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UNITED STATES
SECURITIES AND EXCHANGE COMMISSIONWASHINGTON, D.C. 20549

FORM 20F

|   |                                                                                                 
|-- | ------------------------------------------------------------------------------------------------
|o  | REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF
  THE SECURITIES EXCHANGE ACT OF 1934
|   |                                                                                                 
|OR
|   |                                                                                                 
|x  | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
  SECURITIES EXCHANGE ACT OF 1934          
|   |                                                                                                 
|   | For the fiscal year ended December 31, 2005                                                     
|   |                                                                                                 
|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
  None                                                      |  | Name
  of each exchange on which registered
|                                                                                  |  |                                            
|                                                                                  |  |                                            
|Securities
  registered or to be registered pursuant to Section 12(g) of the Act:

|                                                                                              
|----------------------------------------------------------------------------------------------
|Ordinary Shares, nominal value NIS 0.01 per share                                             
|                                                                                              
|(Title of Class)                                                                              
|                                                                                              
|Securities
  for which there is a reporting obligation pursuant to Section 15(d) of the
  Act:
|                                                                                              
|None                                                                                          
|                                                                                              
|(Title of Class)                                                                              

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

As
of December 31, 2005, the Registrant had outstanding 40,587,804 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:

YesoNox

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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 oNo 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 xNo 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.

Large
Accelerated filer oAccelerated
filer xNon-accelerated
filer o

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

Item 17 o   Item 18 x

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 oNo
x

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PART I

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

|   |                         |                                                      
|-- | ----------------------- | -----------------------------------------------------
|   | ITEM 1.                 | IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS
|   |                         |                                                      
|   | Not
  applicable.      
|   |                         |                                                      
|   | ITEM 2.                 | OFFER STATISTICS AND EXPECTED TIMETABLE              
|   |                         |                                                      
|   | Not
  applicable.      
|   |                         |                                                      
|   | ITEM 3.                 | KEY INFORMATION                                      
|   |                         |                                                      
|A. | SELECTED FINANCIAL DATA

We
derived the consolidated statements of operations data for the years ended
December 31, 2003, 2004 and 2005 and consolidated balance sheets data as of
December 31, 2004 and 2005 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, 2001 and 2002
and the consolidated balance sheets data as of December 31, 2001, 2002 and 2003
from audited consolidated financial statements that are not included in this
Annual Report.

---

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

|                                                                                                        |  |                           |         |      |   |         |   |      |        |      |   |        |  |   |         | 
|------------------------------------------------------------------------------------------------------- |  | ------------------------- | ------- | ---- | - | ------- | - | ---- | ------ | ---- | - | ------ |  | - | ------- | 
|                                                                                                        |  | Year Ended
  December 31, |        
|                                                                                                        |  |                           |        
|                                                                                                        |  | 2001                      |         | 2002 |   | 2003    |   | 2004 |        | 2005 |  
|                                                                                                        |  |                           |         |      |   |         |   |      |        |      |  
|Statement of Operations Data:                                                                           |  |                           |         |      |   |         |   |      |        |      |   |        |  |   |         | 
|Revenues                                                                                                |  | $                         | 35,734  |      | $ | 27,189  |   | $    | 44,228 |      | $ | 82,756 |  | $ | 115,827 | 
|Cost
  of revenues                                                                                      |  |                           | 21,942  |      |   | 13,006  |   |      | 20,037 |      |   | 34,375 |  |   | 46,993  | 
|                                                                                                        |  |                           |         |      |   |         |   |      |        |      |   |        |  |   |         | 
|Gross
  profit                                                                                          |  |                           | 13,792  |      |   | 14,183  |   |      | 24,191 |      |   | 48,381 |  |   | 68,834  | 
|Operating
  expense:                                                                                    |  |                           |         |      |   |         |   |      |        |      |   |        |  |   |         | 
|Research
  and development, net                                                                         |  |                           | 13,807  |      |   | 13,022  |   |      | 15,476 |      |   | 20,009 |  |   | 24,415  | 
|Selling
  and marketing                                                                                 |  |                           | 13,852  |      |   | 14,288  |   |      | 14,537 |      |   | 19,891 |  |   | 25,944  | 
|General
  and administrative                                                                            |  |                           | 5,044   |      |   | 3,353   |   |      | 4,066  |      |   | 4,851  |  |   | 6,004   | 
|                                                                                                        |  |                           |         |      |   |         |   |      |        |      |   |        |  |   |         | 
|Total
  operating expenses                                                                              |  |                           | 32,703  |      |   | 30,663  |   |      | 34,079 |      |   | 44,751 |  |   | 56,363  | 
|                                                                                                        |  |                           |         |      |   |         |   |      |        |      |   |        |  |   |         | 
|Operating
  income (loss)                                                                               |  |                           | (18,911 | )    |   | (16,480 | ) |      | (9,888 | )    |   | 3,630  |  |   | 12,471  | 
|Financial
  income, net                                                                                 |  |                           | 6,388   |      |   | 2,623   |   |      | 1,883  |      |   | 2,165  |  |   | 2,457   | 
|Equity
  in losses of affiliated companies                                                              |  |                           | 750     |      |   | 300     |   |      | 429    |      |   | 516    |  |   | 693     | 
|                                                                                                        |  |                           |         |      |   |         |   |      |        |      |   |        |  |   |         | 
|Income
  (loss) before taxes on income                                                                  |  |                           | (13,273 | )    |   | (14,157 | ) |      | (8,434 | )    |   | 5,279  |  |   | 14,235  | 
|Taxes
  on income                                                                                       |  |                           | -       |      |   | -       |   |      | -      |      |   | 273    |  |   | 799     | 
|                                                                                                        |  |                           |         |      |   |         |   |      |        |      |   |        |  |   |         | 
|Net
  income (loss)                                                                                     |  | $                         | (13,273 | )    | $ | (14,157 | ) | $    | (8,434 | )    | $ | 5,006  |  | $ | 13,436  | 
|                                                                                                        |  |                           |         |      |   |         |   |      |        |      |   |        |  |   |         | 
|Basic
  net earnings (loss) per share                                                                   |  | $                         | (0.34   | )    | $ | (0.37   | ) | $    | (0.22  | )    | $ | 0.13   |  | $ | 0.33    | 
|                                                                                                        |  |                           |         |      |   |         |   |      |        |      |   |        |  |   |         | 
|Diluted
  net earnings (loss) per share                                                                 |  | $                         | (0.34   | )    | $ | (0.37   | ) | $    | (0.22  | )    | $ | 0.12   |  | $ | 0.31    | 
|                                                                                                        |  |                           |         |      |   |         |   |      |        |      |   |        |  |   |         | 
|Weighted
  average number of ordinary of shares used in computing basic net earnings
  (loss) per share |  |                           | 39,591  |      |   | 38,518  |   |      | 37,509 |      |   | 38,614 |  |   | 40,296  | 
|                                                                                                        |  |                           |         |      |   |         |   |      |        |      |   |        |  |   |         | 
|Weighted
  average number of ordinary shares used in computing diluted net earnings per
  share         |  |                           | 39,591  |      |   | 38,518  |   |      | 37,509 |      |   | 42,607 |  |   | 43,086  | 
|                                                                                                        |  |                           |         |      |   |         |   |      |        |      |   |        |  |   |         | 

|                                                                                         |  |              |         |      |   |         |  |      |         |      |   |         |  |   |         | 
|---------------------------------------------------------------------------------------- |  | ------------ | ------- | ---- | - | ------- |  | ---- | ------- | ---- | - | ------- |  | - | ------- | 
|                                                                                         |  | December 31, |        
|                                                                                         |  |              |        
|                                                                                         |  | 2001         |         | 2002 |   | 2003    |  | 2004 |         | 2005 |  
|                                                                                         |  |              |         |      |   |         |  |      |         |      |  
|Balance Sheet Data:                                                                      |  |              |         |      |   |         |  |      |         |      |   |         |  |   |         | 
|Cash and cash equivalents                                                                |  | $            | 50,086  |      | $ | 47,799  |  | $    | 48,898  |      | $ | 166,832 |  | $ | 70,957  | 
|Short-term bank deposits,
  structured notes, marketable securities and accrued interest |  |              | 79,984  |      |   | 63,074  |  |      | -       |      |   | -       |  |   | 71,792  | 
|Working capital                                                                          |  |              | 126,242 |      |   | 108,370 |  |      | 46,232  |      |   | 171,447 |  |   | 150,798 | 
|Long-term
  bank deposits, structured notes and marketable securities                    |  |              | -       |      |   | -       |  |      | 50,270  |      |   | 50,195  |  |   | 77,572  | 
|Total assets                                                                             |  |              | 148,416 |      |   | 129,814 |  |      | 128,530 |      |   | 272,145 |  |   | 292,223 | 
|Senior convertible notes                                                                 |  |              | -       |      |   | -       |  |      | -       |      |   | 120,660 |  |   | 120,836 | 
|Total shareholders equity                                                               |  |              | 131,255 |      |   | 113,384 |  |      | 106,518 |      |   | 121,985 |  |   | 139,106 | 
|Capital stock                                                                            |  |              | 113,998 |      |   | 114,755 |  |      | 116,639 |      |   | 126,826 |  |   | 130,744 | 

-2-

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

Risks Related to Our
Business and Industry

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

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

The slowdown in capital expenditures by
telecommunications service providers in prior years had a material adverse
effect on our results of operations. Another down turn in technology spending
could have a material adverse effect on our results of operations.

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

-3-

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

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

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

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

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

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

-4-

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

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

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

Historically,
a substantial portion of our revenue has been derived from large purchases by a
small number of OEMs and network equipment providers, systems integrators and
distributors. For example, our top three customers accounted for approximately
24.8% of our revenues in 2005, 29.0% of our revenues in 2004 and 26.9% of our
revenues in 2003. Sales to Nortel
Networks accounted for 16.3% of our revenues in 2005 compared to 18.6% of our
revenues in 2004 and 14.3% of our revenues in 2003. We do not enter into
sales agreements in which the customer is obligated to purchase a set quantity
of our products. Based on our experience, we expect that our customer base may
change from period to period. If we lose a large customer and fail to add new
customers there could be a material adverse effect on our results of
operations.

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

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

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

| |   |                                                                                       
| | - | --------------------------------------------------------------------------------------
| |  | size, timing
  and pricing of orders, including order deferrals and delayed shipments;
| |   |                                                                                       
| |  | launching of
  new product generations;                                               
| |   |                                                                                       
| |  | length of
  approval processes or market testing;                                     
| |   |                                                                                       
| |  | technological
  changes in the telecommunications industry;                           

-5-

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| |   |                                                                                                                          
| | - | -------------------------------------------------------------------------------------------------------------------------
| |  | competitive
  pricing pressures;                                                                                         
| |   |                                                                                                                          
| |  | the timing
  and approval of government research and development grants;                                                 
| |   |                                                                                                                          
| |  | accuracy of
  telephone company, distributor and original equipment manufacturer forecasts
  of their customers demands;
| |   |                                                                                                                          
| |  | changes in
  our operating expenses;                                                                                     
| |   |                                                                                                                          
| |  | disruption
  in our sources of supply; and                                                                               
| |   |                                                                                                                          
| |  | general
  economic conditions.                                                                                           

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

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

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

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

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

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

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

-6-

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Our
principal competitors in the sale of signal processing chips are Texas
Instruments, Broadcom, Infineon, Centillium and Mindspeed. Several large
manufacturers of generic signal processors, such as Motorola, Agere Systems 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.

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, Lucent, Alcatel, Siemens, Huawei, Ericsson, UTstarcom, ZTE and from
Cisco Systems, Veraz Networks, Sonus Networks, Tekelec, General Bandwidth,
Telica and Commatch.

Our
principal competitors in the media server market segment are Cantata
Technology, NMS Communications, Convedia, IP Unity, Cognitronics and Aculab. In
addition, we face competition in software-based and hardware-based media
servers from internal development at companies such as Nortel, Lucent, Siemens,
Motorola, Tekelec and Sonus Networks.

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

-7-

---

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

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

Offering to sell directly to carriers or
system operators 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.

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.

-8-

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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.

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

Our
customers expect us to maintain an inventory of products available for purchase
off the shelf subsequent to the initial sales cycle for these products. This
may require us to incur the costs of manufacturing inventory without having a
purchase order for the products. The VoP industry is subject to rapid
technological change and volatile customer demands, which result in a short
product commercial life before a product becomes obsolete. If we are unable to
sell products that
are produced to hold in inventory, we may incur write offs and write downs as a
result of slow moving items, technological obsolescence, excess inventories,
discontinued products and products with market prices lower than cost. Write
offs and write downs could adversely affect our operating results and financial
condition. We wrote off and wrote down inventory in the amount of $835,000 in
2003, $1.2 million in 2004 and $1.2 million in 2005.

-9-

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We are also facing pressure to deliver
through customer hubs and to deliver locally from warehouses in the U.S.

Some
of our U.S. customers have requested us to maintain an inventory of products in
the U.S. Some of these products held in inventory may be produced only for a
specific customer. Maintaining additional inventory in the U.S. requires us to
incur additional manufacturing costs and increases the risk that we will incur
inventory write offs. Holding in inventory products manufactured for a specific
customer results in additional warehouse and carrying costs and could result in
additional write-offs if that customer does not purchase inventory manufactured
specifically for it. If we are unable to sell inventory held in the U.S. that
was not manufactured for a specific customer, we may need to incur additional
shipping costs in order to sell the inventory in another country.

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

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

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

-10-

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

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.

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.

-11-

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

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

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

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

On
May 19, 2005, the FCC issued an order that requires interconnected VoIP service
providers to be able to deliver all 911 calls to the customers local emergency
operator. Interconnected providers are those companies that enable VoIP
customers to receive calls from and make calls to the traditional public switched
telephone network. The FCC also indicated that it would adopt rules in the
future that would require a method for determining the location of a VoIP
customer making a 911 call without the customer having to report this
information. VoIP service providers may have difficulties complying with this
order in the required time frame, as well as any future orders issued by the
FCC. Equipment and software manufacturers may have difficulty in complying with
new technical requirements.

On
May 3, 2006, the FCC issued an order that requires interconnected VoIP service
providers to be prepared to accommodate law enforcement wiretaps. The FCC found
that VoIP services are covered by the Communications Assistance for Law
Enforcement Act, or CALEA, which requires the FCC to preserve the ability of
law enforcement agencies to conduct court-ordered wiretaps in the face of
technological change. The FCC established a deadline of May 14, 2007 by which
covered VoIP service providers must be in full compliance with all relevant
CALEA requirements. VoIP service providers may have difficulties complying with
this order in the required time frame, as well as any future orders issued by
the FCC. Equipment and software manufacturers may have difficulty in complying
with new technical requirements.

-12-

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On
June 21, 2006, the FCC adopted a rule that requires VoIP service providers to
help subsidize services in rural and low-income areas. The FCC rule requires
contribution of 10.5% of a VoIP service providers long-distance revenue to the
universal service fund if such long-distance calls pass through traditional
phone networks.

The
cost of providing Internet phone service could increase as a result of these
actions by the FCC which could result in slower growth and decreased
profitability for this industry. The increase in regulation of VoIP services
and the increase in the cost of these services could adversely affect sales of
our products and adversely affect our results of operations.

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

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

Growth in
the demand for security features may increase the use of encryption technology
in our products. The use 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.

-13-

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We are subject to new
regulations that will require us to use components based on environmentally
friendly materials. Compliance with these regulations may increase our costs
and adversely affect our results of operations.

We
are affected by new telecommunications industry regulations requiring the use
of environmentally-friendly materials in telecommunications equipment. For
example, pursuant to a European Community directive, telecom equipment
suppliers are required to stop using specified materials that are not
environmentally friendly by July 1, 2006. In addition, telecom equipment
suppliers are required under this directive to eliminate the lead 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 lead from all components. We will be dependent on our suppliers for
components and sub-system modules, such as semiconductors and printed circuit
boards, to comply with these requirements. Some of our products may not comply
with this directive in 2006. We will attempt to comply with this directive in
2007. This may harm our ability to sell our products in the European Union and
in any other countries that may adopt this directive.

Compliance
with this directive, 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 addition, the incorporation of new components may
adversely affect equipment reliability and durability.

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 we use in our products that do not comply with these
regulations may decide to stop manufacturing these components prior to the July
2006 compliance date. Similarly, 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 28% of our revenues in 2004 and 32% of our revenues in 2005 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:

-14-

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| |   |                                                                 
| | - | ----------------------------------------------------------------
| |  | economic and political instability in foreign countries;        
| |   |                                                                 
| |  | staffing and managing foreign operations;                       
| |   |                                                                 
| |  | increased risk of collection; and                               
| |   |                                                                 
| |  | burdens that may be imposed by tariffs and other trade barriers.

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

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

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

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

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

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

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

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

-15-

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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.

