |  | Year ended
 December 31, |        
|           |  |                          |        
|           |  | 2005                     |         | 2006 |   | 2007    | 
|           |  |                          |         |      |   |         | 
|           |  |                          |         |      |   |         |  |   |         | 
|Technology |  | $                        | 62,287  |      | $ | 70,013  |  | $ | 56,426  | 
|Networking |  |                          | 53,540  |      |   | 77,340  |  |   | 101,809 | 
|           |  |                          |         |      |   |         |  |   |         | 
|           |  |                          |         |      |   |         |  |   |         | 
|           |  | $                        | 115,827 |      | $ | 147,353 |  | $ | 158,235 | 
|           |  |                          |         |      |   |         |  |   |         | 

|          |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|--------- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 17:- | SUBSEQUENT EVENTS (UNAUDITED)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|          |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|          | In April
 2008, the Company entered into a loan agreement with a bank in Israel that
 provides for borrowings of up to $15,000. The loan bears interest at LIBOR
 plus 1.5% with respect to $11,500 of borrowings and LIBOR plus 0.65% with
 respect to $3,500 of borrowings. The principal amount borrowed is repayable
 in 20 equal quarterly payments through May 2013. The bank has a lien of our
 assets and we are required to maintain $3,500 of compensating balances with
 the bank. The agreement requires the
 Company, among other things, to maintain shareholders equity at specified
 levels and to achieve certain levels of operating income. The agreement also
 restricts the Company from paying dividends. As of June 22, 2008, there was
 $15,000 outstanding under this loan agreement.

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

F-47

---



NATURAL SPEECH COMMUNICATION LTD.

FINANCIAL STATEMENTS

AS OF DECEMBER 31, 2007

IN U.S. DOLLARS

|                                                            |  |        
|----------------------------------------------------------- |  | -------
|                                                            |  | Page   
|                                                            |  |        
|                                                           
|Auditors Report                                            |  | F-49   
|                                                            |  |        
|Balance Sheets                                              |  | F-50-51
|                                                            |  |        
|Statements of Operations                                    |  | F-52   
|                                                            |  |        
|Statements of Changes in Shareholders
 Equity (Deficiency) |  | F-53   
|                                                            |  |        
|Statements of Cash Flows                                    |  | F-54   
|                                                            |  |        
|Notes to Financial Statements                               |  | F-55-68

F-48

---



|                       |                             
|---------------------- | ----------------------------
|(ERNST & YOUNG LOGO)   | Kost
Forer Gabbay & Kasierer
|3 Aminadav St.        
|Tel-Aviv 67067, Israel
|                      
|Tel: 972 (3)6232525   
|Fax: 972 (3)5622555   
|www.ey.com/il         

AUDITORS REPORT

To the Shareholders of

NATURAL SPEECH COMMUNICATION LTD.

We
have audited the accompanying balance sheets of Natural Speech Communication
Ltd. (the Company) as of December 31, 2007 and 2006, and the related
statements of operations, changes in shareholders equity (deficiency) and cash
flows for each of the three years in the period ended December 31, 2007. These
financial statements are the responsibility of the Companys board of directors
and management. Our responsibility is to express an opinion on these financial
statements based on our audits.

We
conducted our audit in accordance with generally accepted auditing standards in
Israel, including those prescribed by the Auditors Regulations (Auditors Mode
of Performance), 1973. Those standards require that we plan and perform the
audit to obtain reasonable assurance about whether the financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by the board of directors and management, as well as evaluating
the overall financial statement presentation. We believe that our audit
provides a reasonable basis for our opinion.

As
discussed in Note 2b to the financial statements, the financial statements have
been prepared in U.S. dollars and not in reported amount, as required by
Accounting Standard No. 12 of the Israel Accounting Standard Board.

As
discussed in Note 1b to the financial statements, the Company has incurred an
accumulated deficit of $ 16,264 thousand since inception, and has negative cash
flows from operating activities. The Companys ability to continue its
operations is dependent upon additional support from investors until profitability
is achieved. The accompanying financial statements do not include any
adjustments to reflect the possible future effects on the recoverability and
classification of asset carrying amounts or the amounts and classification of
liabilities that might result from the outcome of this uncertainty.

In
our opinion, except for the two matters discussed above, the financial
statements referred to above present fairly, in all material respects, the
financial position of the Company as of December 31, 2007 and 2006 and the
results of operations, changes in shareholders equity (deficiency) and cash
flows for each of the three years in the period ended December 31, 2007, in
conformity with generally accepted accounting principles in Israel.

|                  |                                 
|----------------- | --------------------------------
|Tel-Aviv,
 Israel | KOST FORER GABBAY & KASIERER    
|June 22,
 2008    | A Member of Ernst & Young Global

F-49

---



|                                 
|---------------------------------
|NATURAL SPEECH COMMUNICATION LTD.
|                                 
|BALANCE SHEETS                   
|                                 
|U.S. dollars in thousands        

|                                       |  |              |       |      |   |     | 
|-------------------------------------- |  | ------------ | ----- | ---- | - | --- | 
|                                       |  | December 31, |      
|                                       |  |              |      
|                                       |  | 2007         |       | 2006 |  
|                                       |  |              |       |      |  
|ASSETS                                 |  |              |       |      |   |     | 
|                                       |  |              |       |      |   |     | 
|CURRENT
  ASSETS:                      |  |              |       |      |   |     | 
|Cash and cash equivalents              |  | $            | 446   |      | $ | 154 | 
|Trade receivables                      |  |              | 34    |      |   | 210 | 
|Other receivables and prepaid expenses |  |              | 16    |      |   | 7   | 
|Inventories                            |  |              | 57    |      |   | 50  | 
|                                       |  |              |       |      |   |     | 
|                                       |  |              |       |      |   |     | 
|Total
  current assets                 |  |              | 553   |      |   | 421 | 
|                                       |  |              |       |      |   |     | 
|                                       |  |              |       |      |   |     | 
|LONG-TERM
  LEASE DEPOSITS             |  |              | 18    |      |   | 22  | 
|                                       |  |              |       |      |   |     | 
|                                       |  |              |       |      |   |     | 
|PROPERTY AND
  EQUIPMENT, NET (Note 3) |  |              | 444   |      |   | 162 | 
|                                       |  |              |       |      |   |     | 
|                                       |  |              |       |      |   |     | 
|Total
  assets                         |  | $            | 1,015 |      | $ | 605 | 
|                                       |  |              |       |      |   |     | 

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

F-50

---



|                                 
|---------------------------------
|NATURAL SPEECH COMMUNICATION LTD.
|                                 
|BALANCE SHEETS                   
|                                 
|U.S. dollars in thousands        

|                                                          |  |              |         |      |   |         |  
|--------------------------------------------------------- |  | ------------ | ------- | ---- | - | ------- | -
|                                                          |  | December 31, |        
|                                                          |  |              |        
|                                                          |  | 2007         |         | 2006 |  
|                                                          |  |              |         |      |  
|LIABILITIES AND SHAREHOLDERS EQUITY
  (DEFICIENCY)       |  |              |         |      |   |         |  
|                                                          |  |              |         |      |   |         |  
|CURRENT LIABILITIES:                                      |  |              |         |      |   |         |  
|Trade payables                                            |  | $            | 244     |      | $ | 98      |  
|Employees and payroll accruals                            |  |              | 253     |      |   | 162     |  
|Deferred Revenues                                         |  |              | 120     |      |   | 6       |  
|Other payables and accrued expenses                       |  |              | 142     |      |   | 49      |  
|                                                          |  |              |         |      |   |         |  
|                                                          |  |              |         |      |   |         |  
|Total
  current liabilities                               |  |              | 759     |      |   | 315     |  
|                                                          |  |              |         |      |   |         |  
|                                                          |  |              |         |      |   |         |  
|LONG-TERM
  LIABILITIES:                                  |  |              |         |      |   |         |  
|Accrued severance pay                                     |  |              | 74      |      |   | 45      |  
|Long-term loans from shareholders (Note
4)                |  |              |        |      |   | 1,350   |  
|                                                          |  |              |         |      |   |         |  
|                                                          |  |              |         |      |   |         |  
|Total
  long-term liabilities                             |  |              | 74      |      |   | 1,395   |  
|                                                          |  |              |         |      |   |         |  
|                                                          |  |              |         |      |   |         |  
|COMMITMENTS
  AND CONTINGENT LIABILITIES (Note 5)         |  |              |         |      |   |         |  
|                                                          |  |              |         |      |   |         |  
|SHAREHOLDERS
  DEFICIENCY (Note 6):                      |  |              |         |      |   |         |  
|Share capital                                             |  |              | 88      |      |   | 40      |  
|Additional paid-in capital                                |  |              | 16,358  |      |   | 13,383  |  
|Accumulated deficit                                       |  |              | (16,264 | )    |   | (14,528 | )
|                                                          |  |              |         |      |   |         |  
|                                                          |  |              |         |      |   |         |  
|Total
  shareholders equity (deficiency)                 |  |              | 182     |      |   | (1,105  | )
|                                                          |  |              |         |      |   |         |  
|                                                          |  |              |         |      |   |         |  
|Total
  liabilities and shareholders equity (deficiency) |  | $            | 1,015   |      | $ | 605     |  
|                                                          |  |              |         |      |   |         |  