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

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

The
success of our business also depends upon our continuing ability to attract and
retain other highly-qualified management, technical, sales and marketing
personnel. We need highly-qualified technical personnel who are capable of
developing technologies and products and providing the technical support
required by our customers. We are experiencing increasing competitive pressure
with respect to retaining and hiring employees in the high technology sector in
Israel, because technology-related businesses have resumed recruitment efforts
after the reduction in demand for these types of employees following the
slowdown in technology-related fields that began in 2001. If we fail to hire
and retain skilled employees, our business may be adversely affected.

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 2005 we invested in MailVision Ltd. and CTI Squared Ltd, and
increased our investment in Natural Speech Communication. In April 2003, we
purchased a product group from Nortel Networks and in May 2004 we purchased
Ai-Logix Inc., now known as AudioCodes USA Inc. We have recognized
losses from the investment in Natural Speech Communication in our results of
operations in each of the past three years.

-16-

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On May 16,
2006, we entered into an agreement to acquire Nuera Communications Inc., or
Nuera, for $85 million in cash, subject to reduction for certain expenses, plus
an earn out arrangement under which we have agreed to pay up to an additional
$5 million if Nuera achieves certain revenue milestones during the first 12
months following consummation of the transaction. Nuera provides Voice over Internet
Protocal (VoIP) infrastructure solutions for broadband and long distance
networks. This transaction is significantly larger than our other acquisitions
and investments to date. If all of the conditions to the transaction are
satisfied and it is completed, 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.

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. As Nuera is significantly larger
than any other acquisition we have made, there is likely to be a greater
diversion of managements time and resources in connection with the
consummation of this transaction and subsequent integration and operation of
Nueras business. Acquired businesses, technologies or joint ventures may not
be successfully integrated with our products and operations. We may not realize
the intended benefits of any acquisition, investment or joint venture and we
may incur future 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; and
| |   |                                                                        
| |  | write-offs
  of in-process research and development.                   

If
acquisitions disrupt our operations, our business may suffer.

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

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

-17-

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

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

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

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

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

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

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

-18-

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

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

We have not yet evaluated our internal
controls over financial reporting in compliance with Section 404 of the
Sarbanes-Oxley Act.

We
are required to comply with the internal control evaluation and certification
requirements of Section 404 of the Sarbanes-Oxley Act by no later than the end
of our 2006 fiscal year. We are in the
process of determining whether our existing internal controls over financial
reporting systems are compliant with Section 404. This process may divert
internal resources and will take a significant amount of time and effort to
complete. If it is determined that we are not in compliance with Section 404,
we may be required to implement new internal control procedures and reevaluate
our financial reporting. We may experience higher than anticipated operating
expenses as well as higher independent auditor fees during the implementation
of these changes and thereafter. Further, we may need to hire additional
qualified personnel in order for us to be compliant with Section 404. If we are
unable to implement these changes effectively or efficiently, it could harm our
operations, financial reporting or financial results and could result in our
being unable to obtain an unqualified report on internal controls from our
independent auditors.

Risks Relating to Operations in Israel

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

We
are incorporated under the laws of the State of Israel, and our principal
offices are located in the State of Israel. Political, economic and military
conditions in Israel directly affect our operations. Terrorist attacks against
Israel have greatly intensified since September 2000, which have led to ongoing
hostilities between Israel, the Palestinian Authority and other groups in the
West Bank and Gaza Strip. The future of relations between the Palestinian
Authority and Israel is uncertain. In January 2006, Hamas, an Islamic movement
responsible for many attacks against Israelis, won the majority of the seats in
the Parliament of the Palestinian Authority. The election of a majority of
Hamas-supported candidates is expected to be a major obstacle to relations
between Israel and the Palestinian Authority, as well as to the stability in
the Middle East as a whole.

-19-

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We
cannot predict the effect on us of an increase in these hostilities or any
future armed conflict, political instability or violence in the region. Some of
our officers and employees in Israel are obligated to perform up to 36 days of
military reserve duty annually and are subject to being called for additional
active duty under emergency circumstances. We cannot predict the full impact of
these conditions on us in the future, particularly if emergency circumstances
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.

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

A
substantial portion of the cost of our Israeli operations, mainly personnel and
facility-related, is incurred in New Israeli Shekels (NIS). In 2005,
approximately 35% of our costs were incurred in NIS. As a result, we bear the
risk that the rate of inflation in Israel will exceed the rate of devaluation
of the New Israeli Shekel in relation to the dollar or that the timing of such
devaluations were to lag considerably behind inflation, which will increase our
costs as expressed in dollars.

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

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

We
benefit from certain government programs and tax benefits, particularly as a
result of exemptions and reductions resulting from the approved enterprise
status of our existing production facilities and programs in Israel. 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.

On
April 1, 2005, an amendment to the law came into effect (the Amendment) which
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 Beneficiary Enterprise, such as
provisions generally requiring that at least 25% of the Beneficiary
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.

-20-

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In
addition, the law provides that terms and benefits included in any certificate
of approval already granted 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.

In
2005, we recognized a grant of $417,000 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. A
recent 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.

-21-

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

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. Israeli courts may refuse to
hear a claim based on a violation of U.S. securities laws because Israel is not
the most appropriate forum to bring such a claim. In addition, even if an
Israeli court agrees to hear a claim, it may determine that Israeli law and not
U.S. law is applicable to the claim. If U.S. law is found to be applicable, the
content of applicable U.S. law must be proved as a fact which can be a
time-consuming and costly process. Certain matters of procedure will also be
governed by Israeli law. There is little binding case law in Israel addressing
these matters. Additionally, there is doubt as to the enforceability of civil
liabilities under the Securities Act and the Securities Exchange Act in
original actions instituted in Israel.

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

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

Risks Relating to
our Ordinary Shares and our Notes

The price of our ordinary shares may
fluctuate significantly.

The
market price for our ordinary shares, as well as the prices of shares of other
technology companies, has been volatile. Between January 1, 2004 and June 16,
2006, our share price has fluctuated from a low of $8.48 to a high of $17.00
The following factors may cause significant fluctuations in the market price of
our ordinary shares:

| |   |                                                                                          
| | - | -----------------------------------------------------------------------------------------
| |  | fluctuations
  in our quarterly revenues and earnings or those of our competitors;       
| |   |                                                                                          
| |  | shortfalls
  in our operating results compared to levels forecast by securities analysts;
| |   |                                                                                          
| |  | announcements
  concerning us, our competitors or telephone companies;                   

-22-

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| |   |                                                                                                      
| | - | -----------------------------------------------------------------------------------------------------
| |  | announcements
  of technological innovations;                                                        
| |   |                                                                                                      
| |  | the introduction
  of new products;                                                                  
| |   |                                                                                                      
| |  | changes in
  product price policies involving us or our competitors;                                 
| |   |                                                                                                      
| |  | market
  conditions in the industry;                                                                 
| |   |                                                                                                      
| |  | the
  conditions of the securities markets, particularly in the technology and
  Israeli sectors; and
| |   |                                                                                                      
| |  | political,
  economic and other developments in the State of Israel and worldwide.                   

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

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

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

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 Stock 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.

-23-

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

Our
notes are 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 June 16, 2006,
our existing subsidiaries had no outstanding indebtedness (excluding
intercompany debt and other liabilities).

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

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

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

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

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

| |   |                                                                                                                                                                                                                                                                                 
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | requiring
  the dedication of a portion of our expected cash flow to service our
  indebtedness, thereby reducing the amount of our expected cash flow available
  for other purposes, including funding our research and development programs
  and other capital expenditures;
| |   |                                                                                                                                                                                                                                                                                 
| |  | increasing
  our vulnerability to general adverse economic conditions;                                                                                                                                                                                                          
| |   |                                                                                                                                                                                                                                                                                 
| |  | limiting our
  ability to obtain additional financing; and                                                                                                                                                                                                                      

-24-

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

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

| |   |                                             
| | - | --------------------------------------------
| |  | reducing our
  operating expenses;          
| |   |                                             
| |  | reducing or
  delaying capital expenditures;
| |   |                                             
| |  | selling
  assets; or                        
| |   |                                             
| |  | raising
  additional equity capital.        

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

-25-

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

On
November 9, 2009, November 9, 2014 or November 9, 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.

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

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

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

Based
on the composition of our gross income and the composition and value of our
gross assets during 2004 and 2005, we do not believe that we would be treated
as a passive foreign investment company (PFIC) for U.S. federal income tax
purposes for either the 2004 or 2005 tax year.While it is possible that we
would have been classified as a PFIC in 2001, 2002 and 2003, there can be no
assurance that we will not be treated as a PFIC in any future tax year. If we
are a PFIC for any tax year, U.S. shareholders who owned our ordinary shares
during such year may be subject to increased United States federal income tax
liabilities and reporting requirements for such year and succeeding years, even
if we are no longer a PFIC in such succeeding years. We urge U.S. holders of
our ordinary shares to review Item 10E.  Taxation  United States Tax Considerations
 United States Federal Income Taxes  Passive Foreign Investment Company
Status in this Annual Report and to consult their own tax advisors with
respect to the U.S. federal income tax consequences of an investment in our
ordinary shares.

-26-

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

Major Developments since January 1, 2005

Agreement
to Acquire Nuera Communications Inc.

On May 16,
2006, we entered into an Agreement and Plan of Merger with Nuera
Communications, Inc., or Nuera, a leading provider of Voice over
Internet Protocol, or VoIP, infrastructure solutions for broadband and long
distance networks. Nuera, which is headquartered in San Diego, California,
designs, manufactures and sells packet voice gateways to communication service
providers worldwide. Its products work over a variety of media (cable,
wireless, copper and fiber). Nueras Open Reliable Communications Architecture,
or ORCA, product portfolio of VoIP gateways, softswitches and management
systems provide telephony solutions for cable and digital subscriber line, or
DSL, networks, international long distance networks and enterprise networks.
Nuera has a broad client base in North America as well as in Asia and Europe.
Nuera is headquartered in San Diego, California.

The
consideration for the transaction will consist of $85 million in cash, subject
to reduction for certain expenses, plus an earn out arrangement under which we
have agreed to pay up to an additional $5 million if Nuera achieves certain
revenue milestones during the first 12 months after consummation of the
transaction. There
will be an escrow of $7.5 million of the purchase price paid at closing for a
period of one year following closing, to secure up to $7.5 million of certain
indemnification obligations under the merger agreement. Upon the consummation
of the merger, Nuera will become a wholly-owned subsidiary of AudioCodes USA.

The
transaction is subject to customary conditions for transactions of this nature,
including antitrust clearance under the Hart-Scott-Rodino Antitrust Improvement
Act and other regulatory approvals. If these conditions are satisfied, the
transaction is expected to be consummated early in the third quarter of 2006.
The transaction has been approved by our board of directors and by the board of
directors and stockholders of Nuera. We cannot
be sure that the acquisition of Nuera will be consummated when
anticipated or at all.

Other Recent
Developments

Acquisition
of AudioCodes USA Inc (formerly called Ai-Logix Inc.)

In
May, 2004, we acquired all of the outstanding shares of capital stock of
Ai-Logix Inc., now known as AudioCodes USA,
a leading provider of advanced voice recording hardware technology
located in Somerset, New Jersey.

-27-

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

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

Acquisition
of UAS

In
April 2003, we purchased from Nortel Networks Limited selected assets of its
Universal Audio Server business, or UAS. As part of the transaction, Nortel
Networks granted to us a license to use its UAS technology. We undertook to act
as an exclusive supplier to Nortel Networks for its UAS products over a period
of three years that ended in April 2006.

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

Sale
of Our 2.00% Senior Convertible Notes Due 2024

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

-28-

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

Introduction

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

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

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

Our
products consist of:

| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Signal
  processor chips, which process voice, data and fax signals and compress this
  information into packets so that it can be sent between traditional telephone
  networks and packet networks.                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| |  | Communications
  boards and modules for communication system products that are deployed on
  both access networks and enterprise networks. The carrier network
  applications for these boards and modules include media gateways, which
  terminate calls from the Public Switched Telephone Network (PSTN), packetize
  and compress the call and then switch the call to the packet network, and
  vice-versa. The enterprise applications for these products include Computer
  Telephony Integration (CTI) deployments for contact centers, providing call
  logging and recording utilizing either industry standard or proprietary
  protocols.                   
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| |  | System
  products, including media servers and media gateways, for access networks,
  trunking applications in carrier networks, and enterprise networks. These
  systems enable voice, data and fax to be transmitted over Internet and other
  protocols, and interface with third party equipment to facilitate the
  introduction of enhanced voice and data services. Media servers provide
  enhanced conferencing, multi-language announcement functionality, and other
  media server applications for voice over packet networks. Our media gateway
  products include low density analog media gateways and low, mid and high
  density digital media gateways.

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

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

| |   |                                                                                                                                                  
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------
| |  | telephony
  over packet networks based on Internet protocols or networks based on
  asynchronous transfer mode standards, known as ATM standards;
| |   |                                                                                                                                                  
| |  | telephony
  over the wireless or cable television infrastructure; and                                                                            
| |   |                                                                                                                                                  
| |  | telephone
  service over high speed modems operating over wireless links or data modems,
  known as digital subscriber line, or DSL, modems.     

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

Industry Background

Market Trends

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

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

-30-

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| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Emergence of packet networks and advances
  in networking technologies. Traditional voice communications networks were not designed to
  handle the dramatic increase in data traffic, the need for high-speed data
  communication and the need to serve a much larger number of users. As data
  traffic becomes the dominant factor in communications and as service
  providers begin to build and maintain converged networks for integrated voice
  and data services, a new generation of data-centric networks is being
  developed. This development has been enabled by a new generation of packet
  networking technologies. The capabilities to effectively carry voice and fax
  and preserve the quality of communications over these new networks have been
  made possible by the recent rapid advances in voice compression technologies,
  the advent of digital signal processing chips and new packet voice, fax and
  data networking technologies and protocols. The surge in data traffic has led
  to the need for new packet-based infrastructures. As a result, service
  providers are seeking to exploit the advances in high speed and packet voice
  networking technologies to build networks that are more cost effective than
  the traditional circuit-switched telephone networks.
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| |  | Competition in the telecommunications
  industry.
  Competitive local exchange carriers and alternative carriers are trying to
  penetrate the local telephone market with varying degrees of success by
  bypassing the incumbent local telephone company network through the use of
  emerging packet technologies in new functions like telephony transmission
  over cable networks and digital subscriber line networks. In addition, there
  is a growth of toll bypass service providers, who seek to use public or
  private networks in order to bypass incumbent networks. Although these new
  and traditional service providers are not our direct customers, they are
  creating market demand for equipment manufactured by our customers. The surge
  in data traffic and the growth in overall volume and capacity of
  infrastructures have also created a need for new infrastructure equipment that
  is capable of more efficient utilization of the available networks.                                                                                                                                                                                                                                                                                                                         
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| |  | New technologies. The expected extension of voice over
  packet technologies into wireless networks alongside the introduction of new
  wireless standards (referred to often as Second and Third Generations) and
  cable networks suggest a business opportunity for the deployment of such
  technologies and products in these market segments. It is possible that the
  introduction of Voice over Packet technologies into wireless and cable networks
  will then place pressure on the traditional circuit switch service providers
  to modernize their equipment so as to be able to compete with the new
  offerings, including price reductions of these alternative networks.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| |  | Provision of different services. As VoIP gains wide acceptance, service
  providers are looking for ways to differentiate themselves other than by
  offering cheaper services. This has led to the emergence of wide band
  vocoders that use a higher sampling rate than used in legacy TDM networks,
  allowing service providers to offer very high quality voice and music
  transmission over IP networks.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| |  | Broadband Access. The transmission of voice telephony is
  expected to increase as access to high speed broad band internet connections
  grows. Voice telephony over broadband depends on voice over packet
  technologies.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         

-31-

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Circuit-Switched versus Packet Networks

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

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

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

Convergence of Voice
and Data

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

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

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

The Challenges

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

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

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

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

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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.

AudioCodes Solution

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

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

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

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| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Digital signal processing design expertise. Our extensive experience and expertise in
  designing advanced digital signal processing algorithms enables us to
  implement them efficiently in real time systems. Digital signal algorithms
  are computerized methods used to extract information out of signals. In
  designing our signal processors, we use minimal digital signal processing
  memory and processing power resources. This allows us to develop higher
  density solutions than our competitors. Our expertise is comprehensive and
  extends to all of the functions required to perform voice compression, fax
  and modem transmission over packet networks and telephone signaling
  processing.                                                                                                                                                                                                                                                             
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| |  | Compressed voice communications systems
  design expertise. We have the expertise to design and develop the various building
  blocks and the complete gateways and media servers required for complete
  voice over packet systems. In building these systems, we develop hardware
  architectures, voice packetization software and signaling software, and
  integrate them with our signal processors to develop a complete, high
  performance compressed voice communications system. We assist our customers
  in integrating our signal processors into their hardware and software systems
  to ensure high voice quality, high completion rate of fax and data
  transmissions and telephone signaling processing accuracy. Further, we are
  able to customize our off-the-shelf products to meet our customers specific
  needs, thereby providing them with a complete, integrated solution and
  enabling them to market their products with a reduced time to market.