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

F-51

---



|                                 
|---------------------------------
|NATURAL SPEECH COMMUNICATION LTD.
|                                 
|STATEMENTS OF OPERATIONS         
|                                 
|U.S. dollars in thousands        

|                           |  |                         |       |      |   |       |  |   |       | 
|-------------------------- |  | ----------------------- | ----- | ---- | - | ----- |  | - | ----- | 
|                           |  | Year ended December 31, |      
|                           |  |                         |      
|                           |  | 2007                    |       | 2006 |   | 2005  | 
|                           |  |                         |       |      |   |       | 
|                           |  |                         |       |      |   |       |  |   |       | 
|Revenues                   |  | $                       | 1,123 |      | $ | 378   |  | $ | 691   | 
|Cost of
  revenues         |  |                         | 230   |      |   | 62    |  |   | 90    | 
|                           |  |                         |       |      |   |       |  |   |       | 
|                           |  |                         |       |      |   |       |  |   |       | 
|Gross profit               |  |                         | 893   |      |   | 316   |  |   | 601   | 
|                           |  |                         |       |      |   |       |  |   |       | 
|                           |  |                         |       |      |   |       |  |   |       | 
|Operating
  expenses:      |  |                         |       |      |   |       |  |   |       | 
|Research and development   |  |                         | 1,499 |      |   | 1,084 |  |   | 1,233 | 
|Sales and marketing        |  |                         | 756   |      |   | 721   |  |   | 733   | 
|General and administrative |  |                         | 348   |      |   | 258   |  |   | 209   | 
|                           |  |                         |       |      |   |       |  |   |       | 
|                           |  |                         |       |      |   |       |  |   |       | 
|Total operating
  expenses |  |                         | 2,603 |      |   | 2,063 |  |   | 2,175 | 
|                           |  |                         |       |      |   |       |  |   |       | 
|                           |  |                         |       |      |   |       |  |   |       | 
|Operating
  loss           |  |                         | 1,710 |      |   | 1,747 |  |   | 1,574 | 
|Financial
  expenses, net  |  |                         | 26    |      |   | 33    |  |   | 21    | 
|                           |  |                         |       |      |   |       |  |   |       | 
|                           |  |                         |       |      |   |       |  |   |       | 
|Loss                       |  | $                       | 1,736 |      | $ | 1,780 |  | $ | 1,595 | 
|                           |  |                         |       |      |   |       |  |   |       | 

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

F-52

---



|                                                          
|----------------------------------------------------------
|NATURAL SPEECH COMMUNICATION LTD.                         
|                                                          
|STATEMENTS OF CHANGES IN SHAREHOLDERS EQUITY (DEFICIENCY)
|                                                          
|U.S. dollars in thousands                                 

|                                   |  |                  |   |                   |   |                              |  |                                  |        |                      |   |                                            |  |   |         |   |   |        |  
|---------------------------------- |  | ---------------- | - | ----------------- | - | ---------------------------- |  | -------------------------------- | ------ | -------------------- | - | ------------------------------------------ |  | - | ------- | - | - | ------ | -
|                                   |  | Ordinary
 shares |   | Preferred
 shares |   | Additional
 paid-in
 capital |  | Advances on
 account of 
 shares |        | Deficit
 accumulated |   | Total
 shareholders
 equity
 (deficiency) | 
|                                   |  |                  |   |                   |   |                              |  |                                  |        |                      |   |                                            | 
|                                   |  |                  |   |                   |   |                              |  |                                  |        |                      |   |                                            |  |   |         |   |   |        |  
|Balance as
 of January 1, 2005     |  | $                | 1 |                   | $ | 23                           |  | $                                | 11,704 |                      | $ |                                           |  | $ | (11,153 | ) | $ | 575    |  
|                                   |  |                  |   |                   |   |                              |  |                                  |        |                      |   |                                            |  |   |         |   |   |        |  
|Net loss                           |  |                  |  |                   |   |                             |  |                                  |       |                      |   |                                           |  |   | (1,595  | ) |   | (1,595 | )
|                                   |  |                  |   |                   |   |                              |  |                                  |        |                      |   |                                            |  |   |         |   |   |        |  
|                                   |  |                  |   |                   |   |                              |  |                                  |        |                      |   |                                            |  |   |         |   |   |        |  
|Balance as
 of December 31, 2005   |  |                  | 1 |                   |   | 23                           |  |                                  | 11,704 |                      |   |                                           |  |   | (12,748 | ) |   | (1,020 | )
|                                   |  |                  |   |                   |   |                              |  |                                  |        |                      |   |                                            |  |   |         |   |   |        |  
|Issuance of
 Preferred shares      |  |                  |  |                   |   | 16                           |  |                                  | 1,201  |                      |   | 478                                        |  |   |        |   |   | 1,695  |  
|Net loss                           |  |                  |  |                   |   |                             |  |                                  |       |                      |   |                                           |  |   | (1,780  | ) |   | (1,780 | )
|                                   |  |                  |   |                   |   |                              |  |                                  |        |                      |   |                                            |  |   |         |   |   |        |  
|                                   |  |                  |   |                   |   |                              |  |                                  |        |                      |   |                                            |  |   |         |   |   |        |  
|Balance as
 of December 31, 2006   |  |                  | 1 |                   |   | 39                           |  |                                  | 12,905 |                      |   | 478                                        |  |   | (14,528 | ) |   | (1,105 | )
|                                   |  |                  |   |                   |   |                              |  |                                  |        |                      |   |                                            |  |   |         |   |   |        |  
|Issuance of
 Preferred shares, net |  |                  |  |                   |   | 48                           |  |                                  | 2,245  |                      |   | 730                                        |  |   |        |   |   | 3,023  |  
|Net loss                           |  |                  |  |                   |   |                             |  |                                  |       |                      |   |                                           |  |   | (1,736  | ) |   | (1,736 | )
|                                   |  |                  |   |                   |   |                              |  |                                  |        |                      |   |                                            |  |   |         |   |   |        |  
|                                   |  |                  |   |                   |   |                              |  |                                  |        |                      |   |                                            |  |   |         |   |   |        |  
|Balance as
 of December 31, 2007   |  | $                | 1 |                   | $ | 87                           |  | $                                | 15,150 |                      | $ | 1,208                                      |  | $ | (16,264 | ) | $ | 182    |  
|                                   |  |                  |   |                   |   |                              |  |                                  |        |                      |   |                                            |  |   |         |   |   |        |  

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

F-53

---



|                                 
|---------------------------------
|NATURAL SPEECH COMMUNICATION LTD.
|                                 
|STATEMENTS OF CASH FLOWS         
|                                 
|U.S. dollars in thousands        