We believe that our products possess the following advantages:

| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Voice over Packet signal processors. Our multi-channel signal processors enable
  our customers and us to create products that meet the reliability, capacity,
  size, power consumption and cost requirements needed for building high
  capacity gateways.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| |  | Multiple and comprehensive product lines. We address both the standards-based open
  telecommunications architecture market or the proprietary system market, we
  are able to address both segments. We can do this because we enable our
  customers to offer multiple applications and address different market
  segments. For example, our voice over IP communications boards target the
  open telecommunications architecture market, while our signal processors,
  modules and voice packetization software target the proprietary system
  market. Our analog and digital media gateways target access, trunking and
  enterprise applications and our digital media gateways target wireless,
  wireline and cable networks.                                                                                                                                
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| |  | Extensive feature set. Our products incorporate an extensive set
  of signal processing functions and features (such as coders, fax processing and
  echo cancellation), functionalities (such as H.323, Media Gateway Control
  Protocol (MGCP), Trunking Gateway Control Protocol (TGCP), Media Gateway
  Control (Megaco) and Session Initiated Protocol (SIP)) and implement a
  complete system. We offer the ability to manage multiple channels of
  communications working independently of each other, with each channel capable
  of performing all of the functions required for voice compression, fax and
  modem transmission, telephone signaling processing and other functions. These
  functions include voice, fax or data detection, echo cancellation, telephone
  tone signal detection and generation and other telephony signaling
  processing.

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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.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| |  | Various entry level products. Our wide product range (chips to media
  gateways and media servers) provides our customers with a range of entry
  level products. We believe that these building blocks enable our customers to
  significantly shorten their time to market by adding their value added
  solution.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| |  | 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 enabling technologies and products for
the transmission of voice, data and fax over packet networks. The following are
key elements of our strategy:

| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Maintain and extend technological
  leadership.
  We intend to capitalize on our expertise in voice compression technology and
  proficiency in designing voice communications systems. In 1995, we
  co-authored the ITU G.723.1 voice coding standard that was adopted by the
  Voice over IP Forum as the recommended standard for use in voice over IP
  gateways. In 1998, we introduced NetCoder®, a new voice coder that was
  designed specifically for IP networks. In 2001, we introduced TrunkPack®
  1610, a cPCI Telephony board supporting PSTN, signaling, MGCP and MEGACO call
  controls. In 2002, we introduced the MediantTM Media Gateways as
  part of our initiative to provide complete media gateways to our network
  equipment provider. In 2002, we also launched our media server product family
  to support IP-based local access and enhanced services for wireless, cable,
  voice virtual private network and IP centrex markets. We 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 equipment manufacturers in the telecommunications and
  networking industries and to establish and maintain long-term working
  relationships with them. We work closely with our customers to engineer
  products and subsystems that meet each customers particular needs. The long
  development cycles usually required to build equipment incorporating our
  products frequently results in close working relationships with our
  customers. By focusing on leading equipment manufacturers with large volume
  potential, we believe that we reach a substantial segment of our potential
  customer base while minimizing the cost and complexity of our marketing
  efforts.
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| |  | Expand and enhance the development of
  highly-integrated products. We plan to continue designing, developing and introducing new
  product lines and product features that address the increasingly
  sophisticated needs of our customers. We believe that our knowledge of core
  technologies and system design expertise enables us to offer better solutions
  that are more complete and contain more features than competitive
  alternatives. We believe that the greatest opportunities for our growth and
  profitability will come from the development of even more highly-integrated
  product lines and product features such as our recently announced digital
  media gateways.                                                                                                                   
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| |  | Build upon existing technologies to
  penetrate new markets. The technology we developed in connection with the IP telephony
  market can be used to serve similar product requirements in emerging markets
  utilizing similar packet networking technologies. These markets include those
  providing telephony over digital subscriber lines, wireless networks and the
  cable television infrastructure.                                                                                                                                                                                                                                                                                                                                                                                                      
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| |  | Develop a network of strategic partners. Part of our strategy has been to sell our
  products through customers that can offer our products as part of a
  full-service solution to their customers. We expect to further develop our
  strategic partner relationships with system integrators and other service
  providers in order to increase our customer base.                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| |  | Acquire complementary businesses and
  technologies.
  We expect to pursue the acquisition of complementary businesses and
  technologies or the establishment of joint ventures to broaden our product
  offerings, enhance the features and functionality of our systems, increase
  our penetration in targeted markets and expand our marketing and distribution
  capabilities. As part of this strategy, we acquired the UAS business from
  Nortel in April 2003 and AudioCodes USA, formerly known as Ai-Logix, in May
  2004. We also entered into an agreement to acquire Nuera in May 2006.                                                                                                                                                                                                             

-37-

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Products

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

| |   |                                                                                                                             
| | - | ----------------------------------------------------------------------------------------------------------------------------
| |  | voice over
  packet processors;                                                                                             
| |   |                                                                                                                             
| |  | media
  gateway modules (TrunkPack® Modules);                                                                               
| |   |                                                                                                                             
| |  | VoIP and
  VoATM 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;                                                               
| |   |                                                                                                                             
| |  | analog media
  gateways for toll bypass access and enterprise applications;                                                 
| |   |                                                                                                                             
| |  | digital
  media gateways with various capacities for wireless, wireline (MediantTM)
  and cable (MediantTM Cable);          
| |   |                                                                                                                             
| |  | media server
  for enhanced services and functionalities such as conferencing and messaging
  (IPmedia Media Servers); and,
| |   |                                                                                                                             
| |  | Element
  management system (EMS).                                                                                          

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

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

Voice Over Packet
Processors

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

-38-

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

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

Media Gateway
Modules

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

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

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

VoIP and VoATM
Communication Boards

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

-39-

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

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

Enhanced Voice
Services and Contact Center Solutions

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

Analog Media
Gateways for Toll Bypass Access and Enterprise Applications

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

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

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

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

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

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

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

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

Universal Audio
Server (IPmediaTMMedia Server)

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

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Element Management
System (EMS)

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

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

Voice and Data
Logging Hardware Integration Board Products

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

Core Technologies

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

Low Bit Rate Voice
Compression Algorithms

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

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

Advanced Digital
Signal Processing Algorithms

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

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| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | 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.                                                       
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |  | Data modem technology.
  We have developed data modem technologies that facilitate data relay over
  packet networks. Our data modem relay software algorithms support all
  existing data modem standards up to a bit rate of 14.4 kbps.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |  | Telephony signaling processing.
  Various telephony signaling standards and protocols are employed to route
  calls over the traditional telephone network, some of which use in-band
  methods, which means that the signaling tones are sent over the telephone
  line just like the voice signal. As a result, in-band signaling tones may
  have to undergo the compression process just like the voice signal. Most low
  bit-rate voice coders, however, are optimized for speech signals and exhibit
  poor tone transfer performance. To overcome this, our processors are equipped
  with tone detection and tone generation algorithms. To provide seamless
  transparency between the traditional telephone network and packet networks
  for signaling, we employ various digital signal processing techniques for
  efficient tone processing.

Voice Communications
Software

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

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Media Processing

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

Digital Cellular
Communications Technology

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

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

VoIP for Telephony
over Cable Networks

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

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

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

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Carrier Grade System
Expertise

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

Customers

Our
customers consist of OEMs, network equipment providers and systems integrators,
carriers and distributors. Historically, we have derived the majority of our
revenues from sales to a small number of customers. The identities of our
principal customers have changed and we expect that they will continue to
change, from year to year. We expect that a small number of customers will
continue to account for a large percentage of our sales. Sales to Nortel
Networks accounted for 18.6% of our revenues in 2004 and 16.3% of our revenues
in 2005. No other customer accounted for more than 5.0% of our revenues in 2004
or in 2005.

Sales and Marketing

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

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

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

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Manufacturing

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

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

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

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.

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We
are subject to telecom industry regulations and requirements set by
telecommunication carriers that address a wide range of areas including
quality, final testing, packaging and use of environmentally friendly
components. We are making efforts to comply with the European Unions
Restriction of Hazardous Substances Directive that requires telecom equipment
suppliers to stop the usage of some materials that are not environmentally
friendly by July 1, 2006. Some of our products may not comply with this
directive in 2006. We will attempt to comply with this directive in 2007. 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 telecommunication equipment. We expect that other countries,
including countries we operate in, will adopt similar directives or other
additional regulations.

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
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.

Our
principal competitors in the sale of signal processing chips are Texas Instruments,
Broadcom, Infineon, Centillium and Mindspeed. Several large manufacturers of
generic signal processors, such as Motorola, Agere Systems 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, Cantana Technology, Acculab and PIKA Technologies, Inc.

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

Our
principal competitors in the media server market segment are Cantana
Technology, NMS Communications, Convedia, IP Unity, Cognitronics and Aculab. In
addition, we face competition in software-based and hardware-based media
servers from internal development at companies such as Nortel, Lucent, Siemens,
Motorola, Tekelec and Sonus Networks.

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.

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

Intellectual Property
and Proprietary Rights

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

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

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

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

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

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.

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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 0.3% - 0.9% of our revenues.

Legal Proceedings

We
are not a party to any material legal proceedings.

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

List of Significant Subsidiaries

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

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

AudioCodes
USA Inc. formerly known as Ai-Logix, a wholly owned subsidiary of AudioCodes
Inc., is a Delaware corporation

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

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

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

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

Our
U.S. subsidiary, AudioCodes USA, Inc., leases a 29,000 square foot facility in
Somerset. New Jersey.

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

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

None.

| |  | 
| |  | 

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| |         |                                              
| | ------- | ---------------------------------------------
| | 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
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:

| |   |                                                       
| | - | ------------------------------------------------------
| |  | Revenue
  recognition and allowance for sales returns;
| |   |                                                       
| |  | Inventories;                                          
| |   |                                                       
| |  | Investment
  in affiliated companies;                 
| |   |                                                       
| |  | Goodwill; and                                         
| |   |                                                       
| |  | Income taxes
  and valuation allowance.               

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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
$294,000 in 2003, $619,000 in 2004 and $545,000 in 2005.

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.

Inventories

Inventories
are stated at the lower of cost or market value. Cost is determined using the
moving average cost method for raw materials and on the basis of direct
manufacturing costs for finished products. We periodically evaluate the
quantities on hand relative to current and historical selling prices and
historical and projected sales volume and technological obsolescence. Based on
these evaluations, inventory write-offs and write-down provisions are provided
to cover risks arising from slow moving items, technological obsolescence,
excess inventories, discontinued products and for market prices lower than
cost. We wrote-off and wrote-down inventory in a total amount of $835,000 in
2003, $1.2 million in 2004 and $1.2 million in 2005.

Investment in Affiliated Companies

Through
December 31, 2005, we had invested an aggregate of $2.5 million in a
privately-held company engaged in speech recognition. In addition, during 2005,
we granted convertible loans in the amount of $611,000. We currently own
approximately 41% of the equity in this company. This investment is accounted
for by the equity method and is reviewed for impairment whenever events or
changes in circumstances indicate that the carrying amount of the investment
may not be recoverable. As of December 31, 2005, based on managements most
recent analyses, no impairment losses have been identified in connection with
this investment.

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In
July, 2005, we had invested $707,000 in an unrelated privately-held company and
currently own 19.5% of its Ordinary shares. This investment is accounted for by
the equity method and is reviewed for impairment whenever events or changes in
circumstances indicate that the carrying amount of the investment may not be
recoverable. As of December 31, 2005, based on managements most recent analyses,
no impairment losses have been identified in connection with this investment.

Goodwill

SFAS
No.142 requires goodwill to be tested for impairment at least annually or
between annual tests in certain circumstances, and written down when impaired,
rather than being amortized as previous accounting standards required. Goodwill
is tested for impairment at the reporting unit level by comparing the fair
value of the reporting unit with its carrying value. We operate in one operating segment, and this
segment comprises our only reporting unit. In connection with our
acquisition of selected assets of UAS, we recorded $4.3 million of goodwill in
2003 and $1.0 million of goodwill in 2004. We recorded $3.8 million of goodwill
in 2004 in connection with our acquisition of AudioCodes USA, formerly
Ai-Logix. We paid an additional $10 million in March 2005 based on the
achievement of revenue milestones and
additional terms by AudioCodes USA during 2004 and 2005. This contingent
was recorded as part of the acquisition cost as additional goodwill during
2005. The Goodwill was reduced in the amount of $ 456,000 upon utilization of
preacquisition carry forward tax losses in accordance with SFAS No. 141.
Goodwill in connection with the UAS and AudioCodes USA acquisitions was
reviewed for impairment during the fourth quarter of 2005. No impairment losses
have been identified in connection with these acquisitions.

Income taxes and valuation allowance

As
part of the process of preparing our consolidated financial statements, we are
required to estimate ourincome tax expense in each of the jurisdictions in which we operate.
This process involvesus
estimating our actual current tax exposure, which is accrued as taxes payable,
together with assessingtemporary
differences resulting from differing treatment of items and for tax and
accounting purposes. Thesedifferences 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 ismore 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 bedifferent 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 amountshave been provided for and any
adjustments
that may result from tax return audits are not likely to materiallyadversely affect our
consolidated results
of operations, financial condition or cash flows.

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

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

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Overview

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

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

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) is
expected to have a material adverse effect on our results of operations,
although it will have no impact on our overall financial position or cash
flows. SFAS No. 123(R) also requires the benefits of tax deductions in excess
of recognized compensation cost to be reported as a financing cash flow, rather
than as an operating cash flow as required under accounting principles in
effect through 2005. This requirement will reduce net operating cash flows and
increase net financing cash flows in periods after adoption.

Nortel
Networks accounted for 14.3% of our total revenues in 2003, 18.6% of our total revenues in 2004 and
16.3% of our revenues in
2005. Our top five customers accounted for 34.2% of our total revenues in 2003,35.7% of our total revenues in 2004 and 31.1%
of our revenues in 2005. Based on our experience, we expect that our largest
customers may change from period to period. If we lose a large customer and
fail to add new customers to replace lost revenue our operating results may be
materially adversely affected.

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

|         |  |      |       |      |  |       |   |  |       |  
|-------- |  | ---- | ----- | ---- |  | ----- | - |  | ----- | -
|         |  | 2003 |       | 2004 |  | 2005  |  
|         |  |      |       |      |  |       |  
|Americas |  |      | 56.9  | %    |  | 62.3  | % |  | 57.5  | %
|Far East |  |      | 23.7  |      |  | 14.3  |   |  | 12.5  |  
|Europe   |  |      | 12.6  |      |  | 13.3  |   |  | 19.4  |  
|Israel   |  |      | 6.8   |      |  | 10.1  |   |  | 10.6  |  
|         |  |      |       |      |  |       |   |  |       |  
|Total    |  |      | 100.0 | %    |  | 100.0 | % |  | 100.0 | %
|         |  |      |       |      |  |       |   |  |       |  

Part
of our strategy involves the acquisition of complementary businesses and
technologies. Our first strategic acquisition involved the purchase of the UAS
product group from Nortel Networks in April 2003. This acquisition added new
media server technology and products that we could offer to our customers and
provided us with research and development capability in the United States. As a
result of our supply agreement with Nortel in connection with this transaction,
we significantly increased our sales to Nortel from the relativity small amount
of sales in 2002 prior to the acquisition, with sales to Nortel accounting for
16.3% of our revenues in 2005 compared to 18.6% of our
revenues in 2004 and 14.3% of our revenues in 2003. We expect that sales to
Nortel will continue to account for a high percentage of our revenues in 2006.

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

The
increase in the percentage of our revenues in 2005 from customers located in
Europe was due to increased sales in Eastern Europe. The increase in the
percentage of our revenues from customers located in the Americas during 2004
was primarily the result of our increased sales in the United States due to
increased sales to Nortel and inclusion of sales by AudioCodes USA.

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

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

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

Unfavorable
economic conditions affected the communications sector during the period from
2000 to 2003. This caused a decrease in our revenues from 2000 to 2001 and from
2001 to 2002. It also resulted in our net losses in 2001, 2002 and 2003. Sales
of products, particularly for applications in converged networks, to OEMs for
use by large service providers declined significantly during these periods. In
response to our revenue decreases, we implemented expense control programs to
reduce operating expenses, while at the same time we continued to invest in
developing products that we believe our customers will need as the market for
telecommunications equipment improves. Many companies that had reduced their
capital expenditures during the recent economic downturn have begun to invest again
in their communications networks. The acceptance of next generation
packet-switched networks is contributing to these infrastructure investments as
enterprises and service providers begin to increase their use of IP networks
for data traffic, such as fax transmissions, and VoIP. These improving market
conditions helped our revenues to increase in 2003, 2004 and 2005, and we
expect our revenues in 2006 to exceed our revenues in 2005.