|                                                                                         |  |                          |        |      |   |        |   |   |        |  
|---------------------------------------------------------------------------------------- |  | ------------------------ | ------ | ---- | - | ------ | - | - | ------ | -
|                                                                                         |  | Year ended
 December 31, |       
|                                                                                         |  |                          |       
|                                                                                         |  | 2007                     |        | 2006 |   | 2005   |  
|                                                                                         |  |                          |        |      |   |        |  
|Cash flows
 from operating activities:                                                   |  |                          |        |      |   |        |   |   |        |  
|                                                                                         |  |                          |        |      |   |        |   |   |        |  
|Net loss                                                                                 |  | $                        | (1,736 | )    | $ | (1,780 | ) | $ | (1,595 | )
|Adjustments to reconcile net loss to net
 cash used in operating activities:             |  |                          |        |      |   |        |   |   |        |  
|Depreciation                                                                             |  |                          | 76     |      |   | 80     |   |   | 103    |  
|Increase (decrease) in accrued severance
 pay                                            |  |                          | 29     |      |   | (28    | ) |   |       |  
|Decrease (increase) in trade receivables                                                 |  |                          | 176    |      |   | 154    |   |   | (258   | )
|Decrease (increase) in other receivables,
 prepaid expenses and long-term lease deposits |  |                          | (5     | )    |   | (1     | ) |   | 281    |  
|Increase in inventories                                                                  |  |                          | (7     | )    |   | (5     | ) |   | (16    | )
|Increase (decrease) in trade payables                                                    |  |                          | 52     |      |   | 42     |   |   | (11    | )
|Increase (decrease) in employees and
 payroll accruals                                   |  |                          | 91     |      |   | 5      |   |   | (10    | )
|Increase (decrease) in deferred revenues                                                 |  |                          | 114    |      |   | (4     | ) |   | (4     | )
|Increase (decrease) in other payables and
 accrued expenses                              |  |                          | 93     |      |   | (36    | ) |   | 55     |  
|                                                                                         |  |                          |        |      |   |        |   |   |        |  
|                                                                                         |  |                          |        |      |   |        |   |   |        |  
|Net cash
 used in operating activities                                                   |  |                          | (1,117 | )    |   | (1,573 | ) |   | (1,455 | )
|                                                                                         |  |                          |        |      |   |        |   |   |        |  
|                                                                                         |  |                          |        |      |   |        |   |   |        |  
|Cash flows
 from investing activities:                                                   |  |                          |        |      |   |        |   |   |        |  
|                                                                                         |  |                          |        |      |   |        |   |   |        |  
|Purchase of property and equipment                                                       |  |                          | (264   | )    |   | (33    | ) |   | (100   | )
|                                                                                         |  |                          |        |      |   |        |   |   |        |  
|                                                                                         |  |                          |        |      |   |        |   |   |        |  
|Net cash
 used in investing activities                                                   |  |                          | (264   | )    |   | (33    | ) |   | (100   | )
|                                                                                         |  |                          |        |      |   |        |   |   |        |  
|                                                                                         |  |                          |        |      |   |        |   |   |        |  
|Cash flows
 from financing activities:                                                   |  |                          |        |      |   |        |   |   |        |  
|                                                                                         |  |                          |        |      |   |        |   |   |        |  
|Proceeds from issuance of Preferred shares,
 net                                         |  |                          | 943    |      |   | 1,217  |   |   | 1,433  |  
|Proceeds from receipt of advances on
 account of shares                                  |  |                          | 730    |      |   | 478    |   |   | 10     |  
|                                                                                         |  |                          |        |      |   |        |   |   |        |  
|                                                                                         |  |                          |        |      |   |        |   |   |        |  
|Net cash
 provided by financing activities                                               |  |                          | 1,673  |      |   | 1,695  |   |   | 1,443  |  
|                                                                                         |  |                          |        |      |   |        |   |   |        |  
|                                                                                         |  |                          |        |      |   |        |   |   |        |  
|Increase
 (decrease) in cash and cash equivalents                                        |  |                          | 292    |      |   | 89     |   |   | (112   | )
|Cash and
 cash equivalents at the beginning of the year                                  |  |                          | 154    |      |   | 65     |   |   | 177    |  
|                                                                                         |  |                          |        |      |   |        |   |   |        |  
|                                                                                         |  |                          |        |      |   |        |   |   |        |  
|Cash and
 cash equivalents at the end of the year                                        |  | $                        | 446    |      | $ | 154    |   | $ | 65     |  
|                                                                                         |  |                          |        |      |   |        |   |   |        |  
|                                                                                         |  |                          |        |      |   |        |   |   |        |  
|Supplement disclosure of non-cash investing activities:                                  |  |                          |        |      |   |        |   |   |        |  
|                                                                                         |  |                          |        |      |   |        |   |   |        |  
|Purchasing property and equipment                                                        |  | $                        | 96     |      | $ | 2      |   | $ |       |  
|                                                                                         |  |                          |        |      |   |        |   |   |        |  
|                                                                                         |  |                          |        |      |   |        |   |   |        |  
|Supplemental
 disclosure of non-cash financing activities:                               |  |                          |        |      |   |        |   |   |        |  
|                                                                                         |  |                          |        |      |   |        |   |   |        |  
|Issuance of Preferred shares against
 long-term loans from shareholders                  |  | $                        | 1,350  |      | $ |       |   | $ |       |  
|                                                                                         |  |                          |        |      |   |        |   |   |        |  

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

F-54

---



|                                                           
|-----------------------------------------------------------
|NATURAL SPEECH COMMUNICATION LTD.                          
|                                                           
|NOTES TO FINANCIAL
 STATEMENTS                             
|                                                           
|U.S. dollars in
 thousands, except share and per share data

|         |        
|-------- | -------
|NOTE 1:- | GENERAL

| |    |                                                                                                                                                                                                                                                                                                                            
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | a. | Natural
 Speech Communication Ltd. (the Company) provides speech recognition
 products for the telephony and security markets.                                                                                                                                                                                           
| |    |                                                                                                                                                                                                                                                                                                                            
| | b. | The Company
 has an accumulated deficit of $16,264 and negative cash flows from operating
 activities. The Companys ability to continue to operate is dependent upon
 additional financial support from investors. The Companys management
 believes that additional funds can be raised from existing and new investors.

|         |                                                                                                                                     |                                                                                                                                                                                                                                                                                                          | 
|-------- | ----------------------------------------------------------------------------------------------------------------------------------- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | 
|NOTE 2:- | SIGNIFICANT ACCOUNTING POLICIES                                                                                                    
|         |                                                                                                                                     |                                                                                                                                                                                                                                                                                                          | 
|         | The
 significant accounting policies applied in the preparation of the financial
 statements on a consistent basis, are as follows:
|         |                                                                                                                                     |                                                                                                                                                                                                                                                                                                          | 
|         | a.                                                                                                                                  | Use of
 estimates:                                                                                                                                                                                                                                                                                      
|         |                                                                                                                                     |                                                                                                                                                                                                                                                                                                          | 
|         |                                                                                                                                     | The
 preparation of financial statements in conformity with generally accepted
 accounting principles requires management to make estimates and assumptions
 that affect the reported amounts in the financial statements and the
 accompanying notes. Actual results could differ from those estimates.
|         |                                                                                                                                     |                                                                                                                                                                                                                                                                                                          | 
|         | b.                                                                                                                                  | Financial
 statements in U.S. dollars:                                                                                                                                                                                                                                                                  
|         |                                                                                                                                     |                                                                                                                                                                                                                                                                                                          | 
|         |                                                                                                                                     | The
 Companys management believes that the dollar is the primary currency of the
 economic environment in which the Company operates. Thus, the functional and
 reporting currency of the Company is the dollar.                                                                                       
|         |                                                                                                                                     |                                                                                                                                                                                                                                                                                                          | 
|         |                                                                                                                                     | Non-monetary
 assets and liabilities (assets and liabilities presented in historical values
 as of the date of purchase or production) have been adjusted in accordance to
 the changes in the U.S. dollar exchange rate as of the date of purchase or
 production.                                     
|         |                                                                                                                                     |                                                                                                                                                                                                                                                                                                          | 
|         |                                                                                                                                     | Monetary
 assets and liabilities (assets and liabilities that are presented at current
 or realization values as of balance sheet date) are presented in the
 financial statements according to U.S. dollar exchange rate as of the balance
 sheet date.                                                
|         |                                                                                                                                     |                                                                                                                                                                                                                                                                                                          | 
|         |                                                                                                                                     | Statement of
 income amounts have been translated using average exchange rates prevailing
 during the year.                                                                                                                                                                                             
|         |                                                                                                                                     |                                                                                                                                                                                                                                                                                                          | 
|         | c.                                                                                                                                  | Cash
 equivalents:                                                                                                                                                                                                                                                                                      
|         |                                                                                                                                     |                                                                                                                                                                                                                                                                                                          | 
|         |                                                                                                                                     | Cash
 equivalents are short-term highly liquid investments that are readily
 convertible into cash with original maturities of three months or less.                                                                                                                                                    

F-55

---



|                                                          
|----------------------------------------------------------
|NATURAL SPEECH COMMUNICATION LTD.                         
|                                                          
|NOTES TO FINANCIAL STATEMENTS                             
|                                                          
|U.S. dollars in thousands, except share and per share data

|         |                                        
|-------- | ---------------------------------------
|NOTE 2:- | SIGNIFICANT ACCOUNTING POLICIES (Cont.)

| |    |                                                                                                                                                                                                                                                                                                                                                                                                                       
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | d. | Inventories:                                                                                                                                                                                                                                                                                                                                                                                                          
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                       
| |    | As of
 January 1, 2007, the Company applies Accounting Standard No. 26,
 Inventories. Inventories are measured at the lower of cost or net
 realizable value. Net realizable value is the estimated selling price in the
 ordinary course of business less the estimated costs of completion and costs
 necessary to make the sale. An evaluation of net realizable value is carried
 out in each subsequent period.
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                       
| |    | Cost of
 inventory includes the inventory purchase costs.                                                                                                                                                                                                                                                                                                                                                             
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                       
| |    | Cost is
 determined as follows:                                                                                                                                                                                                                                                                                                                                                                                       
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                       
| |    | Raw
 materials and parts - using the weighted average cost method.                                                                                                                                                                                                                                                                                                                                                    
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                       
| |    | Finished
 products - using the average cost method with the addition of direct
 manufacturing costs.                                                                                                                                                                                                                                                                                                                
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                       
| |    | The Company
 periodically evaluates the condition and age of inventories and provides for
 slow moving inventories accordingly.                                                                                                                                                                                                                                                                                       
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                       
| |    | The Company
 does not believe that the adoption of Accounting Standard No. 26 has a
 material effect on its financial position or results of operations.                                                                                                                                                                                                                                                              
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                       
| | e. | Allowance
 for doubtful accounts:                                                                                                                                                                                                                                                                                                                                                                                     
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                       
| |    | The
 allowance for doubtful accounts is principally determined in respect of
 specific debts whose collection, in the opinion of the Companys management,
 is doubtful.                                                                                                                                                                                                                                              
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                       
| | f. | Property and
 equipment:                                                                                                                                                                                                                                                                                                                                                                                              
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                       
| |    | As of
 January 1, 2007, the Company applies the provisions of Accounting Standard
 No. 27, Fixed Assets of the Israel Accounting Standards Board. Fixed assets
 are stated at cost, including direct acquisition costs and accumulated
 depreciation, and excluding day-to-day servicing expenses.                                                                                                                  
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                       
| |    | Depreciation
 is computed by the straight-line method over the estimated useful lives of
 the assets at the following annual rates:                                                                                                                                                                                                                                                                                   

| |                                     |  |                                                       
| | ----------------------------------- |  | ------------------------------------------------------
| |                                     |  | %                                                     
| |                                     |  |                                                       
| |                                     |  |                                                       
| | Computers
 and peripheral equipment |  | 12 - 33                                               
| | Office
 furniture and equipment     |  | 7 - 33                                                
| | Leasehold
 improvements             |  | Over the term of the lease,
 including renewal options

| |  |                                                                                                                                                         
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | The Company
 does not believe that the adoption of Accounting Standard No. 27 has a
 material effect on its financial position or results of operations.