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, |      
|                                                |  |                         |      
|                                                |  | 2003                    |       | 2004 |  | 2005  |  
|                                                |  |                         |       |      |  |       |  
|Statement of Operations Data:                   |  |                         |       |      |  |       |   |  |       |  
|                                                |  |                         |       |      |  |       |   |  |       |  
|Revenues                                        |  |                         | 100.0 | %    |  | 100.0 | % |  | 100.0 | %
|Cost of revenues                                |  |                         | 45.3  |      |  | 41.5  |   |  | 40.6  |  
|                                                |  |                         |       |      |  |       |   |  |       |  
|Gross profit                                    |  |                         | 54.7  |      |  | 58.5  |   |  | 59.4  |  
|Operating expenses:                             |  |                         |       |      |  |       |   |  |       |  
|Research
  and development, net                 |  |                         | 35.0  |      |  | 24.2  |   |  | 21.1  |  
|Selling
  and marketing                         |  |                         | 32.9  |      |  | 24.0  |   |  | 22.4  |  
|General
  and administrative                    |  |                         | 9.2   |      |  | 5.9   |   |  | 5.2   |  
|                                                |  |                         |       |      |  |       |   |  |       |  
|Total operating expenses                        |  |                         | 77.1  |      |  | 54.1  |   |  | 48.7  |  
|                                                |  |                         |       |      |  |       |   |  |       |  
|Operating income (loss)                         |  |                         | (22.4 | )    |  | 4.4   |   |  | 10.7  |  
|Financial income, net                           |  |                         | 4.3   |      |  | 2.6   |   |  | 2.1   |  
|Equity in losses of affiliated companies,
  net |  |                         | 1.0   |      |  | 0.6   |   |  | 0.6   |  
|                                                |  |                         |       |      |  |       |   |  |       |  
|Income (loss) before taxes on income            |  |                         | (19.1 | )    |  | 6.4   |   |  | 12.2  |  
|Taxes on income                                 |  |                         | -     |      |  | 0.3   |   |  | 0.7   |  
|                                                |  |                         |       |      |  |       |   |  |       |  
|Net income (loss)                               |  |                         | (19.1 | )%   |  | 6.1   | % |  | 11.5  | %
|                                                |  |                         |       |      |  |       |   |  |       |  

Year Ended December 31, 2005 Compared to Year
Ended December 31, 2004

Revenues. Revenues increased
40.0% to $115.8
million in 2005 from $82.8 million in 2004. The increase in revenues was
primarily due to an increase of $15.0 million in sales in the United States
derived mainly from the inclusion of the results of AudioCodes USA for all of
2005. In 2004, the results of AudioCodes USA were included only beginning with
its acquisition in May 2004. Sales in Europe increased by $11.5 million
primarily as a result of higher demand in Eastern Europe for our products. Our
increase in revenues in 2005 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 $68.8 million in 2005
from $48.4 million in 2004. Gross profit as a percentage of revenues increased
to 59.4% in 2005 from 58.5% in 2004. The increase in our gross profit
percentage was primarily a result of higher sales volume that allowed us to
leverage our operations as our manufacturing overhead was spread over a larger
sales base. In addition, the improvement in gross margin was due to favorable
product mix in 2005. The increase in gross profit percentage was also due to
our ability to offset the continued decline in average selling prices of our
products with a reduction in manufacturing costs. The reduction in
manufacturing costs was primarily due to a reduction in our raw material costs.

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 22.0% to $24.4
million in 2005, from $20.0 million in 2004 and decreased as a percentage of
revenues to 21.1% in 2005 from 24.2% in 2004. The increase in net research and
development expenses was primarily due to additions to our research and
development personnel resulting from the acquisition of AudioCodes USA during
the second quarter of 2004. We expect that research and development expenses
will continue to increase in absolute dollar terms as a result of our continued
development of new products.

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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 30.4% in 2005 to
$25.9 million from $19.9 million in 2004. As a percentage of revenues, selling
and marketing expenses decreased to 22.4% in 2005 from 24.0% in 2004. The
increase in selling and marketing expenses was primarily due to an increase in
selling and marketing personnel and associated expenses, as well as additional
personnel as a result of the acquisition of AudioCodes USA. We expect that
selling and marketing expenses will continue to increase in absolute dollar
terms as a result of an expected increase in our sales force and marketing
activities.

General
and Administrative Expenses. General and administrative expenses consist primarily of
compensation for finance, human resources, general management, rent, network
and bad debt reserve, as well as insurance and professional services expenses.
General and administrative expenses increased 23.8% to $6.0 million in 2005
from $4.9 million in 2004. As a percentage of revenues, general and
administrative expenses decreased to 5.2% in 2005 from 5.9% in 2004. The
increase in general and administrative expenses in 2005 was primarily the
result of consolidating the expenses of our AudioCodes USA subsidiary, which
was acquired in May 2004. We expect that general and administrative expenses
will increase in absolute dollar terms to support our expected growth.

Equity
in Losses of Affiliated Companies. Equity in losses of affiliated
companies were $693,000 in 2005 compared to $516,000 in 2004. We believe that
the products being developed by affiliated companies may enable us to enter new
markets and to offer new products.

Financial
Income, Net.
Financial income consists primarily of interest derived on cash and cash
equivalents, 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 2005 was $2.5 million compared with financial income of $2.2
million in 2004. The increase in financial income during 2005 was primarily due
to higher interest rates and interest income, net, on the $120.2 million of net
proceeds from our sale of senior convertible notes in November 2004.

Taxes
on IncomeOur effective tax rate was 5.2% in 2004 and
5.6% in 2005. These relatively low tax rates were mainly achieved as a result
of the Approved Enterprise status granted to our production facilities in
Israel.

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

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

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

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

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

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

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

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

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Approved Enterprises and Corporate Taxes in Israel

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 to four years and a reduced corporate tax rate of
10% to 25% for an additional period of six 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.

Out
of our retained earnings as of December 31, 2005, 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 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.

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 Beneficiary Enterprise, such as
provisions generally requiring that at least 25% of the Beneficiary
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 already granted will remain subject to the provisions of the 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 law has 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.

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

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

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

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

|                          |  |                                  |  |                                |  |                                                     | 
|------------------------- |  | -------------------------------- |  | ------------------------------ |  | --------------------------------------------------- | 
|Year ended
  December 31, |  | Israeli
  inflation 
  rate 
  % |  | NIS 
  Devaluation 
  Rate
  % |  | Israeli inflation
  adjusted for
  devaluation 
  % | 
|                          |  |                                  |  |                                |  |                                                     | 
|2003                      |  | (1.9)                            |  | (7.6)                          |  | 5.7                                                 | 
|2004                      |  | 1.2                              |  | (1.6)                          |  | 2.8                                                 | 
|2005                      |  | 2.4                              |  | 6.8                            |  | (4.4)                                               | 

Recent Accounting
Pronouncements

On
December 16, 2004, the Financial Accounting Standards Board (FASB)
issued Statement No. 123 (revised 2004), Share-Based Payment
(SFAS No. 123(R)), which is a revision of SFAS No. 123. Generally, the
approach in SFAS No. 123(R) is similar to the approach described in SFAS No.
123. However, SFAS No. 123 permitted, but did not require, share-based payments
to employees to be recognized based on their fair values while SFAS No. 123(R) requires
all share-based payments to employees including grants of employee stock
options and shares issued under the ESPP to be recognized based on their fair
values. SFAS No. 123(R) also revises, clarifies and expands guidance in several
areas, including measuring fair value, classifying an award as equity or as a
liability and attributing compensation cost to reporting periods. SFAS No.
123(R) is effective for us for periods commencing January 1, 2006. SFAS No.
123(R) permits public companies to adopt its requirements using either the
modified prospective or modified retrospective method. We adopted SFAS No.
123(R), using the modified prospective method of adoption in which compensation
cost is recognized beginning with the effective date (a) based on the
requirements of Statement SFAS No. 123(R) for all share-based payments granted
after the effective date and (b) based on the requirements of SFAS No. 123 for
all awards granted to employees prior to the effective date of SFAS No. 123(R)
that remain unvested on the effective date.

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In
March 2005, the Securities and Exchange Commission (SEC) released
SEC Staff Accounting Bulletin No. 107, Share-Based
Payment (SAB 107). SAB 107 provides the SEC staffs position regarding the
application of SFAS No. 123(R) and contains interpretive guidance related to
the interaction between SFAS No. 123(R) and certain SEC rules and regulations,
and also provides the SEC staffs views regarding the valuation of share-based
payment arrangements for public companies. The adoption of SFAS No. 123(R) and
SAB 107 have a material effect on our results of operations.

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

In
May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error
Corrections, a replacement of APB No. 20, Accounting Changes and SFAS No. 3,
Reporting Accounting Changes in Interim Financial Statements. SFAS No. 154
provides guidance on the accounting for and reporting of accounting changes and
error corrections. APB No. 20 previously required that most voluntary changes
in accounting principles be recognized by including in net income for the
period of the change, the cumulative effect of changing to the new accounting
principle. SFAS No. 154 requires retroactive application to prior periods
financial statements of a voluntary change in accounting principles unless it
is impracticable. SFAS No. 154 is effective for accounting changes and
corrections of errors made in fiscal years beginning after December 15, 2005.
As of December 31, 2005, adoption of SFAS No. 154 is not expected to have a
material impact on our financial position or results of operation.

In
November 2005, the FASB issued FSP FAS 115-1. The FSP addresses the
determination as to when an investment is considered impaired, whether that
impairment is other than temporary, and the measurement of an impairment loss.
The FSP also includes accounting considerations subsequent to the recognition
of other than-temporary impairment and requires certain disclosures about
unrealized losses that have not been recognized as other-than-temporary
impairments. The guidance in this FSP amends SFAS No. 115, Accounting for
Certain Investments in Debt and Equity. The FSP replaces the impairment
evaluation guidance of EITF Issue No. 03-1, The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain Investments,
with references to the existing other-than-temporary impairment guidance. The
FSP clarifies that an investor should recognize an impairment loss no later
than when the impairment is deemed other-than-temporary, even if a decision to
sell an impaired security has not been made. The guidance in this FSP is to be
applied to reporting periods beginning after December 15, 2005. As of December
31, 2005, adoption of FSP FAS 115-1 is not expected to have a material impact
on our financial position or results of operations.

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

We
have financed our operations for the last three years from the remaining
proceeds from prior public offerings of our Ordinary shares, as well as with
cash from operations generated in 2004 and 2005. In November 2004, we raised
net proceeds of approximately $120.2 million in a private placement of $125.0
million aggregate principal amount of our 2.00% Senior Convertible Notes due
2024. As of December 31, 2005, we had $220.3 million in cash and cash
equivalents, short-term and long-term marketable securities, short-term and
long-term bank deposits and structured notes. We expect to use approximately
$85 million of cash in 2006 to pay the purchase price and related expenses in
connection with our proposed acquisition of Nuera.

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

Our
operating activities provided
cash in the amount of $13.3 million in 2005, primarily due to our net income
and depreciation and amortization expenses, which were partially offset by an
increase in trade receivables and deferred tax assets. Our operating activities
provided cash in the amount of
$3.5 million in 2004, primarily due to our net income, depreciation and
amortization expenses and an increase in trade payables and other payables and
accrued expenses, which were partially offset by an increase in trade
receivables and inventories and other receivables and prepaid expenses. Our
operating activities used cash in the amount of $6.4 million in 2003, primarily
due to our net loss and an increase in trade receivables, which were partially
offset by depreciation and amortization expenses and an increase in trade
payables and other payables and accrued expenses.

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 2004, our investing activities used cash in the amount of $15.9 million, primarily due to
the
acquisition of AudioCodes USA and UAS and the purchase of property and
equipment. In 2003, our investing activities provided cash in the amount of
$6.1 million primarily due to proceeds from short-term bank deposits, which
were partially offset by investment in long-term bank deposits and structured
notes, payments of $4.4 million in connection with the acquisition of UAS and
the purchase of property and equipment. Our capital expenditures were $2.4
million in 2005, $4.3 million in 2004 and $2.0 million in 2003. The majority of
our capital investment has been for testing equipment, an enterprise resources
planning system, computers, peripheral equipment, software, office furniture
and leasehold improvements. We used working capital to finance these
expenditures.

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

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

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

Research and Development

In
order to accommodate the rapidly changing needs of our markets, we place
considerable emphasis on research and development projects designed to improve
our existing products and to develop new ones. We are developing more advanced
communications boards and analog and digital media gateways for carrier and
enterprise applications. Our platforms will feature increased trunk capacity,
new functionalities, enhanced signaling software and compliance with new
control protocols. As of December 31, 2005, 233 of our employees were engaged
primarily in research and development on a full-time basis. We also employed 9
employees on a part-time basis.

Our
research and development expenses were $24.4 million in 2005 compared to $20.0
million in 2004 and $15.5 million in 2003. 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, 2005, we had obtained grants from the OCS aggregating $1.6 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.

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D. TREND
INFORMATION

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

In
2005, we continued to experience pressure to shorten our lead times in
supplying products to customers. Some of our customers are implementing demand
pull programs by which they only purchase our product very close to the time,
if not simultaneously with the time, they plan to sell their product. We are increasing
our sales efforts in new markets, such as Latin America, Eastern Europe and Far
East. We have introduced system level products, and new applications in our
product lines. . We are still experiencing low visibility into customer demand
for our products and our ability to predict our level of sales.

Unfavorable
economic conditions affected the communications sector during the period from
2000 to 2003. This caused a decrease in our revenues from 2000 to 2001 and from
2001 to 2002. It also resulted in our net losses in 2001, 2002 and 2003. Sales
of products, particularly for applications in converged networks, to OEMs for
use by large service providers declined significantly during these periods. In
response to our revenue decreases, we implemented expense control programs to
reduce operating expenses, while at the same time we continued to invest in
developing products that we believe our customers will need as the market for
telecommunications equipment improves. Many companies that had reduced their
capital expenditures during the recent economic downturn have begun to invest
again in their communications networks. The acceptance of next generation
packet-switched networks is contributing to these infrastructure investments as
enterprises and service providers begin to increase their use of IP networks
for data traffic, such as fax transmissions, and VoIP. These improving market
conditions helped our revenues to increase in 2003, 2004 and 2005, and we
expect our revenues in 2006 to exceed our revenues in 2005.

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

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As of December
31, 2005, 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 |                    |  | -         |  |           | -     |                      |  | -     |  |  | 125,000 | 
|                               |  |                          |         |                    |  |           |  |           |       |                      |  |       |  |  |         | 
|Rental and
  lease commitments |  |                          | 18,483  |                    |  | 2,530     |  |           | 4,876 |                      |  | 4,838 |  |  | 6,239   | 
|                               |  |                          |         |                    |  |           |  |           |       |                      |  |       |  |  |         | 
|Total cash
  obligations       |  |                          | 143,483 |                    |  | 2,530     |  |           | 4,876 |                      |  | 4,838 |  |  | 131,239 | 

Our
obligation for accrued severance pay under Israels Severance Pay Law as of
December 31, 2005 was $5.9 million, of which $5.4 million was funded through
deposits into severance pay funds, leaving a net obligation of approximately
$481,000.

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

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

The
following table sets forth certain information with respect to our directors,
senior executive officers and key employees at June 16, 2006:

| |                    |  |     |  |                                                             
| | ------------------ |  | --- |  | ------------------------------------------------------------
| | Name               |  | Age |  | Position                                                    
| |                    |  |     |  |                                                             
| | Shabtai Adlersberg |  | 53  |  | Chairman of the Board, President and Chief Executive Officer
| | Nachum Falek       |  | 35  |  | Vice President, and Chief Financial Officer                 
| | Eyal Frishberg     |  | 47  |  | Vice President, Operations                                  
| | Eli Nir            |  | 39  |  | Vice President, Research and Development                    
| | Lior Aldema        |  | 40  |  | Vice President, Marketing and Product Management            
| | Ben Rabinowitz     |  | 39  |  | Vice President, Marketing and Sales, North America          
| | Yehuda Hershkowitz |  | 39  |  | Vice President, Systems                                     
| | Tal Dor            |  | 37  |  | Vice President, Human Resources                             
| | Gary Drutin        |  | 45  |  | Vice President, Channel Operations and Marketing            
| | Moshe Tal          |  | 52  |  | President and Chief Executive Officer, AudioCodes USA Inc.  
| | David Perez        |  | 44  |  | Vice President, Sales, Asia Pacific                         
| | Joseph Tenne       |  | 50  |  | Director                                                    
| | Dana Gross         |  | 39  |  | Director                                                    
| | Dr. Eyal Kishon    |  | 46  |  | Director                                                    
| | Doron Nevo         |  | 50  |  | 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.