F-56

---



|                                                          
|----------------------------------------------------------
|NATURAL SPEECH COMMUNICATION LTD.                         
|                                                          
|NOTES TO FINANCIAL STATEMENTS                             
|                                                          
|U.S. dollars in thousands, except share and per share data

|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|-------- | --------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 2:- | SIGNIFICANT ACCOUNTING POLICIES (Cont.)
|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|         | g.                                      | Impairment
 of long-lived assets:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|         |                                         | The Company
 evaluates the need to record an impairment of the carrying amount of non-financial assets whenever events or changes in circumstances indicate
 that the carrying amount of the asset is not recoverable. Where the carrying amount of a non-financial asset exceeds its recoverable amount, the asset is considered impaired and is written down to its recoverable amount.                                                                                                                                                                                                              
|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|         |                                         | As of
 December 31, 2007 and 2006, no impairment losses have been identified.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|         | h.                                      | Research and
 development costs:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|         |                                         | Research
 costs are expensed as incurred. An intangible asset arising from development
 expenditure on an individual project is recognized only when the Company can
 demonstrate the technical feasibility of completing the intangible asset so
 that it will be available for use or sale, its intention to complete and its
 ability to use or sell the asset, how the asset will generate future economic
 benefits, the availability of required resources - technical, financial or
 other - to complete the asset, and the ability to measure reliably the
 expenditure during the development.
|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|         | i.                                      | Revenue
 recognition:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|         |                                         | Revenues are
 recognized in the income statement when they can be measured reliably, the
 economic benefits associated with the transaction are expected to flow to the
 Company and the costs incurred or to be incurred in respect of the
 transaction can be measured reliably. Revenues are measured at the fair value
 of the consideration in the transaction less commercial rebates, volume
 discounts and returns.                                                                                                                                                                            
|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|         |                                         | 1.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      | Revenues
 from sale of goods:                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         | The Company
 applies Accounting Standard No. 25 regarding revenues recognition of
 products. Revenues from sale of goods are recognized once all the significant
 risks and rewards of ownership of the goods have been transferred to the
 buyer, the seller no longer retains continuing managerial involvement to the
 degree usually associated with ownership and no longer retains effective
 control over the goods sold.                                                      
|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|         |                                         | 2.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      | Recognition
 of revenues from contracts in progress:                                                                                                                                                                                                                                                                                                                                                                                                                                  
|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         | Revenues
 from performance contracts are recognized on the percentage of completion
 basis provided that the revenues are fixed or can be reasonably estimated,
 collection is probable, costs related to performing the work are determinable
 or can be reasonably determined, there is no substantial uncertainty
 regarding the ability of the Company to complete the contract and to meet the
 contractual terms, and the percentage of completion can be reasonably
 estimated.

F-57

---



|                                                           |                                  
|---------------------------------------------------------- | ---------------------------------
|                                                           | NATURAL SPEECH COMMUNICATION LTD.
|                                                           |                                  
|NOTES TO FINANCIAL STATEMENTS                              |                                  
|                                                          
|U.S. dollars in thousands, except share and per share data |                                  

|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                
|-------- | --------------------------------------- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 2:- | SIGNIFICANT ACCOUNTING POLICIES (Cont.)
|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                
|         | j.                                      | Concentrations
 of credit risks:                                                                                                                                                                                                                                                                                                                                                                                               
|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                
|         |                                         | Financial
 instruments that potentially subject the Company to concentrations of credit
 risk consist principally of cash and cash equivalents and trade receivables.                                                                                                                                                                                                                                                          
|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                
|         |                                         | Cash and
 cash equivalents are invested in major banks in Israel. Management believes
 that the financial institutions that hold the Companys investments are
 financially sound and, accordingly, minimal credit risk exists with respect
 to these investments.                                                                                                                                                             
|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                
|         |                                         | The trade
 receivables of the Company are mainly derived from sales to customers located
 primarily in Israel. The Company performs ongoing credit evaluations of its
 customers. An allowance for doubtful accounts is determined with respect to
 those amounts that the Company has determined to be doubtful of collection.                                                                                                
|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                
|         |                                         | The Company
 has no off-balance-sheet concentration of credit risk such as foreign
 exchange contracts, option contracts or other foreign hedging arrangements.                                                                                                                                                                                                                                                                
|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                
|         | k.                                      | Share-based
 payments:                                                                                                                                                                                                                                                                                                                                                                                                         
|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                
|         |                                         | According to
 the transition provisions of Accounting Standard No. 24 of the Israel Accounting
 Standards Board, Share-based Payment, the Company recognized a benefit in
 respect of grants to employees only for equity-settled share-based payment
 transactions made subsequent to March 15, 2005 that had not yet vested as of
 January 1, 2006.                                                                        
|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                
|         |                                         | The
 Companys employees and other service providers are entitled to remuneration
 in the form of share-based payment transactions as consideration for equity
 instruments (equity settled transactions).                                                                                                                                                                                                                   
|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                
|         |                                         | In
 connection with services provided to the Company, employees and other service
 providers are entitled to share-based payments settled in shares. The cost of
 equity-settled transactions with employees or service providers is measured
 at the fair value of the equity instruments on the date of grant. The fair
 value is determined by an independent appraiser using a binomial
 option-pricing model, see Note 7e.
|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                
|         | l.                                      | Fair value
 of financial instruments:                                                                                                                                                                                                                                                                                                                                                                                          
|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                
|         |                                         | The
 following methods and assumptions were used by the Company in estimating its
 fair value disclosures for financial instruments:                                                                                                                                                                                                                                                                                           
|         |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                
|         |                                         | The carrying
 amounts of cash and cash equivalents, trade receivables, other accounts
 receivable and prepaid expenses, trade payables and other accounts payable
 and accrued expenses approximate their fair value due to the short-term
 maturity of such instruments.                                                                                                                                                      

F-58

---



|                                                           |                                  
|---------------------------------------------------------- | ---------------------------------
|                                                           | NATURAL SPEECH COMMUNICATION LTD.
|                                                           |                                  
|NOTES TO FINANCIAL STATEMENTS                              |                                  
|                                                          
|U.S. dollars in thousands, except share and per share data |                                  

|         |                                         |                                                                                                                                                                                            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |                                                                                                                                                                                                                                                                                                                                                                                                                            
|-------- | --------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 2:- | SIGNIFICANT ACCOUNTING POLICIES (Cont.)
|         |                                        
|         |                                         | Disclosure
 of the effects of new Accounting Standards in the period prior to their
 adoption/Disclosure of the effects of a new Accounting Standard in the period
 prior to its adoption:
|         |                                         |                                                                                                                                                                                            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|         |                                         | 1.                                                                                                                                                                                         | Accounting
 Standard No. 13 (Revised), Effects of Changes in Foreign Currency Exchange
 Rates:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|         |                                         |                                                                                                                                                                                            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|         |                                         |                                                                                                                                                                                            | In May 2007,
 the Israel Accounting Standards Board published Accounting Standard No. 13
 (Revised), Effects of Changes in Foreign Currency Exchange Rates (the
 Standard), which deals with determining the functional currency of an entity
 or of its foreign operations, the translation of transactions in foreign
 currency, the translation of financial statements of foreign operations and
 the translation of financial statements from the functional currency to the
 presentation currency. The Standard applies to financial statements for
 periods commencing on January 1, 2008 and thereafter.
|         |                                         |                                                                                                                                                                                            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|         |                                         |                                                                                                                                                                                            | According to
 the Standard, the term reporting currency was replaced by two terms:
 functional currency and presentation currency.                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|         |                                         |                                                                                                                                                                                            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|         |                                         |                                                                                                                                                                                            | Functional
 currency:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|         |                                         |                                                                                                                                                                                            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|         |                                         |                                                                                                                                                                                            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|         |                                         |                                                                                                                                                                                            | The
 Companys functional currency is the currency that best reflects the economic
 environment in which the Company operates and conducts its transactions.                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|         |                                         |                                                                                                                                                                                            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|         |                                         |                                                                                                                                                                                            | The
 functional currency is separately determined for each investee, including an
 affiliate which is presented at equity, and is used to measure the investees
 financial position and operating results. When the investees functional
 currency differs from that of the Company, the investee represents a foreign
 operation whose financial statements are translated in order to be included
 in the Companys financial statements as follows:                                                                                                                                                              
|         |                                         |                                                                                                                                                                                            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |                                                                                                                                                                                                                                                                                                                                                                                                                            
|         |                                         |                                                                                                                                                                                            | a)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     | Assets and
 liabilities in all balance sheets presented (including comparative data) are
 translated at the closing rate as of each balance sheet presented. Goodwill
 and all fair value adjustments of the assets and liabilities on the date of
 acquisition of the foreign operation are treated as the foreign operations
 assets and liabilities and are translated at the closing rate at each balance
 sheet date.
|         |                                         |                                                                                                                                                                                            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |                                                                                                                                                                                                                                                                                                                                                                                                                            
|         |                                         |                                                                                                                                                                                            | b)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     | Income and
 expenses for every period presented in the statements of income (including
 comparative data) are translated at the average exchange rates for each of
 the periods presented; however, if there have been significant changes in
 foreign exchange rates, income and expenses are translated at the exchange
 rate prevailing on the dates of the actual transactions.                                        
|         |                                         |                                                                                                                                                                                            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |                                                                                                                                                                                                                                                                                                                                                                                                                            
|         |                                         |                                                                                                                                                                                            | c)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     | Share
 capital, capital reserves and other changes in capital are translated at the
 exchange rate prevailing as of the date of incurrence.                                                                                                                                                                                                                                                                                

F-59

---



|                                                           |                                  
|---------------------------------------------------------- | ---------------------------------
|                                                           | NATURAL SPEECH COMMUNICATION LTD.
|                                                           |                                  
|NOTES TO FINANCIAL STATEMENTS                              |                                  
|                                                          
|U.S. dollars in thousands, except share and per share data |                                  

|         |                                         |  |                                                                                                                                                                                                                                                                     |                                                                                                                                                                                                                                                                                                                                                                                                                            
|-------- | --------------------------------------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 2:- | SIGNIFICANT ACCOUNTING POLICIES (Cont.)
|         |                                         |  |                                                                                                                                                                                                                                                                     |                                                                                                                                                                                                                                                                                                                                                                                                                            
|         |                                         |  | d)                                                                                                                                                                                                                                                                  | Retained
 earnings are translated based on the opening balance at the exchange rate as
 of that date and other relevant transactions during the period are translated
 as described in b) and c) above.                                                                                                                                                                                                                    
|         |                                         |  |                                                                                                                                                                                                                                                                     |                                                                                                                                                                                                                                                                                                                                                                                                                            
|         |                                         |  | e)                                                                                                                                                                                                                                                                  | All
 translation differences are recorded as a separate item in shareholders
 equity (foreign currency translation adjustments of foreign operations).                                                                                                                                                                                                                                                                  
|         |                                         |  |                                                                                                                                                                                                                                                                     |                                                                                                                                                                                                                                                                                                                                                                                                                            
|         |                                         |  | Presentation
 currency:                                                                                                                                                                                                                                            
|         |                                         |  |                                                                                                                                                                                                                                                                     |                                                                                                                                                                                                                                                                                                                                                                                                                            
|         |                                         |  | The Company
 can present its financial statements in any currency (or currencies). The
 translation of the Companys financial statements from the functional
 currency to the presentation currency will be presented in an appendix to the
 financial statements.
|         |                                         |  |                                                                                                                                                                                                                                                                     |                                                                                                                                                                                                                                                                                                                                                                                                                            
|         |                                         |  | The
 translation of the Companys results and financial position from the
 functional currency to the presentation currency will be done as follows:                                                                                                               
|         |                                         |  |                                                                                                                                                                                                                                                                     |                                                                                                                                                                                                                                                                                                                                                                                                                            
|         |                                         |  | a)                                                                                                                                                                                                                                                                  | Assets and
 liabilities in all balance sheets presented (including comparative data) are
 translated at the closing rate as of each balance sheet presented. Goodwill
 and all fair value adjustments of the assets and liabilities on the date of
 acquisition of the foreign operation are treated as the foreign operations
 assets and liabilities and are translated at the closing rate at each balance
 sheet date.
|         |                                         |  |                                                                                                                                                                                                                                                                     |                                                                                                                                                                                                                                                                                                                                                                                                                            
|         |                                         |  | b)                                                                                                                                                                                                                                                                  | Income and
 expenses for every period presented in the statements of income (including
 comparative data) are translated at the average exchange rates for each of
 the periods presented; however, if there have been significant changes in
 foreign exchange rates, income and expenses are translated at the exchange
 rate prevailing on the dates of the actual transactions.                                        
|         |                                         |  |                                                                                                                                                                                                                                                                     |                                                                                                                                                                                                                                                                                                                                                                                                                            
|         |                                         |  | c)                                                                                                                                                                                                                                                                  | Share
 capital, capital reserves and other changes in capital are translated at the
 exchange rate prevailing as of the date of incurrence.                                                                                                                                                                                                                                                                                
|         |                                         |  |                                                                                                                                                                                                                                                                     |                                                                                                                                                                                                                                                                                                                                                                                                                            
|         |                                         |  | d)                                                                                                                                                                                                                                                                  | Retained
 earnings are translated based on the opening balance at the exchange rate as
 of that date and other relevant transactions during the period are translated
 as described in b) and c) above.                                                                                                                                                                                                                    
|         |                                         |  |                                                                                                                                                                                                                                                                     |                                                                                                                                                                                                                                                                                                                                                                                                                            
|         |                                         |  | e)                                                                                                                                                                                                                                                                  | All
 translation differences are recorded as a separate item in shareholders
 equity (foreign currency translation adjustments of foreign operations).                                                                                                                                                                                                                                                                  
|         |                                         |  |                                                                                                                                                                                                                                                                     |                                                                                                                                                                                                                                                                                                                                                                                                                            
|         |                                         |  | The Company
 does not expect the adoption of Accounting Standard No. 13 (Revised) will
 have material impact on its financial statements.                                                                                                                          

F-60

---



|                                                           |                                  
|---------------------------------------------------------- | ---------------------------------
|                                                           | NATURAL SPEECH COMMUNICATION LTD.
|                                                           |                                  
|NOTES TO FINANCIAL STATEMENTS                              |                                  
|                                                          
|U.S. dollars in thousands, except share and per share data |                                  

|         |                       
|-------- | ----------------------
|NOTE 3:- | PROPERTY AND EQUIPMENT

|                                   |  |              |       |      |   |       | 
|---------------------------------- |  | ------------ | ----- | ---- | - | ----- | 
|                                   |  | December 31, |      
|                                   |  |              |      
|                                   |  | 2007         |       | 2006 |  
|                                   |  |              |       |      |  
|Cost:                              |  |              |       |      |   |       | 
|Computers and peripheral equipment |  | $            | 1,096 |      | $ | 770   | 
|Office furniture and equipment     |  |              | 253   |      |   | 243   | 
|Leasehold improvements             |  |              | 176   |      |   | 154   | 
|                                   |  |              |       |      |   |       | 
|                                   |  |              |       |      |   |       | 
|                                   |  |              | 1,525 |      |   | 1,167 | 
|                                   |  |              |       |      |   |       | 
|Accumulated
 depreciation:         |  |              |       |      |   |       | 
|Computers and peripheral equipment |  |              | 735   |      |   | 678   | 
|Office furniture and equipment     |  |              | 210   |      |   | 201   | 
|Leasehold improvements             |  |              | 136   |      |   | 126   | 
|                                   |  |              |       |      |   |       | 
|                                   |  |              |       |      |   |       | 
|                                   |  |              | 1,081 |      |   | 1,005 | 
|                                   |  |              |       |      |   |       | 
|                                   |  |              |       |      |   |       | 
|Depreciated
 cost                  |  | $            | 444   |      | $ | 162   | 
|                                   |  |              |       |      |   |       | 

|         |                                                                                                                                                                                                                                                                                                                                                            |             
|-------- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------
|NOTE 4:- | LONG-TERM LOANS FROM SHAREHOLDERS                                                                                                                                                                                                                                                                                                                         
|         |                                                                                                                                                                                                                                                                                                                                                            |             
|         | During the
 first quarter of 2007, the Company entered into a loan conversion and
 investment agreement with its shareholders. According to the agreement, the
 loans, in the amount of $ 1,350, which were received in U.S. dollars during
 2005, bear no interest and have unidentified payment date, were converted to
 Preferred F1 (see also Note 7).
|         |                                                                                                                                                                                                                                                                                                                                                            |             
|NOTE 5:- | ACCRUED SEVERANCE PAY                                                                                                                                                                                                                                                                                                                                     
|         |                                                                                                                                                                                                                                                                                                                                                            |             
|         | a.                                                                                                                                                                                                                                                                                                                                                         | Composition:

|                            |  |              |    |      |   |    | 
|--------------------------- |  | ------------ | -- | ---- | - | -- | 
|                            |  | December 31, |   
|                            |  |              |   
|                            |  | 2007         |    | 2006 |  
|                            |  |              |    |      |  
|                            |  |              |    |      |   |    | 
|Accrued
 severance pay, net |  | $            | 74 |      | $ | 45 | 
|                            |  |              |    |      |   |    | 

| |    |                                                                                                                                                                                                                                                                                                                                
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | b. | According to
 Israeli GAAP, the severance pay liability is measured based on the employees
 latest monthly salary multiplied by the number of years of employment as of
 each balance sheet date, based on the shut down method, and severance pay
 funds are measured at their redemption value at each balance sheet date.