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

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

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

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

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

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

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

Moshe
Tal joined us in May 2004 in connection with the
acquisition of Ai-Logix, now known as AudioCodes USA, Inc. and serves as the
President and CEO of our AudioCodes USA subsidiary. 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

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

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

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

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

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

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

The
aggregate direct remuneration paid to all 15 persons who served in the capacity
of director or senior executive officer during the year ended December 31, 2005
was approximately $1.9 million, including $212,000 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 optionsx are generally exercisable in four or five equal annual payments, commencing
one year from the date of grant.

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A
summary of our stock option activity and related information for the years
ended December 31, 2003, 2004 and 2005 for all 15 persons who served in the
capacity of director or senior executive officer during the year ended December
31, 2005 is as follows:

|                                         |  |                       |           |                                       |   |                       |  |                                        |           |                       |   |                                        |  |  |           |   |   |       | 
|---------------------------------------- |  | --------------------- | --------- | ------------------------------------- | - | --------------------- |  | -------------------------------------- | --------- | --------------------- | - | -------------------------------------- |  |  | --------- | - | - | ----- | 
|                                         |  | 2003                  |           | 2004                                  |   | 2005                  | 
|                                         |  |                       |           |                                       |   |                       | 
|                                         |  | 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 |  |                       | 1,235,686 |                                       | $ | 7.58                  |  |                                        | 1,526,702 |                       | $ | 7.48                                   |  |  | 1,909,435 |   | $ | 9.01  | 
|Adjustments to opening
  balance         |  |                       |           |                                       |   |                       |  |                                        | (39,600   | )                     |   |                                        |  |  | 42,500    |   |   |       | 
|                                         |  |                       |           |                                       |   |                       |  |                                        |           |                       |   |                                        |  |  |           |   |   |       | 
|Granted                                  |  |                       | 325,500   |                                       | $ | 6.64                  |  |                                        | 531,250   |                       | $ | 11.77                                  |  |  | 60,000    |   | $ | 10.17 | 
|Cancelled                                |  |                       | -         |                                       |   | -                     |  |                                        | -         |                       |   | -                                      |  |  | -         |   |   |       | 
|Exercised                                |  |                       | (34,484   | )                                     | $ | 3.09                  |  |                                        | (108,917  | )                     | $ | 5.16                                   |  |  | (5,250    | ) | $ | 3.77  | 
|                                         |  |                       |           |                                       |   |                       |  |                                        |           |                       |   |                                        |  |  |           |   |   |       | 
|Outstanding at the end of the year       |  |                       | 1,526,702 |                                       | $ | 7.48                  |  |                                        | 1,909,435 |                       | $ | 9.11                                   |  |  | 2,006,685 |   | $ | 9.06  | 
|                                         |  |                       |           |                                       |   |                       |  |                                        |           |                       |   |                                        |  |  |           |   |   |       | 

As
of December 31, 2005, options to purchase 1,285,165 ordinary shares were
exercisable at an average exercise price of $8.82 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

Independent Directors; Audit Committee;
Internal Auditor

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

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 a recent amendment 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 director should possess professional expertise. Regulations
specifying the applicable criteria have not yet been promulgated. Both of the
outside directors must serve on the companys statutory audit committee.

-70-

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

Under
the Companies Law and the requirements for listing on the Nasdaq National
Market, our board of directors is required to appoint an audit committee. 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 and Joseph Tenne. Our Board of Directors has determined that Joseph Tenne
is an audit committee financial expert and that he is independent under the
applicable Securities and Exchange Commission and Nasdaq National Market 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.

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.

-71-

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As
of July 2005, 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 Dana Gross.
All members of the Nominating Committee are independent under the applicable
Securities and Exchange Commission and Nasdaq National Market 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
Dana Gross to serve on the compensation committee of the board of directors.

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

| |                    |  |           |  |     
| | ------------------ |  | --------- |  | ----
| | Dana Gross         |  | Class I   |  | 2007
| | Joseph Tenne       |  | Class II  |  | 2008
| | Shabtai Adlersberg |  | Class III |  | 2006

Our
outside directors under the Companies Law, Doron Nevo and Dr. Eyal Kishon, are
not members of any class and serve in accordance with the provisions of the
Companies Law. Mr. Nevos term ends in 2006 and Dr. Kishons term ends in 2008.

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

We
had the following number of employees as of December 31, 2003, 2004 and 2005 in
the areas set forth in the table below:

|                                                 |  |                      |     |      |  |      |  |  |     | 
|------------------------------------------------ |  | -------------------- | --- | ---- |  | ---- |  |  | --- | 
|                                                 |  | As of
  December 31, |    
|                                                 |  |                      |    
|                                                 |  | 2003                 |     | 2004 |  | 2005 | 
|                                                 |  |                      |     |      |  |      | 
|Research and
  development                       |  |                      | 145 |      |  | 213  |  |  | 233 | 
|Sales &
  marketing, technical service & support |  |                      | 119 |      |  | 144  |  |  | 186 | 
|Operations                                       |  |                      | 45  |      |  | 63   |  |  | 73  | 
|Management
  and administration                  |  |                      | 19  |      |  | 25   |  |  | 30  | 
|                                                 |  |                      |     |      |  |      |  |  |     | 
|                                                 |  |                      | 328 |      |  | 445  |  |  | 522 | 
|                                                 |  |                      |     |      |  |      |  |  |     | 

-72-

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Our
employees were located in the following areas as of December 31, 2003, 2004 and
2005.

|                |  |                      |     |      |  |      |  |  |     | 
|--------------- |  | -------------------- | --- | ---- |  | ---- |  |  | --- | 
|                |  | As of
  December 31, |    
|                |  |                      |    
|                |  | 2003                 |     | 2004 |  | 2005 | 
|                |  |                      |     |      |  |      | 
|Israel          |  |                      | 265 |      |  | 320  |  |  | 373 | 
|United
  States |  |                      | 50  |      |  | 105  |  |  | 124 | 
|Far East        |  |                      | 11  |      |  | 15   |  |  | 17  | 
|Europe          |  |                      | 2   |      |  | 3    |  |  | 5   | 
|Latin
  America |  |                      | --  |      |  | 2    |  |  | 3   | 
|                |  |                      |     |      |  |      |  |  |     | 
|                |  |                      | 328 |      |  | 445  |  |  | 522 | 
|                |  |                      |     |      |  |      |  |  |     | 

The
growth in the number of our employees over the past three years was primarily
attributable to an increase in research and development personnel, increased
sales and marketing efforts and our acquisition of Ai-Logix, now known as
AudioCodes USA, in 2004.

Israeli
labor laws and regulations are applicable to our employees in Israel. These
laws principally concern matters such as paid annual vacation, paid sick days,
length of the workday, pay for overtime, insurance for work-related accidents,
severance pay and other conditions of employment. Israeli law generally
requires severance pay, which may be funded by Managers Insurance, described
below, upon the retirement or death of an employee or termination of employment
without cause (as defined under Israeli law). Furthermore, Israeli employees
and employers are required to pay predetermined sums to the National Insurance
Institute. Since January 1, 1995, such amounts also include payments for
national health insurance. The payments to the National Insurance Institute are
approximately 16.1% of wages, of which the employee contributes approximately
65% and the employer contributes approximately 35%.

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

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

-73-

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

The
following table sets forth the share ownership and outstanding number of
options of our directors and officers as of June 23, 2006.

|                          |  |                                    |  |                                  |  |                      | 
|------------------------- |  | ---------------------------------- |  | -------------------------------- |  | -------------------- | 
|Name                      |  | Total Shares 
  Beneficially Owned |  | Percentage of 
  Ordinary Shares |  | Number of 
  Options | 
|Shabtai Adlersberg        |  | 5,016,139                          |  | 12.4                             |  | 633,718              | 
|Nachum Falek              |  | *                                  |  |                                  |  | *                    | 
|Eyal Frishberg            |  | *                                  |  |                                  |  | *                    | 
|Eli Nir                   |  | *                                  |  |                                  |  | *                    | 
|Lior Aldema               |  | *                                  |  |                                  |  | *                    | 
|Ben Rabinowitz            |  | *                                  |  |                                  |  | *                    | 
|Yehuda Hershkowitz        |  | *                                  |  |                                  |  | *                    | 
|Tal Dor                   |  | *                                  |  |                                  |  | *                    | 
|Gary Drutin               |  | *                                  |  |                                  |  | *                    | 
|Moshe Tal                 |  | *                                  |  |                                  |  | *                    | 
|David Perez               |  | *                                  |  |                                  |  | *                    | 
|Joseph Tenne              |  | *                                  |  |                                  |  | *                    | 
|Dana Gross                |  | *                                  |  |                                  |  | *                    | 
|Dr. Eyal Kishon           |  | *                                  |  |                                  |  | *                    | 
|Doron Nevo                |  | *                                  |  |                                  |  | *                    | 
|                         
|*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 23, 2006.

Shabtai
Adlersberg

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

-74-

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Employee Share Plans

We
have an Employee Share Purchase Plan and Employee Share Option Plans for the
granting of options to our employees, officers, directors and consultants. 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.

Employee Share Purchase Plans

We
implemented two Employee Share Purchase Plans in May 2001. One plan is for our
Israeli employees and the other for all our U.S. and other non-Israeli
employees. Under these Plans an aggregate of 2,000,000 of our ordinary shares
were reserved for sale to our employees at a price equal to 85% of the lesser
of fair market value on the first day or last day of each offering period under
the Plans. As of December 31, 2005, we had issued 966,710 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, 2005, options to purchase a total of 6,593,412 shares are
outstanding under the 1997 and 1999 Israeli Plans and options to purchase a
total of 1,340,960 shares are outstanding under the 1997 U.S. Plan. In
addition, a reserve of 811,000 shares has been made available for grant under
the 1999 Israeli Plan and a reserve of 726,000 shares has been made available
for grant under the 1999 U.S. Plan. However, subject to our board deciding
otherwise, each year on July 1, starting with July 1999, the number of shares
that will be made available for grant under both of the 1999 Plans, will be
automatically increased to that number of shares that is equal to 5% of our
outstanding share capital on such a date.

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

-75-

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

To
our knowledge, (A) we are not directly or indirectly owned or controlled (i) by
another corporation or (ii) by any foreign government and (B) there are no
arrangements, the operation of which may at a subsequent date result in a
change in control of AudioCodes. The following table sets forth, as of December
31, 2005, 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)                                                  |  | 5,442,071    |  |                  | 13.3 | % | 
|Leon Bialik(2)                                                         |  | 4,014,312    |  |                  | 9.9  | % | 
|FMR Corp.(3)                                                           |  | 5,769,634    |  |                  | 14.2 | % | 
|Kern Capital (4)                                                       |  | 2,782,700    |  |                  | 6.9  | % | 
|All directors and senior executive officers as a group (15 persons)(5) |  | 6,542,090    |  |                  | 15.6 | % | 

|    |                                                                                                                                                                                                                                                                                                                                                  
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|   
|   
|(1) | Includes options to purchase 427,468 shares, which may be purchased
  pursuant to options exercisable within sixty days following December 31,
  2005.                                                                                                                                                                                           
|   
|(2) | The information is derived from a statement on Schedule 13G/A, dated February 9, 2006 of Leon Bialik filed with
  the Securities and Exchange Commission.                                                                                                                                                                                        
|   
|(3) | The information is derived from the joint statement on Schedule
  13G/A, dated January 10, 2006, of FMR Corp., Edward C. Johnson 3d, Fidelity
  Management & Research Company and Fid Blue Chip Growth Fund filed with
  the Securities and Exchange Commission. The address of FMR Corp. is 82
  Devonshire Street, Boston, Massachusetts 02109.
|   
|(4) | The information is derived from a statement on Schedule 13G, dated February 14, 2006 of
  Kern Capital Management, Robert E. Kern Jr. and David G. Kern filed with the
  Securities and Exchange Commission.                                                                                                                                     
|   
|(5) | Includes 1,304,765 ordinary shares, which may be purchased pursuant
  to options exercisable within sixty days following December 31, 2005.                                                                                                                                                                                                      

During
2005, Mr. Adlersberg acquired 2,837 of our ordinary shares and Mr. Bialik
acquired 86,090 of our ordinary shares. During 2004, Mr. Adlersberg acquired
93,421 of our ordinary shares and Mr. Bialik sold 421,500 of our ordinary
shares. During 2003, Mr. Adlersberg acquired 285,130 of our ordinary shares and
Mr. Bialik sold 208,000 of our ordinary shares.

FMR
Corp. held 14.2% of our ordinary shares as of December 31, 2005, as compared to
8.2% of our ordinary shares as of December 31, 2004 and 7.3% of our ordinary
shares as of December 31, 2003. Kern Capital held 6.9% of our ordinary shares
as of December 31, 2005 as compared to 6.7% of our ordinary shares as of
December 31, 2004 and less than 5% of our ordinary shares as of December 31,
2003.

-76-

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As
of June 23, 2006, there were approximately 24 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.

|   |                                 
|-- | --------------------------------
|C. | 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 National Market and The Tel Aviv Stock
Exchange under the symbol AUDC.

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

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

-77-

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|              |  |                 |   |       |  |   |      | 
|------------- |  | --------------- | - | ----- |  | - | ---- | 
|Calendar Year |  | Price Per Share |  
|              |  |                 |  
|              |  | High            |   | Low   | 
|              |  |                 |   |       | 
|2005          |  |                 | $ | 17.00 |  | $ | 8.67 | 
|2004          |  |                 | $ | 16.88 |  | $ | 8.48 | 
|2003          |  |                 | $ | 11.74 |  | $ | 2.10 | 
|2002          |  |                 | $ | 5.91  |  | $ | 1.61 | 
|2001          |  |                 | $ | 25.75 |  | $ | 1.60 | 

|                |                                        |                 |      |       |     |   |       | 
|--------------- | -------------------------------------- | --------------- | ---- | ----- | --- | - | ----- | 
|Calendar Period |                                        | Price Per Share |     
|                |                                        |                 |     
|                |                                        |                 | High |       | Low |  
|                |                                        |                 |      |       |     |  
|2006            |                                        |                 |      |       |     |   |       | 
|                | Second quarter (through June 23, 2006) |                 | $    | 14.33 |     | $ | 10.38 | 
|                | First quarter                          |                 | $    | 14.64 |     | $ | 11.36 | 
|2005            |                                        |                 |      |       |     |   |       | 
|                | Fourth quarter                         |                 | $    | 11.90 |     | $ | 9.62  | 
|                | Third quarter                          |                 | $    | 11.20 |     | $ | 8.95  | 
|                | Second quarter                         |                 | $    | 12.18 |     | $ | 8.67  | 
|                | First quarter                          |                 | $    | 17.00 |     | $ | 10.66 | 
|2004            |                                        |                 |      |       |     |   |       | 
|                | Fourth quarter                         |                 | $    | 16.88 |     | $ | 11.85 | 
|                | Third quarter                          |                 | $    | 13.97 |     | $ | 9.51  | 
|                | Second quarter                         |                 | $    | 12.98 |     | $ | 8.48  | 
|                | First quarter                          |                 | $    | 16.10 |     | $ | 10.35 | 

|               |          |                 |      |       |     |   |       | 
|-------------- | -------- | --------------- | ---- | ----- | --- | - | ----- | 
|Calendar Month |          | Price Per Share |     
|               |          |                 |     
|               |          |                 | High |       | Low |  
|               |          |                 |      |       |     |  
|2006           |          |                 |      |       |     |   |       | 
|               | May      |                 | $    | 14.00 |     | $ | 11.91 | 
|               | April    |                 | $    | 14.33 |     | $ | 13.25 | 
|               | March    |                 | $    | 14.64 |     | $ | 11.57 | 
|               | February |                 | $    | 13.02 |     | $ | 11.36 | 
|               | January  |                 | $    | 13.28 |     | $ | 11.37 | 
|2005           |          |                 |      |       |     |   |       | 
|               | December |                 | $    | 11.85 |     | $ | 10.01 | 

The
following table sets forth, for the periods indicated, the high and low sales
prices of our ordinary shares as reported by The Tel Aviv Stock Exchange. Our
shares commenced trading on The Tel Aviv Stock Exchange on October 21, 2001.
All share prices shown in the following table are in NIS. As of December 31,
2005, the exchange rate was equal to approximately 4.603 NIS per U.S. $1.00.