F-61

---



|                                                           |                                  
|---------------------------------------------------------- | ---------------------------------
|                                                           | NATURAL SPEECH COMMUNICATION LTD.
|                                                           |                                  
|NOTES TO FINANCIAL STATEMENTS                              |                                  
|                                                          
|U.S. dollars in thousands, except share and per share data |                                  

|         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |                
|-------- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ---------------
|NOTE 6:- | COMMITMENTS AND CONTINGENT LIABILITIES                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |                
|         | The Company
 participated in programs sponsored by the Israeli Government for the support
 of research and development activities. The Company had obtained grants from
 the Office of the Chief Scientist at Israels Ministry of Industry, Trade and
 Labor (the OCS) aggregating to $ 3,239 for certain of the Companys
 development projects. The Company is obligated to pay royalties to the OCS,
 amounting to 3% of the sales of the products and other related revenues
 generated from such projects, up to an amount equal to 100% of the grants
 received, linked to the U.S. dollar plus interest on the unpaid amount
 received based on the twelve month LIBOR rate applicable to dollar deposits.
|         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |                
|         | Royalties
 paid or accrued amounted to $ 65 and $ 11 in 2007 and 2006, respectively.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |                
|         | As of
 December 31, 2007, the Company has an outstanding contingent obligation to
 pay royalties (including accumulated interest) in the amount of $ 3,488.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |                
|NOTE 7:- | SHAREHOLDERS EQUITY (DEFICIENCY)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |                
|         | a.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   | Share
 capital:

|                                 |  |                     |           |                        |  |           |  |      |         |  |  |         | 
|-------------------------------- |  | ------------------- | --------- | ---------------------- |  | --------- |  | ---- | ------- |  |  | ------- | 
|                                 |  | Authorized          |           | Issued and outstanding | 
|                                 |  |                     |           |                        | 
|                                 |  | December 31,        |           | December 31,           | 
|                                 |  |                     |           |                        | 
|                                 |  | 2007                |           | 2006                   |  | 2007      |  | 2006 |        
|                                 |  |                     |           |                        |  |           |  |      |        
|                                 |  | Number of shares *) |          
|                                 |  |                     |          
|Shares of
 NIS 1 par value each: |  |                     |           |                        |  |           |  |      |         |  |  |         | 
|Ordinary
 shares (1)             |  |                     | 1,304,000 |                        |  | 684,000   |  |      | 3,299   |  |  | 3,299   | 
|Ordinary
 Class A shares (2)     |  |                     | 3,000     |                        |  | 3,000     |  |      | 200     |  |  | 200     | 
|Preferred A
 shares (3)          |  |                     | 2,500     |                        |  | 2,500     |  |      | 919     |  |  | 919     | 
|Preferred B
 shares (3)          |  |                     | 2,500     |                        |  | 2,500     |  |      | 983     |  |  | 983     | 
|Preferred C
 shares (3)          |  |                     | 1,500     |                        |  | 1,500     |  |      | 809     |  |  | 809     | 
|Preferred D
 shares (3)          |  |                     | 2,500     |                        |  | 2,500     |  |      | 1,863   |  |  | 1,863   | 
|Preferred E
 shares (3)          |  |                     | 4,000     |                        |  | 4,000     |  |      | 3,246   |  |  | 3,246   | 
|Preferred F
 shares (3)          |  |                     | 200,000   |                        |  | 200,000   |  |      | 94,381  |  |  | 94,381  | 
|Preferred F1
 shares (3)         |  |                     | 80,000    |                        |  |          |  |      | 75,000  |  |  |        | 
|Preferred G
 shares (3)          |  |                     | 100,000   |                        |  | 100,000   |  |      | 72,222  |  |  | 67,526  | 
|Preferred H
 shares (3)          |  |                     | 100,000   |                        |  |          |  |      | 34,736  |  |  |        | 
|Preferred I
 shares (3)          |  |                     | 200,000   |                        |  |          |  |      | 87,926  |  |  |        | 
|                                 |  |                     |           |                        |  |           |  |      |         |  |  |         | 
|                                 |  |                     |           |                        |  |           |  |      |         |  |  |         | 
|                                 |  |                     | 2,000,000 |                        |  | 1,000,000 |  |      | 375,584 |  |  | 173,226 | 
|                                 |  |                     |           |                        |  |           |  |      |         |  |  |         | 

| |     |                                                                                                                                                                                        
| | --- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | *)  | Each 100
 shares of NIS 0.01 par value were consolidated to one share of NIS 1 par
 value (see note 7c).                                                                               
|
| | (1) | Ordinary
 shares:                                                                                                                                                                      
| |     | The Ordinary
 shares confer upon the holders the right to receive notice to participate and
 vote in general meetings of the Company, and the right to receive dividends,
 if declared.

F-62

---



NATURAL SPEECH COMMUNICATION LTD.

|                                                          
|----------------------------------------------------------
|NOTES TO FINANCIAL STATEMENTS                             
|                                                          
|U.S. dollars in thousands, except share and per share data

|         |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                    |                                                                                                                                                                                                                                                                                                                                                                                                                                    
|-------- | ----------------------------------------- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 7:- | SHAREHOLDERS EQUITY (DEFICIENCY) (Cont.)
|         |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                    |                                                                                                                                                                                                                                                                                                                                                                                                                                    
|         |                                           | (2)                                                                                                                                                                                                                                                                                                                                                                                                                                | Ordinary
 Class A shares:                                                                                                                                                                                                                                                                                                                                                                                                          
|         |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                    |                                                                                                                                                                                                                                                                                                                                                                                                                                    
|         |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                    | Ordinary
 Class A shares confer upon their holders the right to participate in any
 distribution of dividends, bonus shares or any other distribution of assets
 of the Company. They do not confer upon their holders the right to vote
 and/or to participate in the general meetings of the Company. The Ordinary
 Class A shares are convertible into Ordinary shares, upon an IPO of the
 Company, on a one-for-one basis.    
|         |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                    |                                                                                                                                                                                                                                                                                                                                                                                                                                    
|         |                                           | (3)                                                                                                                                                                                                                                                                                                                                                                                                                                | Preferred
 shares:                                                                                                                                                                                                                                                                                                                                                                                                                 
|         |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                    |                                                                                                                                                                                                                                                                                                                                                                                                                                    
|         |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                    | The
 Preferred shares (A, B, C, D, E, F, F1,
G, H and I) have
 the same rights as the Ordinary shares. In addition, the shares are
 convertible into Ordinary shares and have a preference in liquidation. The
 Preferred shares are convertible, at the holders option, or upon an IPO of
 the Company, into Ordinary shares on a weighted average ratchet basis,
 according to the share purchase agreement.
|         |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                    |                                                                                                                                                                                                                                                                                                                                                                                                                                    
|         | b.                                        | In April
 2006, the Company entered into an investment agreement, according to which
 the Company should issue 72,222 Preferred G shares of NIS 1 par value each,
 for a total consideration of $1,300. As of December 31, 2006 the Company
 issued only 67,526 Preferred G shares and therefore recorded in additional
 paid in capital an amount of $84. During 2007 the Company issued the
 remaining 4,696 Preferred G shares.
|         |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                    |                                                                                                                                                                                                                                                                                                                                                                                                                                    
|         |                                           | During 2006
 the Company received from its shareholders payments on account of future
 investment agreement in the amount of $478. The payments were recorded as
 advances on account of shares.                                                                                                                                                                                                                                  
|         |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                    |                                                                                                                                                                                                                                                                                                                                                                                                                                    
|         |                                           | On January
 18, 2007, the Company entered into an investment agreement, according to
 which the Company issued 34,736 Preferred H shares of NIS 1 par value each,
 for a total consideration of $625. As part of Preferred H shares issuance the
 Company recorded advances on account of shares in the amount of $478 and
 received an additional amount of $147.                                                                
|         |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                    |                                                                                                                                                                                                                                                                                                                                                                                                                                    
|         |                                           | On January
 18, 2007, the Company entered into a loan conversion and investment
 agreement, according to which the Company issued 75,000 Preferred F1 shares
 of NIS 1 par value each, for a total consideration of $1,350. As part of the
 agreement, the Company converted long term loans from shareholders in the
 amount of $1,350 (see also Note 4).                                                                        
|         |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                    |                                                                                                                                                                                                                                                                                                                                                                                                                                    
|         |                                           | On April 26,
 2007, the Company entered into an investment agreement, according to which
 the Company should issue 88,889 Preferred I shares of NIS 1 par value each,
 for a total consideration of $800. As part of the issuance, the Company
 received $800 from its shareholders, net of issuance expenses in the amount
 of $4.                                                                                               
|         |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                    |                                                                                                                                                                                                                                                                                                                                                                                                                                    
|         |                                           | During 2007
 the Company received from its shareholders payments on account of future
 investment agreement in the amount of $730. The payments were recorded as
 advances on account of shares.                                                                                                                                                                                                                                  

F-63

---



NATURAL SPEECH COMMUNICATION LTD.

|                                                          
|----------------------------------------------------------
|NOTES TO FINANCIAL STATEMENTS                             
|                                                          
|U.S. dollars in thousands, except share and per share data

|         |                                           |                                                                                                                                                                                                                                                  
|-------- | ----------------------------------------- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 7:- | SHAREHOLDERS EQUITY (DEFICIENCY) (Cont.)
|         |                                          
|         | c.                                        | On April 26,
  2007, the Company approved a reverse split at a ratio of 100-to-1 of all
  shares (authorized and issued) included in these financial statements for all
  periods presented.                                                     
|         |                                           |                                                                                                                                                                                                                                                  
|         |                                           | Namely, each
  100 shares of NIS 0.01 par value shall be consolidated to one share of NIS 1
  par value.                                                                                                                                         
|         |                                           |                                                                                                                                                                                                                                                  
|         | d.                                        | On May 21,
  2007, the Company cancelled most of its outstanding employee stock options
  and granted new options. The Company accounted for these changes as
  modification in accordance with Accounting Standard No. 24.                      
|         |                                           |                                                                                                                                                                                                                                                  
|         | e.                                        | Stock option
  plans:                                                                                                                                                                                                                            
|         |                                           |                                                                                                                                                                                                                                                  
|         |                                           | On May 21,
  2007, the Companys 2002 option plan was cancelled.                                                                                                                                                                                 
|         |                                           |                                                                                                                                                                                                                                                  
|         |                                           | Under the
  Companys 2003 Stock Option Plan (the Plan), options may be granted to
  officers, directors and employees of the Company.                                                                                                         
|         |                                           |                                                                                                                                                                                                                                                  
|         |                                           | As of
  December 31, 2007, an aggregate of 9,849 Ordinary shares of the Company are
  still available for future grant.                                                                                                                          
|         |                                           |                                                                                                                                                                                                                                                  
|         |                                           | The options
  granted under the plan vest over a period of four years. The options expire
  no later than 10 years from the date of grant. Any options, which are
  forfeited or cancelled before expiration, become available for future grants.
|         |                                           |                                                                                                                                                                                                                                                  
|         |                                           | The fair
  value of each option is estimated on the date of grant using the Black &
  Scholes option valuation model that uses the assumptions noted in the
  following table:                                                                   

|                         |  |                                 |           |   | 
|------------------------ |  | ------------------------------- | --------- | - | 
|                         |  | Year ended
  December 31
  2007 |          
|                         |  |                                 |          
|                        
|Expected volatility      |  |                                 | 50        | % | 
|Expected dividends       |  |                                 | 0         | % | 
|Expected term (in years) |  |                                 | 3.04-6.25 |  
|Risk free interest       |  |                                 | 5         | % | 

| | As of
  December 31, 2007 the fair value of the Companys Ordinary shares was
  estimated in the amount of $0 per share, therefore, compensation expenses
  were not recorded.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F-64

---



|                                                          
|----------------------------------------------------------
|NATURAL SPEECH COMMUNICATION LTD.                         
|                                                          
|NOTES TO FINANCIAL STATEMENTS                             
|                                                          
|U.S. dollars in thousands, except share and per share data

|         |                                          
|-------- | -----------------------------------------
|NOTE 7:- | SHAREHOLDERS EQUITY (DEFICIENCY) (Cont.)

|                                         |  |                         |         |                                       |   |                                                                  |  |                     |      |                                       |  |                                                                 |   |   |    |  |  |      | 
|---------------------------------------- |  | ----------------------- | ------- | ------------------------------------- | - | ---------------------------------------------------------------- |  | ------------------- | ---- | ------------------------------------- |  | --------------------------------------------------------------- | - | - | -- |  |  | ---- | 
|                                         |  | Year ended December 31, |        
|                                         |  |                         |        
|                                         |  | 2007                    |         | 2006                                  |  
|                                         |  |                         |         |                                       |  
|                                         |  | Number
  of options     |         | Weighted
  average
  exercise
  price |   | Weighted
  average
  remaining
  contractual
  term (in
  years) |  | Number
  of options |      | Weighted
  average
  exercise
  price |  | Weighted
  average
  remaining
  contractual
  term (in
  years |  
|                                         |  |                         |         |                                       |   |                                                                  |  |                     |      |                                       |  |                                                                 |  
|Options outstanding at beginning of year |  |                         | 14,269  |                                       | $ | 41                                                               |  |                     |      |                                       |  | 15,620                                                          |   | $ | 43 |  |  |      | 
|Cancelled                                |  |                         | (13,026 | )                                     | $ | 41                                                               |  |                     |      |                                       |  |                                                                |   | $ |   |  |  |      | 
|Granted                                  |  |                         | 83,000  |                                       | $ | 11.68                                                            |  |                     | 9.39 |                                       |  |                                                                |   | $ |   |  |  |      | 
|Forfeited                                |  |                         | (1,043  | )                                     | $ | 42                                                               |  |                     |      |                                       |  | (1,351                                                          | ) | $ | 57 |  |  |      | 
|                                         |  |                         |         |                                       |   |                                                                  |  |                     |      |                                       |  |                                                                 |   |   |    |  |  |      | 
|                                         |  |                         |         |                                       |   |                                                                  |  |                     |      |                                       |  |                                                                 |   |   |    |  |  |      | 
|Options outstanding at end of year       |  |                         | 83,200  |                                       | $ | 11.66                                                            |  |                     | 9.39 |                                       |  | 14,269                                                          |   | $ | 41 |  |  | 7.4  | 
|                                         |  |                         |         |                                       |   |                                                                  |  |                     |      |                                       |  |                                                                 |   |   |    |  |  |      | 
|                                        
|Options exercisable at end of year       |  |                         | 35,868  |                                       | $ | 11.03                                                            |  |                     | 9.39 |                                       |  | 7,753                                                           |   | $ | 58 |  |  | 7.28 | 
|                                         |  |                         |         |                                       |   |                                                                  |  |                     |      |                                       |  |                                                                 |   |   |    |  |  |      | 

| |    |                                                                                                                
| | -- | ---------------------------------------------------------------------------------------------------------------
| | *) | Each 100
  shares of NIS 0.01 par value were consolidated to one share of NIS 1 par
  value (see also note 7c).

|         |              |                                                                                                                                                                                                                                                                                                                                                                                                                            
|-------- | ------------ | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|         | f.           | Warrants
  issued to customer:                                                                                                                                                                                                                                                                                                                                                                                             
|         |              |                                                                                                                                                                                                                                                                                                                                                                                                                            
|         |              | On January
  5, 2003, the Company entered into a commercial agreement, which regulated the
  relationship between the Company and a customer for a period of six years.                                                                                                                                                                                                                                                    
|         |              |                                                                                                                                                                                                                                                                                                                                                                                                                            
|         |              | As part of
  the agreement the customer will have the right to exercise a warrant to
  purchase 4,444 Preferred B shares at an exercise price equal to their par
  value, provided that the customer shall commercially launch a service to its
  subscribers based upon the Companys products, exercisable for a period of 12
  months from the date of launching the service, which has not yet commenced.              
|         |              |                                                                                                                                                                                                                                                                                                                                                                                                                            
|NOTE 8:- | INCOME TAXES
|         |             
|         | a.           | Measurement
  of taxable income under the Income Tax (Inflationary Adjustments) Law, 1985:                                                                                                                                                                                                                                                                                                                                 
|         |              |                                                                                                                                                                                                                                                                                                                                                                                                                            
|         |              | The Companys
  results for tax purposes are measured under the Income Tax (Inflationary
  Adjustments) Law, 1985, results for tax purposes are measured in real terms,
  in accordance with the changes in the Israeli Consumer Price Index (Israeli
  CPI). Accordingly, until 2004, results for tax purposes were measured in
  terms of earnings in NIS after certain adjustments for increases in the
  Israeli CPI.
|         |              |                                                                                                                                                                                                                                                                                                                                                                                                                            
|         | b.           | Corporate
  tax rates in Israel:                                                                                                                                                                                                                                                                                                                                                                                           
|         |              |                                                                                                                                                                                                                                                                                                                                                                                                                            
|         |              | Taxable
  income of Israeli companies is subject to tax at the rate of 29% in 2007, 27%
  in 2008, 26% in 2009 and 25% in 2010 and thereafter                                                                                                                                                                                                                                                                              