-78-

---

---



|                                   |  |                 |           |           |     |           |          
|---------------------------------- |  | --------------- | --------- | --------- | --- | --------- | ---------
|Calendar Year                      |  | Price Per Share |          
|                                   |  |                 |          
|                                   |  |                 | High      |           | Low |          
|                                   |  |                 |           |           |     |          
|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 
|2001 (commencing October 21, 2001) |  |                 | NIS 26.90 |           |     | NIS 10.25 |          

|                |                                        |                 |      |           |     |  |           | 
|--------------- | -------------------------------------- | --------------- | ---- | --------- | --- |  | --------- | 
|Calendar Period |                                        | Price Per Share |     
|                |                                        |                 |     
|                |                                        |                 | High |           | Low | 
|                |                                        |                 |      |           |     | 
|2006            |                                        |                 |      |           |     |  |           | 
|                | Second quarter (through June 23, 2006) |                 |      | NIS 65.27 |     |  | NIS 46.98 | 
|                | First quarter                          |                 |      | NIS 66.27 |     |  | NIS 50.52 | 
|2005            |                                        |                 |      |           |     |  |           | 
|                | Fourth quarter                         |                 |      | NIS 53.70 |     |  | NIS 46.55 | 
|                | Third quarter                          |                 |      | NIS 50.05 |     |  | NIS 41.06 | 
|                | Second quarter                         |                 |      | NIS 53.97 |     |  | NIS 40.20 | 
|                | First quarter                          |                 |      | NIS 73.80 |     |  | NIS 46.91 | 
|2004            |                                        |                 |      |           |     |  |           | 
|                | Fourth quarter                         |                 |      | NIS 70.00 |     |  | NIS 52.12 | 
|                | Third quarter                          |                 |      | NIS 57.93 |     |  | NIS 43.00 | 
|                | Second quarter                         |                 |      | NIS 57.10 |     |  | NIS 39.10 | 
|                | First quarter                          |                 |      | NIS 74.90 |     |  | NIS 46.01 | 

|               |          |                 |      |           |     |  |           | 
|-------------- | -------- | --------------- | ---- | --------- | --- |  | --------- | 
|Calendar Month |          | Price Per Share |     
|               |          |                 |     
|               |          |                 | High |           | Low | 
|               |          |                 |      |           |     | 
|2006           |          |                 |      |           |     |  |           | 
|               | May      |                 |      | NIS 62.29 |     |  | NIS 55.00 | 
|               | April    |                 |      | NIS 65.27 |     |  | NIS 60.22 | 
|               | March    |                 |      | NIS 66.27 |     |  | NIS 53.31 | 
|               | February |                 |      | NIS 60.50 |     |  | NIS 53.38 | 
|               | January  |                 |      | NIS 61.75 |     |  | NIS 50.52 | 
|2005           |          |                 |      |           |     |  |           | 
|               | December |                 |      | NIS 53.70 |     |  | NIS 47.21 | 

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

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

|   |                     
|-- | --------------------
|D. | SELLING SHAREHOLDERS
|   |                     
|   | Not
  applicable.   

-79-

---

---



|   |                      
|-- | ---------------------
|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

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

| |   |                                                                                                                                                         
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | to plan,
  develop and market voice signal systems;                                                                                                     
| |   |                                                                                                                                                         
| |  | to purchase,
  import, market and wholesale and retail distribute, in Israel and abroad,
  consumption goods and accompanying products;                 
| |   |                                                                                                                                                         
| |  | to serve as
  representatives of bodies, entrepreneurs and companies from Israel and abroad
  with respect to their activities in Israel and abroad; and
| |   |                                                                                                                                                         
| |  | to carry out
  any activity as determined by the lawful management.                                                                                     

Borrowing Powers

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

Amendment of Articles of Association

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

Dividends

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.

-80-

---

---



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.

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

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
50% voting power represented at the meeting in person or by proxy and voting
thereon, provide for shares with such preferred or deferred rights or rights of
redemption, or other special rights and/or such restrictions, whether in regard
to dividends, voting repayment of share capital or otherwise, as may be
stipulated in such resolution.

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

-81-

---

---



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

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

Shareholders Meetings

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

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

| |   |                                                                                                                                                       
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | at least two
  directors;                                                                                                                             
| |   |                                                                                                                                                       
| |  | at least
  one-quarter of the directors in office; or                                                                                                 
| |   |                                                                                                                                                       
| |  | shareholders
  who hold at least 5% of the outstanding equity and at least 1% of the voting
  rights, or at least 5% of the outstanding voting rights.

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

Notice of General Meetings; Omission to Give
Notice

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

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

-82-

---

---



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.

Indemnification of Directors and Officers

We
have entered into agreements with each of our directors and senior officers to
insure, indemnify and exculpate them against some types of claims, subject to
dollar limits and other limitations. These agreements provide, subject to
Israeli law, for us to indemnify each of these directors and senior officers
for any of the following obligations or expenses that they may incur:

| |   |                                                                                                                                                                                                                                                                                                                                                                                
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | § | monetary liability imposed
  on the director or senior officer in favor of a third party in a judgment,
  including a settlement or an arbitral award confirmed by a court, for an act
  that the director or senior officer performed by virtue of being our director
  or senior officer,                                                                                    
| |   |                                                                                                                                                                                                                                                                                                                                                                                
| | § | reasonable legal costs,
  including attorneys fees, expended by a director or senior officer as a
  result of an investigation or proceeding instituted against the director or
  senior officer by a competent authority, provided that such investigation or
  proceeding concludes without the filing of an indictment against the director
  or senior officer and either:

| |   |                                                                                                                                                                                      
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | o | no financial liability was
  imposed on the director or senior officer in lieu of criminal proceedings, or                                                                           
|
| | o | financial liability was
  imposed on the director or senior officer in lieu of criminal proceedings but
  the alleged criminal offense does not require proof of criminal intent, and

| |   |                                                                                                                                                                     
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | § | reasonable legal costs,
  including attorneys fees, expended by the director or senior officer or for
  which the director or senior officer is charged by a court:

| |   |                                                                                                                                     
| | - | ------------------------------------------------------------------------------------------------------------------------------------
| | o | in an action brought
  against the director or senior officer by us, on our behalf or on behalf of a
  third party,                 
|
| | o | in a criminal action in
  which the director or senior officer is found innocent, or                                                
|
| | o | in a criminal action in
  which the director or senior officer is convicted but in which proof of
  criminal intent is not required.

-83-

---

---



Approval of Transactions under Israeli Law

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

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

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

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

-84-

---

---



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.
Extraordinary transactions with a controlling shareholder or in which a
controlling shareholder has a personal interest, and the engagement of a
controlling shareholder as an office holder or employee, generally require the
approval of the audit committee, the board of directors and the shareholders.
The shareholder approval must include at least one-third of the shares of
non-interested shareholders voted on the matter. However, the transaction can
be approved by shareholders without this one-third approval if the total shares
of non-interested shareholders voted against the transaction do not represent
more than one percent of the voting rights in the company.

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

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

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

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

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

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

-85-

---

---



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

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

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

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

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

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

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

-86-

---

---



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

On
May 12, 2004, we acquired the outstanding shares of capital stock of Ai-Logix,
now known as AudioCodes USA, Inc. pursuant to a between us, AudioCodes Inc.,
Ai-Logix and AI Technologies N.V. We paid $10 million in cash at the closing
and an additional $10 million in March 2005 based on the achievement of revenue
milestones and additional terms by the acquired business during 2004 and 2005.

On May 16,
2006, we entered into an Agreement and Plan of Merger with Nuera
Communications, Inc., or Nuera. The consideration for the transaction will consist of $85
million in cash, subject to reduction for certain expenses, plus an earn out
arrangement under which we have agreed to pay up to an additional $5 million if
Nuera achieves certain revenue milestones during the first 12 months after
consummation of the transaction. There will be an escrow of $7.5 million of the purchase price paid at
closing for a period of one year following closing, to secure up to $7.5
million of certain indemnification obligations under the merger agreement. Upon
the consummation of the merger, Nuera will become a wholly-owned subsidiary of
AudioCodes USA. The transaction
is subject to customary conditions for transactions of this nature, including
antitrust clearance under the Hart-Scott-Rodino Antitrust Improvement Act and
other regulatory approvals. If these conditions are satisfied, the transaction
is expected to be consummated early in the third quarter of 2006. The
transaction has been approved by our board of directors and by the board of
directors and stockholders of Nuera. We cannot be sure that the acquisition of
Nuera will be consummated when anticipated or at all.

-87-

---

---



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

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

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

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

The
following is a summary of the material Israeli and United States 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

On
July 25, 2005 the Israeli parliament passed the Law for the Amendment of the
Income Tax Ordinance (No.147 and Temporary Order) - 2005 (hereinafter - the
Amendment).

Under
the amendment, a gradual decrease in the corporate tax rate in Israel will be
in effect as follows: in 2006 - 31%, in 2007 - 29%, in 2008 - 27%, in 2009 -
26% and in 2010 and thereafter - 25%. Furthermore, beginning in 2010, upon
reduction of the corporate tax rate to 25%, capital gains will be subject to a
tax of 25%.

-88-

---

---



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. A Foreign Investors Company, or FIC,
defined in the Investment Law as a company of which more than 25% of its
shareholders are non-Israeli residents, may enjoy benefits for a period of up
to ten years, or twelve years if it complies with certain export criteria
stipulated in the Investment Law (the actual length of the benefits period is
graduated based on the percentage of foreign ownership).

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

Our
production facilities have been granted the status of approved enterprise.
Income arising from our approved enterprise facilities is tax-free under the
alternative package of benefits described above and entitled to reduced tax
rates based on the level of foreign ownership for specified periods. We have
derived, and expect to continue to derive, a substantial portion of our
operating income from our approved enterprise facilities. The tax benefits
attributable to our current approved enterprises are scheduled to expire
gradually from 2007 to 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 will be based, among
other things, on the criteria set forth in the Investment Law and related
regulations, the then prevailing policy of the Investment Center, and the
specific objectives and financial criteria of the company. Accordingly, there
can be no assurance that any new investment programs will be approved as
approved enterprises. In addition, the benefits available to an approved
enterprise are conditional upon the fulfillment of conditions stipulated in the
Investment Law and related regulations and the criteria set forth in the
specific certificate of approval. In the event that a company does not meet
these conditions, it will be subject to corporate tax at the rate then in
effect under Israeli law for such tax year. As of December 31, 2005, 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 Beneficiary Enterprise, such as
provisions generally requiring that at least 25% of the Beneficiary
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 already granted 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 has 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 June 7, 2005,
the authority of the Research Committee to approve the transfer of manufacture
outside of Israel was expanded.

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

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

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

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.                                                                        

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

Commencing
in taxable year 2003, 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. Such an
elective obligates the Company for three years. Accordingly, commencing taxable
year 2003, results for tax purposes are measured in terms of earnings in
dollars. We elected to extend the term of the above mentioned tax measurement
by another year.

Capital Gains Tax Applicable to Resident and
Non-Resident Shareholders

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

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

| |   |                                                                                                                                                                        
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | publicly
  traded on The Tel Aviv Stock Exchange, or the TASE;                                                                                                         
| |   |                                                                                                                                                                        
| |  | publicly
  traded on Nasdaq or a recognized stock exchange or regulated market in a
  country that has a treaty for the prevention of double taxation with Israel;
  or
| |   |                                                                                                                                                                        
| |  | companies
  dually traded on both the TASE and on Nasdaq or a recognized stock exchange
  or a regulated market outside of Israel.                                     

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

| |   |                                                                                                                                     
| | - | ------------------------------------------------------------------------------------------------------------------------------------
| |  | to a
  relative (as defined in the tax reform);                                                                                     
| |   |                                                                                                                                     
| |  | by dealers
  in securities;                                                                                                         
| |   |                                                                                                                                     
| |  | by
  shareholders that report in accordance with the Inflationary Adjustments Law;
  or                                             
| |   |                                                                                                                                     
| |  | by
  shareholders who acquired their shares prior to an initial public offering
  (that are subject to a different tax arrangement).

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

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

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

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

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

Foreign Exchange Regulations

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

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

| |   |                                                                                                                                                                                                                                                                                                                                                             
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | an
  individual who is either a U.S. citizen or a resident of the U.S. for U.S.
  federal income tax purposes;                                                                                                                                                                                                                                              
| |   |                                                                                                                                                                                                                                                                                                                                                             
| |  | a corporation
  (or an entity taxable as a corporation) created or organized under the laws
  of the U.S. or any political subdivision thereof;                                                                                                                                                                                                             
| |   |                                                                                                                                                                                                                                                                                                                                                             
| |  | an estate,
  the income of which is subject to U.S. federal income tax regardless of the
  source of its income; and                                                                                                                                                                                                                                        
| |   |                                                                                                                                                                                                                                                                                                                                                             
| |  | a trust, if
  either (a) a U.S. court is able to exercise primary supervision over the
  administration of the trust and one or more U.S. persons have the authority
  to control all the substantial decisions of the trust, or (b) the trust has a
  valid election in effect under applicable U.S. Treasury regulations to be
  treated as a U.S. person.

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

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

Distributions With
Respect to Our Ordinary Shares

The
amount of a distribution with respect to our ordinary shares will equal the
amount of cash and the fair market value of any property distributed and will
also include the amount of any Israeli taxes withheld, as described below under
Israeli Tax Considerations  Tax on Dividends. Other than distributors in
liquidation and distributions in redemption of stock that are treated as
exchanges, a distribution paid by us with respect to our ordinary shares to a
U.S. holder generally will be treated as a dividend to the extent that the
distribution does not exceed our current and accumulated earnings and profits,
as determined for U.S. federal income tax purposes. The amount of any
distribution that exceeds these earnings and profits will be treated first as a
non-taxable return of capital, reducing the U.S. holders tax basis in its
ordinary shares, and then generally as capital gain. Currently, an individual
U.S. holders qualified dividend income is subject to tax at a reduced rate
of 15%.

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For
this purpose, qualified dividend income generally includes dividends paid by
a foreign corporation to an individual holder if such 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 a foreign corporation will not
qualify for the 15% U.S. federal income tax rate, however, if such corporation
is treated, for the tax year in which the dividends are paid or the preceding
tax year, as a passive foreign investment company for U.S. federal income tax
purposes.

As
discussed in more detail below under Passive Foreign Investment Company
Status, we do not believe that we currently would be classified as a passive
foreign investment company for U.S. federal income tax purposes. Accordingly,
dividend distributions with respect to our ordinary shares should be treated as
qualified dividend income and, subject to U.S. holders satisfaction of
certain minimum holding period requirements, should be eligible for the reduced
15% U.S. federal income tax rate. Corporate holders of our ordinary shares
generally will not be allowed a deduction for dividends received on our
ordinary shares.

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

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

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Disposition of Our
Ordinary Shares

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

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

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

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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).

Based
on the composition of our gross income and the composition and value of our
gross assets during 2005, we do not believe that we were a PFIC in 2005. While it is
possible that we would have been classified as a PFIC under the Asset Test in 2001,
2002 and 2003 principally because a significant portion of our assets continued
to consist of the cash raised in connection with the two public offerings of
our ordinary shares in 1999, and the public market value of our ordinary shares
declined significantly during 2001, 2002 and the first half of 2003, we do not
believe we would have been treated as a PFIC in 2004. The tests for
determining whether we are a PFIC for any tax year are applied annually, and it
is difficult to make accurate predictions regarding the composition of our
future income and assets, the factors which are relevant to this determination.
In addition, there is no definitive method prescribed in the Code, United
States Treasury Regulations or administrative or judicial interpretations
thereof for determining the value of a foreign corporations assets for
purposes of the Asset Test. While the legislative history of the United States
Taxpayer Relief Act of 1997 indicates that the total value of a
publicly-traded foreign corporations assets generally will be treated as equal
to the sum of the aggregate value of its outstanding stock plus its
liabilities, there remains substantial uncertainty regarding the valuation of
a publicly-traded foreign corporations assets for purposes of the Asset Test.
Moreover, certain factors relevant to the PFIC determination, such as declines
in the market value of our stock, are not within our control and can cause us
to become a PFIC. Accordingly, there can be no assurance that we will not be
deemed a PFIC in any future tax year.

-98-

---

---



In
view of the uncertainty regarding our use of the net proceeds realized from our
sale of notes in November 2004, the valuation of our assets for purposes of the
Asset Test and the complexity of the issues regarding our treatment as a PFIC,
U.S. holders are urged to consult their own tax advisors for guidance as to our
status as a PFIC. For those U.S. holders who determine that we were a PFIC in
2005 or in any subsequent tax year and notify us in writing of their request
for the information required in order to effectuate the QEF Election described
below, we will promptly make such information available to them.