F-65

---



|                                                          
|----------------------------------------------------------
|NATURAL SPEECH COMMUNICATION LTD.                         
|                                                          
|NOTES TO FINANCIAL STATEMENTS                             
|                                                          
|U.S. dollars in thousands, except share and per share data

|         |                       |                                                                                                                                                                                                                                                            |                                                                                                                                                                                                                                                                                                                                                                   
|-------- | --------------------- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 8:- | INCOME TAXES (Cont.) 
|         |                      
|         | c.                    | Net
  operating losses carryforwards:                                                                                                                                                                                                                     
|         |                       |                                                                                                                                                                                                                                                           
|         |                       | The Company
  has accumulated net operating losses carryforward for tax purposes as of
  December 31, 2007, amounting to approximately $16,000, which may be carried
  forward and offset against taxable income in the future for an indefinite
  period.
|         |                       |                                                                                                                                                                                                                                                           
|NOTE 9:- | FINANCIAL INSTRUMENTS
|         |                      
|         | a.                    | Risks
  arising from financial instruments:                                                                                                                                                                                                               
|         |                       |                                                                                                                                                                                                                                                           
|         |                       | The Companys
  activities expose it to various financial risks such as market risk
  (including currency risk and other price risks) and credit risk.                                                                                                    
|         |                       |                                                                                                                                                                                                                                                           
|         |                       | 1.                                                                                                                                                                                                                                                         | Foreign
  currency exchange rate risk:                                                                                                                                                                                                                                                                                                                            
|         |                       |                                                                                                                                                                                                                                                            |                                                                                                                                                                                                                                                                                                                                                                   
|         |                       |                                                                                                                                                                                                                                                            | The Company
  operates in a number of countries and is exposed to foreign currency exchange
  rate risks resulting from the exposure to different currencies. Foreign
  currency exchange rate risks arise from recognized assets and liabilities
  denominated in a currency other than the functional currency and net
  investments in foreign operations.     
|         |                       |                                                                                                                                                                                                                                                            |                                                                                                                                                                                                                                                                                                                                                                   
|         |                       | 2.                                                                                                                                                                                                                                                         | Credit risk:                                                                                                                                                                                                                                                                                                                                                      
|         |                       |                                                                                                                                                                                                                                                            |                                                                                                                                                                                                                                                                                                                                                                   
|         |                       |                                                                                                                                                                                                                                                            | The Company
  performs ongoing credit evaluations of its customers. An allowance for
  doubtful accounts is determined with respect to those amounts that the
  Company has determined to be doubtful of collection.                                                                                                                                              
|         |                       |                                                                                                                                                                                                                                                            |                                                                                                                                                                                                                                                                                                                                                                   
|         |                       | 3.                                                                                                                                                                                                                                                         | Cash flow
  risk in respect of interest rates:                                                                                                                                                                                                                                                                                                                    
|         |                       |                                                                                                                                                                                                                                                            |                                                                                                                                                                                                                                                                                                                                                                   
|         |                       |                                                                                                                                                                                                                                                            | The Company
  is exposed to risk in respect of changes in the market rate of interest. The
  Company is obligated to pay royalties to the OCS linked to the U.S. dollar
  plus interest on the unpaid amount received based on the twelve month LIBOR
  rate applicable to dollar deposits. The variable rates of interest expose the
  Company to cash flow risk.

F-66

---



NATURAL SPEECH COMMUNICATION LTD.

|                                                          
|----------------------------------------------------------
|NOTES TO FINANCIAL STATEMENTS                             
|                                                          
|U.S. dollars in thousands, except share and per share data

|          |                                               
|--------- | ----------------------------------------------
|NOTE 10:- | ADDITIONAL DISCLOSURE OF PROFIT AND LOSS ITEMS

|                                          |  |                         |       |      |   |       |  |   |       | 
|----------------------------------------- |  | ----------------------- | ----- | ---- | - | ----- |  | - | ----- | 
|                                          |  | Year ended December 31, |      
|                                          |  |                         |      
|                                          |  | 2007                    |       | 2006 |   | 2005  | 
|                                          |  |                         |       |      |   |       | 
|Revenues                                  |  |                         |       |      |   |       |  |   |       | 
|                                          |  |                         |       |      |   |       |  |   |       | 
|Revenues from sales                       |  | $                       | 1,123 |      | $ | 378   |  | $ | 691   | 
|                                          |  |                         |       |      |   |       |  |   |       | 
|                                          |  |                         |       |      |   |       |  |   |       | 
|                                          |  | $                       | 1,123 |      | $ | 378   |  | $ | 691   | 
|                                          |  |                         |       |      |   |       |  |   |       | 
|                                          |  |                         |       |      |   |       |  |   |       | 
|Cost of revenues                          |  |                         |       |      |   |       |  |   |       | 
|                                          |  |                         |       |      |   |       |  |   |       | 
|Cost of revenues from sales               |  | $                       | 230   |      | $ | 62    |  | $ | 90    | 
|                                          |  |                         |       |      |   |       |  |   |       | 
|                                          |  |                         |       |      |   |       |  |   |       | 
|                                          |  | $                       | 230   |      | $ | 62    |  | $ | 90    | 
|                                          |  |                         |       |      |   |       |  |   |       | 
|                                          |  |                         |       |      |   |       |  |   |       | 
|Research and development expenses         |  |                         |       |      |   |       |  |   |       | 
|                                          |  |                         |       |      |   |       |  |   |       | 
|Salaries and related expenses             |  | $                       | 1,050 |      | $ | 822   |  | $ | 864   | 
|Subcontractors                            |  |                         | 174   |      |   | 35    |  |   | 59    | 
|Car rental and maintenance                |  |                         | 100   |      |   | 96    |  |   | 102   | 
|Other expenses                            |  |                         | 175   |      |   | 131   |  |   | 208   | 
|                                          |  |                         |       |      |   |       |  |   |       | 
|                                          |  |                         |       |      |   |       |  |   |       | 
|Total research and development expenses   |  | $                       | 1,499 |      | $ | 1,084 |  | $ | 1,233 | 
|                                          |  |                         |       |      |   |       |  |   |       | 
|                                          |  |                         |       |      |   |       |  |   |       | 
|Sales and marketing expenses              |  |                         |       |      |   |       |  |   |       | 
|                                          |  |                         |       |      |   |       |  |   |       | 
|Salaries and related expenses             |  | $                       | 469   |      | $ | 318   |  | $ | 321   | 
|Subcontractors                            |  |                         | 101   |      |   | 201   |  |   | 239   | 
|Travel expenses                           |  |                         | 43    |      |   | 68    |  |   | 43    | 
|Car rental and maintenance                |  |                         | 56    |      |   | 46    |  |   | 41    | 
|Other expenses                            |  |                         | 87    |      |   | 88    |  |   | 89    | 
|                                          |  |                         |       |      |   |       |  |   |       | 
|                                          |  |                         |       |      |   |       |  |   |       | 
|Total sales and marketing expenses        |  | $                       | 756   |      | $ | 721   |  | $ | 733   | 
|                                          |  |                         |       |      |   |       |  |   |       | 
|                                          |  |                         |       |      |   |       |  |   |       | 
|General and administrative expenses       |  |                         |       |      |   |       |  |   |       | 
|                                          |  |                         |       |      |   |       |  |   |       | 
|Salaries and related expenses             |  | $                       | 174   |      | $ | 113   |  | $ | 114   | 
|Consultancy and professional fees         |  |                         | 60    |      |   | 24    |  |   | 32    | 
|Others expenses                           |  |                         | 114   |      |   | 121   |  |   | 63    | 
|                                          |  |                         |       |      |   |       |  |   |       | 
|                                          |  |                         |       |      |   |       |  |   |       | 
|Total general and administrative expenses |  | $                       | 348   |      | $ | 258   |  | $ | 209   | 
|                                          |  |                         |       |      |   |       |  |   |       | 

F-67

---



NATURAL SPEECH COMMUNICATION LTD.

|                                                          
|----------------------------------------------------------
|NOTES TO FINANCIAL STATEMENTS                             
|                                                          
|U.S. dollars in thousands, except share and per share data

|          |                                                                                                                                                                                                                                                                                                                                                                                                                                   
|--------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 11:- | DISCLOSURE OF RECONCILIATION TO US GAAP                                                                                                                                                                                                                                                                                                                                                                                           
|          |                                                                                                                                                                                                                                                                                                                                                                                                                                   
|          | There were
  no adjustments required to the net loss for each of the three years ended
  December 31, 2007.                                                                                                                                                                                                                                                                                                                       
|          |                                                                                                                                                                                                                                                                                                                                                                                                                                   
|NOTE 12:- | SUBSEQUENT EVENT                                                                                                                                                                                                                                                                                                                                                                                                                  
|          |                                                                                                                                                                                                                                                                                                                                                                                                                                   
|          | On October
  11, 2007, the Company entered into an investment agreement, according to
  which the Company should issue 93,257 Preferred I shares of NIS 1 par value
  each, for a total consideration of $839. An amount of $730 was recorded as
  advances on account of shares during 2007 (See also note 7b). During January
  2008, the Company received from its shareholders the remaining payments in
  the amount of $109.

|
|
|

F-68


---



EXHIBIT INDEX

|            |  |                                                                                                                                                       
|----------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |  | Exhibit                                                                                                                                               
|            |  |                                                                                                                                                       
|            |  |                                                                                                                                                       
|4.34        |  | Amendment
  No. 9 to OEM Purchase and Sale No. 011449 between AudioCodes Ltd. and Nortel
  Networks Ltd., dated as of October 30, 2007.#              
|            |  |                                                                                                                                                       
|4.35        |  | Letter
  Agreements, dated April 30, 2008 between First International Bank of Israel,
  as lender, and AudioCodes Ltd., as borrower.                 
|            |  |                                                                                                                                                       
|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.
|            |  |                                                                                                                                                       
|15.1        |  | Consent of
  Kost Forer and Gabbay & Kasierer, a member of Ernst & Young Global.                                                                      
|            |  |                                                                                                                                                       
|15.2        |  | Consent of Squar, Milner, Peterson, Miranda and Williamson, LLP.                                                                                      

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

---