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

|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Excess
  distributions by us to a U.S. holder would be taxed in a special way.
  Excess distributions with respect to any U.S. holder are amounts received
  by such U.S. holder with respect to our ordinary shares in any tax year that
  exceed 125% of the average distributions received by such U.S. holder from us
  during the shorter of (i) the three previous years, or (ii) such U.S.
  holders holding period of our ordinary shares before the then-current tax
  year. Excess distributions must be allocated ratably to each day that a U.S.
  holder has held our ordinary shares. A U.S. holder must include amounts allocated
  to the current tax year in its gross income as ordinary income for that year.
  A U.S. holder must pay tax on amounts allocated to each prior tax year in
  which we were a PFIC at the highest rate in effect for such prior year on
  ordinary income and the tax is subject to an interest charge at the rate
  applicable to deficiencies for income tax.
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| | The entire
  amount of any gain realized by a U.S. holder upon the sale or other
  disposition of our ordinary shares also would be treated as an excess
  distribution subject to tax as described above.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| | The tax
  basis in ordinary shares acquired from a decedent who was a U.S. holder would
  not receive a step-up to fair market value as of the date of the decedents
  death but would instead be equal to the decedents basis, if lower.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          

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

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

-99-

---

---



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

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

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

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

Information Reporting
And Backup Withholding

Any
dividends paid on our ordinary shares to U.S. holders may be subject to U.S.
federal tax information reporting requirements and the U.S. backup withholding
tax (the backup withholding rate currently is 28%). In addition, the proceeds
of a U.S. holders sale of ordinary shares may be subject to tax information
reporting and the U.S. backup withholding tax. Backup withholding will not
apply if the U.S. holder (i) is a corporation or other exempt recipient, and
demonstrates the fact when so required, or (ii) the U.S. holder provides a U.S.
taxpayer identification number, certifies as to no loss of exemption from
backup withholding and complies with any other applicable backup withholding
requirements. U. S. holders required to establish their exemption from backup
withholding generally must provide a certification on the U.S. Internal Revenue
Service Form W-9. Any amounts withheld under the U.S. backup withholding tax
rules will be allowed as a refund or a credit against the U.S. holders U.S.
federal income tax liability, provided the required information is furnished to
the U.S. Internal Revenue Service.

-100-

---

---



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

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

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.

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 obtained 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.

|   |                       
|-- | ----------------------
|I. | SUBSIDIARY INFORMATION
|   |                       
|   | Not
  applicable.     

-101-

---

---



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

Our
exposure to market risk for changes in interest rates relates primarily to our
investment in marketable securities. Our marketable securities portfolio
includes U.S. government debt instruments and corporate debt instruments. The
fair value of our long and short-term securities is based upon their market
values as of December 31, 2005. In addition, we have contracted several
structured note deals that are sensitive to changes in interest rates. Due to
the nature of our investments, we do not believe that there is any material
market risk exposure. Therefore, no quantitative tabular disclosures are
required. However, we may in the future undertake hedging or other similar
transactions or invest in market risk sensitive instruments if management
determines that it is necessary to offset these risks. See Item 3. Key
InformationD. Risk FactorsRisks Relating to Operations in Israel.

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

During
2003, we entered into forward contracts to hedge a portion of the anticipated
NIS payroll payments for periods of one to six months. These forward contracts
are designated as cash flows hedges, as defined by SFAS No. 133, as amended,
and are all highly effective as hedges of these expenses when the salary is
recorded. The effective portion of the hedged instruments is included in
payroll expenses in the statement of operations. During the year ended December
31, 2003, we recognized net income of $426,000 related to the forward contracts
hedging salary payments. At December 31, 2003, we expected to reclassify
$145,000 of net profit on derivative instruments from accumulated other
comprehensive income to earnings during the next twelve months.

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

During
the year ended December 31, 2005, we recognized net loss of $151,000 related to
the forward contracts hedging salary payments. At December 31, 2005, we
expected to reclassify $84,000 of net profit on derivative instruments from
accumulated other comprehensive income to earnings during the next twelve
months.

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

-102-

---

---



PART II

| |                   |                                                                               
| | ----------------- | ------------------------------------------------------------------------------
| | ITEM 13.          | DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES                               
| |                   |                                                                               
| | Not
  applicable.
| |                  
| | ITEM 14.          | MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF
  PROCEEDS
|
| | Not applicable   
| |                   |                                                                               
| | ITEM 15.          | CONTROLS AND PROCEDURES                                                       

As
of the end of the period covered by this report, we performed an evaluation of
the effectiveness of the design and operation of our disclosure controls and
procedures (as such term is defined in Rule 15d-15(e) under the Exchange Act).
The evaluation was performed with the participation of our key corporate senior
management and under the supervision and with the participation of our chief
executive officer and chief financial officer. Based on this evaluation, our
principal executive officer and principal financial officer have concluded that
our disclosure controls and procedures are designed to ensure that information
required to be disclosed by us in the reports that we file or submit under the
Securities Exchange Act of 1934 is (i) recorded, processed, summarized and
reported, within the time periods specified in the Commissions rules and forms
and (ii) accumulated and communicated to our management, including our
principal executive and principal financial officers, as appropriate to allow
timely decisions regarding required disclosure.

In
addition, no changes in our internal control over financial reporting have
occurred during the period covered by this Annual Report that have materially
affected our internal controls 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

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

-103-

---

---



| |           |                                       
| | --------- | --------------------------------------
| | 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, 2005. The following table presents the aggregate fees
for professional audit services and other services rendered by Kost Forer
Gabbay & Kasierer in 2004 and 2005.

|                     |  |                                                  |     |      |  |     | 
|-------------------- |  | ------------------------------------------------ | --- | ---- |  | --- | 
|                     |  | Year ended December 31,
  (Amounts in thousands) |    
|                     |  |                                                  |    
|                     |  | 2004                                             |     | 2005 | 
|                     |  |                                                  |     |      | 
|Audit Fees           |  |                                                  | 80  |      |  | 115 | 
|Audit
  Related Fees |  |                                                  | 230 |      |  | 51  | 
|Tax Fees             |  |                                                  | 53  |      |  | 65  | 
|All Other
  Fees     |  |                                                  |    |      |  | 4   | 
|                     |  |                                                  |     |      |  |     | 
|Total                |  |                                                  | 363 |      |  | 235 | 
|                     |  |                                                  |     |      |  |     | 

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

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

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

Audit Committee Pre-approval Policies and
Procedures

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

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

-104-

---

---



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

During
2005, 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-39 hereto.

-105-

---

---



| |                                                                   | 
| | ----------------------------------------------------------------- | 
| | ITEM 19.                                                          | 
| |                                                                   | 
| | The
  following exhibits are filed as part of this Annual Report:

|           |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|---------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|ExhibitNo. |  | Exhibit                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|           |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|           |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|1.1        |  | Memorandum of Association of Registrant.*                                                                                                                                                                                                                                                                                                                                                                                                                                        
|           |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|1.2        |  | Articles of Association of Registrant, as amended.**                                                                                                                                                                                                                                                                                                                                                                                                                              
|           |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|2.1        |  | Indenture, dated November 9, 2004, between AudioCodes Ltd. and U.S.
  Bank National Association, as Trustee, with respect to the 2.))% Senior
  Convertible Notes due 2024.****                                                                                                                                                                                                                                                                                                   
|           |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|4.1        |  | AudioCodes Ltd. 1997 Key Employee Option Plan (C).*                                                                                                                                                                                                                                                                                                                                                                                                                               
|           |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|4.2        |  | AudioCodes Ltd. 1997 Key Employee Option Plan, Qualified Stock Option
  PlanU.S. Employees (D).*                                                                                                                                                                                                                                                                                                                                                                                 
|           |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|4.3        |  | Founders Agreement between Shabtai Adlersberg and Leon Bialik, dated
  January 1, 1993.*                                                                                                                                                                                                                                                                                                                                                                                        
|           |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|4.4        |  | 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).*                                                                                                                                                                                                                                                                                                                                                                                 

-106-

---

---



|           |  |                                                                                                                                                                                                                                                                                                 
|---------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|ExhibitNo. |  | Exhibit                                                                                                                                                                                                                                                                                         
|           |  |                                                                                                                                                                                                                                                                                                 
|           |  |                                                                                                                                                                                                                                                                                                 
|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.§                                                                                                                                                                                                                              
|           |  |                                                                                                                                                                                                                                                                                                 
|4.13       |  | AudioCodes Ltd. 2001 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.§§                                                                                                                                                                                   
|           |  |                                                                                                                                                                                                                                                                                                 
|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       |  | Registration Rights Agreement, dated as of November 9, 2004, between
  AudioCodes Ltd. and Merrill Lynch, Pierce, Fenner & Smith
  Incorporated, Lehman Brothers Inc. and CIBC World Markets Corp.****                                                                                          
|           |  |                                                                                                                                                                                                                                                                                                 
|4.22       |  | Amendment
  No. 2 to OEM Purchase and Sale No. 011449 between AudioCodes Ltd and Nortel
  Networks Ltd., dated as of January 1, 2005 *****§§§                                                                                                                                                   
|           |  |                                                                                                                                                                                                                                                                                                 
|4.23       |  | Amendment
  No. 3 to OEM Purchase and Sale No. 011449 between AudioCodes Ltd and Nortel
  Networks Ltd., dated as of February 15, 2005 *****§§§                                                                                                                                                 
|           |  |                                                                                                                                                                                                                                                                                                 
|4.24       |  | Amendment
  No. 5 to OEM Purchase and Sale No. 011449 between AudioCodes Ltd and Nortel
  Networks Ltd., dated as of January 1, 2005 *****§§§                                                                                                                                                   
|           |  |                                                                                                                                                                                                                                                                                                 
|4.25       |  | Amendment
  No. 6 to OEM Purchase and Sale No. 011449 between AudioCodes Ltd and Nortel
  Networks Ltd., dated as of April 1, 2005 §§§                                                                                                                                                          

-107-

---

---



|           |  |                                                                                                                                                                                                           
|---------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|ExhibitNo. |  | Exhibit                                                                                                                                                                                                   
|           |  |                                                                                                                                                                                                           
|           |  |                                                                                                                                                                                                           
|4.26       |  | Lease Agreement between AudioCodes Inc. and CA-Gateway Office Limited
  Partnership, effective as of December, 2004. §§§                                                                                  
|           |  |                                                                                                                                                                                                           
|4.27       |  | Amendment No. 4 to OEM Purchase and Sale No. 011449 between
  AudioCodes Ltd and Nortel Networks Ltd., dated as of April 28, 2005 #                                                                       
|           |  |                                                                                                                                                                                                           
|4.28       |  | 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.
|           |  |                                                                                                                                                                                                           
|8.1        |  | Subsidiaries of the Registrant.                                                                                                                                                                           
|           |  |                                                                                                                                                                                                           
|12.1       |  | Certification of Shabtai Adlersberg, President and Chief Executive
  Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                                                   
|           |  |                                                                                                                                                                                                           
|12.2       |  | Certification of Nachum Falek, Vice President and Chief Financial
  Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                                                    
|           |  |                                                                                                                                                                                                           
|13.1       |  | Certification by Chief Executive Officer Pursuant to 18 U.S.C.
  Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of
  2002.                                                    
|           |  |                                                                                                                                                                                                           
|13.2       |  | Certification by Chief Financial Officer Pursuant to 18 U.S.C.
  Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of
  2002.                                                    
|           |  |                                                                                                                                                                                                           
|14.1       |  | Consent of Kost Forer Gabbay & Kasierer, a member of Ernst &
  Young Global.                                                                                                                              

|      |                                                                                                                                                                                                                                                                                            
|----- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|     
|*     | Incorporated herein by reference to Registrants Registration
  Statement on Form F-1 (File No. 333-10352) .                                                                                                                                                                               
|      |                                                                                                                                                                                                                                                                                            
|     | Hebrew original and English summary of Hebrew original.                                                                                                                                                                                                                                    
|      |                                                                                                                                                                                                                                                                                            
|    | English summary of Hebrew original.                                                                                                                                                                                                                                                        
|      |                                                                                                                                                                                                                                                                                            
|     | Incorporated herein by reference to Registrants Registration
  Statement on Form S-8 (File No. 333-13268) .                                                                                                                                                                               
|      |                                                                                                                                                                                                                                                                                            
|§     | Incorporated herein by reference to Registrants Registration
  Statement on Form S-8 (File No. 333-13378) .                                                                                                                                                                               
|      |                                                                                                                                                                                                                                                                                            
|**    | Incorporated herein by reference to Registrants Form 20-F for the
  fiscal year ended December 31, 2000.                                                                                                                                                                                  
|      |                                                                                                                                                                                                                                                                                            
|***   | Incorporated herein by reference to Registrants Form 20-F for the fiscal
  year ended December 31, 2002.                                                                                                                                                                                  
|      |                                                                                                                                                                                                                                                                                            
|****  | Incorporated by reference herein to Registrants Registration
  Statement on Form F-3 (File No. 333-123859).                                                                                                                                                                               
|      |                                                                                                                                                                                                                                                                                            
|***** | Confidential treatment has been granted for certain portions of the
  indicated document. The confidential portions have been omitted and filed
  separately with the Securities and Exchange Commission as required by Rule
  24b-2 promulgated under the Securities Exchange Act of 1934.

-108-

---

---



|    |                                                                                                                                                                                                                                                                                               
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|§§  | 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                                                                                                                                                                                      
|    |                                                                                                                                                                                                                                                                                               
|#   | 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.

-109-

---

---



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
  29, 2006 |                 |                                                     

---

---



EXHIBIT INDEX

|           |  |                                                                                                                                                                                                           
|---------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|ExhibitNo. |  | Exhibit                                                                                                                                                                                                   
|           |  |                                                                                                                                                                                                           
|           |  |                                                                                                                                                                                                           
|4.27       |  | Amendment No. 4 to OEM Purchase and Sale No. 011449 between
  AudioCodes Ltd and Nortel Networks Ltd., dated as of April 28, 2005 *                                                                       
|           |  |                                                                                                                                                                                                           
|4.28       |  | 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.
|           |  |                                                                                                                                                                                                           
|8.1        |  | Subsidiaries of the Registrant.                                                                                                                                                                           
|           |  |                                                                                                                                                                                                           
|12.1       |  | Certification of Shabtai Adlersberg, President and Chief Executive
  Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                  
|           |  |                                                                                                                                                                                                           
|12.2       |  | Certification of Nachum Falek, Vice President and Chief Financial
  Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                   
|           |  |                                                                                                                                                                                                           
|13.1       |  | Certification by Chief Executive Officer Pursuant to 18 U.S.C.
  Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of
  2002.                                                    
|           |  |                                                                                                                                                                                                           
|13.2       |  | Certification by Chief Financial Officer Pursuant to 18 U.S.C.
  Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of
  2002.                                                    
|           |  |                                                                                                                                                                                                           
|14.1       |  | Consent of Kost Forer and Gabbay & Kasierer, a member of Ernst
  & Young Global.                                                                                                                          

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

---

---

AUDIOCODES LTD. AND
ITS SUBSIDIARIES

CONSOLIDATED FINANCIAL STATEMENTS

AS OF DECEMBER 31, 2005

IN U.S. DOLLARS

INDEX

|                                                          |           
|--------------------------------------------------------- | ----------
|                                                          | Page      
|                                                          |           
|                                                          |           
|Report of Independent Registered Public Accounting
  Firm | F-2       
|                                                          |           
|Consolidated Balance Sheets                               | F-3 - F-4 
|                                                          |           
|Consolidated Statements of Operations                     | F-5       
|                                                          |           
|Statements of Changes in Shareholders
  Equity           | F-6       
|                                                          |           
|Consolidated Statements of Cash Flows                     | F-7 - F-8 
|                                                          |           
|Notes to Consolidated Financial Statements                | F-9 - F-39

---

---



REPORT OF
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders of

AUDIOCODES LTD.

We have
audited the accompanying consolidated balance sheets of AudioCodes Ltd. (the
Company) and its subsidiaries as of December 31, 2004 and 2005, 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,
2005. These financial statements are the responsibility of the Companys
management. Our responsibility is to express an opinion on these financial
statements and schedule based on our audits.

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

In our
opinion, the consolidated financial statements referred to above, present
fairly, in all material respects, the consolidated financial position of the
Company and its subsidiaries at December 31, 2004 and 2005, and the related consolidated
results of their operations and their cash flows for each of the three years in
the period ended December 31, 2005, in conformity with U.S. generally accepted
accounting principles.

|                 |  |                                 
|---------------- |  | --------------------------------
|Tel-Aviv, Israel |  | KOST FORER GABBAY & KASIERER    
|February 1, 2006 |  | A Member of Ernst & Young Global

F - 2

---

---



AUDIOCODES LTD. AND ITS SUBSIDIARIES

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

|                                                                                                                               |  |                |         |      |   |         | 
|------------------------------------------------------------------------------------------------------------------------------ |  | -------------- | ------- | ---- | - | ------- | 
|                                                                                                                               |  | December
  31, |        
|                                                                                                                               |  |                |        
|                                                                                                                               |  | 2004           |         | 2005 |  
|                                                                                                                               |  |                |         |      |  
|                                                                                                                               |  |                |         |      |   |         | 
|ASSETS                                                                                                                         |  |                |         |      |   |         | 
|                                                                                                                               |  |                |         |      |   |         | 
|CURRENT ASSETS:                                                                                                                |  |                |         |      |   |         | 
|Cash and cash equivalents                                                                                                      |  | $              | 166,832 |      | $ | 70,957  | 
|Short-term bank deposits and structured
  note                                                                                 |  |                | -       |      |   | 61,929  | 
|Short-term marketable securities and
  accrued interest                                                                        |  |                | -       |      |   | 9,863   | 
|Trade receivables (net of allowance for
  doubtful accounts of $685 and $553 as of December 31, 2004 and 2005,
  respectively) |  |                | 14,470  |      |   | 17,990  | 
|Other receivables and prepaid expenses                                                                                         |  |                | 4,608   |      |   | 4,891   | 
|Inventories                                                                                                                    |  |                | 10,059  |      |   | 11,562  | 
|                                                                                                                               |  |                |         |      |   |         | 
|                                                                                                                               |  |                |         |      |   |         | 
|Total current assets                                                                                                           |  |                | 195,969 |      |   | 177,192 | 
|                                                                                                                               |  |                |         |      |   |         | 
|                                                                                                                               |  |                |         |      |   |         | 
|LONG-TERM INVESTMENTS:                                                                                                         |  |                |         |      |   |         | 
|Long-term bank deposits and structured
  notes                                                                                 |  |                | 50,195  |      |   | 27,781  | 
|Long-term marketable securities                                                                                                |  |                | -       |      |   | 49,791  | 
|Investment in affiliated companies                                                                                             |  |                | 487     |      |   | 1,112   | 
|Deferred tax assets                                                                                                            |  |                | -       |      |   | 2,489   | 
|Severance pay funds                                                                                                            |  |                | 4,538   |      |   | 5,406   | 
|                                                                                                                               |  |                |         |      |   |         | 
|                                                                                                                               |  |                |         |      |   |         | 
|Total long-term investments                                                                                                    |  |                | 55,220  |      |   | 86,579  | 
|                                                                                                                               |  |                |         |      |   |         | 
|                                                                                                                               |  |                |         |      |   |         | 
|PROPERTY AND EQUIPMENT, NET                                                                                                    |  |                | 6,694   |      |   | 6,494   | 
|                                                                                                                               |  |                |         |      |   |         | 
|                                                                                                                               |  |                |         |      |   |         | 
|INTANGIBLE ASSETS, DEFERRED CHARGES AND
  OTHER, NET                                                                           |  |                | 5,127   |      |   | 3,279   | 
|                                                                                                                               |  |                |         |      |   |         | 
|                                                                                                                               |  |                |         |      |   |         | 
|GOODWILL                                                                                                                       |  |                | 9,135   |      |   | 18,679  | 
|                                                                                                                               |  |                |         |      |   |         | 
|                                                                                                                               |  |                |         |      |   |         | 
|Total assets                                                                                                                   |  | $              | 272,145 |      | $ | 292,223 | 
|                                                                                                                               |  |                |         |      |   |         | 

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

F - 3

---

---



AUDIOCODES LTD. AND ITS SUBSIDIARIES

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

|                                                                                                                                                                                                            |  |                |         |      |   |         |  
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | -------------- | ------- | ---- | - | ------- | -
|                                                                                                                                                                                                            |  | December
  31, |        
|                                                                                                                                                                                                            |  |                |        
|                                                                                                                                                                                                            |  | 2004           |         | 2005 |  
|                                                                                                                                                                                                            |  |                |         |      |  
|                                                                                                                                                                                                            |  |                |         |      |   |         |  
|LIABILITIES AND SHAREHOLDERS EQUITY                                                                                                                                                                        |  |                |         |      |   |         |  
|                                                                                                                                                                                                            |  |                |         |      |   |         |  
|CURRENT
  LIABILITIES:                                                                                                                                                                                      |  |                |         |      |   |         |  
|Trade payables                                                                                                                                                                                              |  | $              | 6,541   |      | $ | 7,774   |  
|Other payables and accrued expenses                                                                                                                                                                         |  |                | 17,981  |      |   | 18,620  |  
|                                                                                                                                                                                                            |  |                |         |      |   |         |  
|                                                                                                                                                                                                            |  |                |         |      |   |         |  
|Total
  current liabilities                                                                                                                                                                                 |  |                | 24,522  |      |   | 26,394  |  
|                                                                                                                                                                                                            |  |                |         |      |   |         |  
|                                                                                                                                                                                                            |  |                |         |      |   |         |  
|ACCRUED
  SEVERANCE PAY                                                                                                                                                                                     |  |                | 4,978   |      |   | 5,887   |  
|                                                                                                                                                                                                            |  |                |         |      |   |         |  
|                                                                                                                                                                                                            |  |                |         |      |   |         |  
|SENIOR
  CONVERTIBLE NOTES                                                                                                                                                                                  |  |                | 120,660 |      |   | 120,836 |  
|                                                                                                                                                                                                            |  |                |         |      |   |         |  
|                                                                                                                                                                                                            |  |                |         |      |   |         |  
|COMMITMENTS
  AND CONTINGENT LIABILITIES                                                                                                                                                                    |  |                |         |      |   |         |  
|                                                                                                                                                                                                            |  |                |         |      |   |         |  
|SHAREHOLDERS
  EQUITY:                                                                                                                                                                                     |  |                |         |      |   |         |  
|Share capital -                                                                                                                                                                                             |  |                |         |      |   |         |  
|Ordinary shares of NIS 0.01 par value-                                                                                                                                                                      |  |                |         |      |   |         |  
|Authorized: 100,000,000 as of December 31, 2004 and 2005;                                                                                                                                                   |  |                |         |      |   |         |  
|Issued: 43,808,132
  shares as of December 31, 2004 and 44,529,943 shares as of December 31,
  2005; Outstanding: 39,865,993 shares as of December 31, 2004 and 40,587,804
  shares as of December 31, 2005 |  |                | 126     |      |   | 128     |  
|Additional paid-in capital                                                                                                                                                                                  |  |                | 126,700 |      |   | 130,616 |  
|Treasury stock                                                                                                                                                                                              |  |                | (11,320 | )    |   | (11,320 | )
|Deferred stock compensation                                                                                                                                                                                 |  |                | (108    | )    |   | (72     | )
|Accumulated other comprehensive income                                                                                                                                                                      |  |                | 353     |      |   | 84      |  
|Retained earnings                                                                                                                                                                                           |  |                | 6,234   |      |   | 19,670  |  
|                                                                                                                                                                                                            |  |                |         |      |   |         |  
|                                                                                                                                                                                                            |  |                |         |      |   |         |  
|Total
  shareholders equity                                                                                                                                                                                |  |                | 121,985 |      |   | 139,106 |  
|                                                                                                                                                                                                            |  |                |         |      |   |         |  
|                                                                                                                                                                                                            |  |                |         |      |   |         |  
|Total
  liabilities and shareholders equity                                                                                                                                                                |  | $              | 272,145 |      | $ | 292,223 |  
|                                                                                                                                                                                                            |  |                |         |      |   |         |  

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

F - 4

---

---



AUDIOCODES LTD. AND ITS SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS


---

U.S.
dollars in thousands, except per share data


|                                                |  |                         |        |      |   |        |  |   |         | 
|----------------------------------------------- |  | ----------------------- | ------ | ---- | - | ------ |  | - | ------- | 
|                                                |  | Year ended December 31, |       
|                                                |  |                         |       
|                                                |  | 2003                    |        | 2004 |   | 2005   | 
|                                                |  |                         |        |      |   |        | 
|                                               
|Revenues                                        |  | $                       | 44,228 |      | $ | 82,756 |  | $ | 115,827 | 
|Cost of revenues                                |  |                         | 20,037 |      |   | 34,375 |  |   | 46,993  | 
|                                                |  |                         |        |      |   |        |  |   |         | 
|                                                |  |                         |        |      |   |        |  |   |         | 
|Gross profit                                    |  |                         | 24,191 |      |   | 48,381 |  |   | 68,834  | 
|                                                |  |                         |        |      |   |        |  |   |         | 
|                                                |  |                         |        |      |   |        |  |   |         | 
|Operating expenses:                             |  |                         |        |      |   |        |  |   |         | 
|Research
  and development, net                 |  |                         | 15,476 |      |   | 20,009 |  |   | 24,415  | 
|Selling
  and marketing                         |  |                         | 14,537 |      |   | 19,891 |  |   | 25,944  | 
|General
  and administrative                    |  |                         | 4,066  |      |   | 4,851  |  |   | 6,004   | 
|                                                |  |                         |        |      |   |        |  |   |         | 
|                                                |  |                         |        |      |   |        |  |   |         | 
|Total operating expenses                        |  |                         | 34,079 |      |   | 44,751 |  |   | 56,363  | 
|                                                |  |                         |        |      |   |        |  |   |         | 
|                                                |  |                         |        |      |   |        |  |   |         | 
|Operating income (loss)                         |  |                         | (9,888 | )    |   | 3,630  |  |   | 12,471  | 
|Financial income, net                           |  |                         | 1,883  |      |   | 2,165  |  |   | 2,457   | 
|Equity in losses of affiliated companies,
  net |  |                         | 429    |      |   | 516    |  |   | 693     | 
|                                                |  |                         |        |      |   |        |  |   |         | 
|                                                |  |                         |        |      |   |        |  |   |         | 
|Income (loss) before taxes on income            |  |                         | (8,434 | )    |   | 5,279  |  |   | 14,235  | 
|Taxes on income                                 |  |                         | -      |      |   | 273    |  |   | 799     | 
|                                                |  |                         |        |      |   |        |  |   |         | 
|                                                |  |                         |        |      |   |        |  |   |         | 
|Net income (loss)                               |  | $                       | (8,434 | )    | $ | 5,006  |  | $ | 13,436  | 
|                                                |  |                         |        |      |   |        |  |   |         | 
|                                                |  |                         |        |      |   |        |  |   |         | 
|Basic net earnings (loss) per share             |  | $                       | (0.22  | )    | $ | 0.13   |  | $ | 0.33    | 
|                                                |  |                         |        |      |   |        |  |   |         | 
|                                                |  |                         |        |      |   |        |  |   |         | 
|Diluted net earnings (loss) per share           |  | $                       | (0.22  | )    | $ | 0.12   |  | $ | 0.31    | 
|                                                |  |                         |        |      |   |        |  |   |         | 

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

F - 5

---

---



AUDIOCODES LTD. AND ITS SUBSIDIARIES

STATEMENTS
OF CHANGES IN SHAREHOLDERS EQUITY


---

U.S.
dollars in thousands


|                                                                               |  |                 |     |                                |   |                  |  |                                 |         |                                              |   |                     |   |                                        |      |                                |   |        |   |   |        |   |   |         |  
|------------------------------------------------------------------------------ |  | --------------- | --- | ------------------------------ | - | ---------------- |  | ------------------------------- | ------- | -------------------------------------------- | - | ------------------- | - | -------------------------------------- | ---- | ------------------------------ | - | ------ | - | - | ------ | - | - | ------- | -
|                                                                               |  | Share
  capital |     | Additional
  paid-in
  capital |   | Treasury
  stock |  | Deferred
  stock
  compensation |         | Accumulated
  other
  comprehensive
  income |   | Retained
  earnings |   | Total
  comprehensive 
  income (loss) |      | Total
  shareholders
  equity |  
|                                                                               |  |                 |     |                                |   |                  |  |                                 |         |                                              |   |                     |   |                                        |      |                                |  
|                                                                              
|Balance as of January 1, 2003                                                  |  | $               | 120 |                                | $ | 114,635          |  | $                               | (11,105 | )                                            | $ | -                   |   | $                                      | 72   |                                | $ | 9,662  |   |   |        |   | $ | 113,384 |  
|                                                                               |  |                 |     |                                |   |                  |  |                                 |         |                                              |   |                     |   |                                        |      |                                |   |        |   |   |        |   |   |         |  
|Purchase of treasury
stock                                                     |  |                 | -   |                                |   | -                |  |                                 | (215    | )                                            |   | -                   |   |                                        | -    |                                |   | -      |   |   |        |   |   | (215    | )
|Issuance of shares upon
exercise of options and employee stock
  purchase plan |  |                 | 1   |                                |   | 1,659            |  |                                 | -       |                                              |   | -                   |   |                                        | -    |                                |   | -      |   |   |        |   |   | 1,660   |  
|Deferred stock
compensation                                                    |  |                 | -   |                                |   | 224              |  |                                 | -       |                                              |   | (224                | ) |                                        | -    |                                |   | -      |   |   |        |   |   | -       |  
|Amortization of deferred stock
compensation                                    |  |                 | -   |                                |   | -                |  |                                 | -       |                                              |   | 50                  |   |                                        | -    |                                |   | -      |   |   |        |   |   | 50      |  
|Comprehensive loss,
net:                                                       |  |                 |     |                                |   |                  |  |                                 |         |                                              |   |                     |   |                                        |      |                                |   |        |   |   |        |   |   |         |  
|Unrealized gain on forward
contracts, net                                      |  |                 | -   |                                |   | -                |  |                                 | -       |                                              |   | -                   |   |                                        | 73   |                                |   | -      |   | $ | 73     |   |   | 73      |  
|Net loss                                                                       |  |                 | -   |                                |   | -                |  |                                 | -       |                                              |   | -                   |   |                                        | -    |                                |   | (8,434 | ) |   | (8,434 | ) |   | (8,434  | )
|                                                                               |  |                 |     |                                |   |                  |  |                                 |         |                                              |   |                     |   |                                        |      |                                |   |        |   |   |        |   |   |         |  
|Total comprehensive loss,
net                                                  |  |                 |     |                                |   |                  |  |                                 |         |                                              |   |                     |   |                                        |      |                                |   |        |   | $ | (8,361 | ) |   |         |  
|                                                                               |  |                 |     |                                |   |                  |  |                                 |         |                                              |   |                     |   |                                        |      |                                |   |        |   |   |        |   |   |         |  
|Balance as of December 31, 2003                                                |  |                 | 121 |                                |   | 116,518          |  |                                 | (11,320 | )                                            |   | (174                | ) |                                        | 145  |                                |   | 1,228  |   |   |        |   |   | 106,518 |  
|                                                                               |  |                 |     |                                |   |                  |  |                                 |         |                                              |   |                     |   |                                        |      |                                |   |        |   |   |        |   |   |         |  
|Issuance of shares upon
exercise of options and employee stock
  purchase plan |  |                 | 5   |                                |   | 10,182           |  |                                 | -       |                                              |   | -                   |   |                                        | -    |                                |   | -      |   |   |        |   |   | 10,187  |  
|Amortization of deferred stock
compensation                                    |  |                 | -   |                                |   | -                |  |                                 | -       |                                              |   | 66                  |   |                                        | -    |                                |   | -      |   |   |        |   |   | 66      |  
|Comprehensive income,
net:                                                     |  |                 |     |                                |   |                  |  |                                 |         |                                              |   |                     |   |                                        |      |                                |   |        |   |   |        |   |   |         |  
|Unrealized gain on forward
contracts, net                                      |  |                 | -   |                                |   | -                |  |                                 | -       |                                              |   | -                   |   |                                        | 208  |                                |   | -      |   | $ | 208    |   |   | 208     |  
|Net income                                                                     |  |                 | -   |                                |   | -                |  |                                 | -       |                                              |   | -                   |   |                                        | -    |                                |   | 5,006  |   |   | 5,006  |   |   | 5,006   |  
|                                                                               |  |                 |     |                                |   |                  |  |                                 |         |                                              |   |                     |   |                                        |      |                                |   |        |   |   |        |   |   |         |  
|Total comprehensive income,
net                                                |  |                 |     |                                |   |                  |  |                                 |         |                                              |   |                     |   |                                        |      |                                |   |        |   | $ | 5,214  |   |   |         |  
|                                                                               |  |                 |     |                                |   |                  |  |                                 |         |                                              |   |                     |   |                                        |      |                                |   |        |   |   |        |   |   |         |  
|Balance as of December 31, 2004                                                |  |                 | 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 |  
|                                                                               |  |                 |     |                                |   |                  |  |                                 |         |                                              |   |                     |   |                                        |      |                                |   |        |   |   |        |   |   |         |  

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

F - 6

---

---



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

|                                                                                                                |  |                           |         |      |   |         |   |   |          |  
|--------------------------------------------------------------------------------------------------------------- |  | ------------------------- | ------- | ---- | - | ------- | - | - | -------- | -
|                                                                                                                |  | Year ended
  December 31, |        
|                                                                                                                |  |                           |        
|                                                                                                                |  | 2003                      |         | 2004 |   | 2005    |  
|                                                                                                                |  |                           |         |      |   |         |  
|Cash flows from operating
  activities:                                                                         |  |                           |         |      |   |         |   |   |          |  
|Net income (loss)                                                                                               |  | $                         | (8,434  | )    | $ | 5,006   |   | $ | 13,436   |  
|Adjustments required to
  reconcile net income (loss) to net cash provided by (used in) operating
  activities: |  |                           |         |      |   |         |   |   |          |  
|Depreciation and
amortization                                                                                   |  |                           | 3,040   |      |   | 2,979   |   |   | 3,369    |  
|Amortization of marketable
  securities premiums and accretion of discounts, net                                |  |                           | -       |      |   | -       |   |   | 143      |  
|Equity in losses of affiliated
  companies, net                                                                 |  |                           | 429     |      |   | 516     |   |   | 693      |  
|Amortization of deferred stock
  compensation                                                                   |  |                           | 50      |      |   | 66      |   |   | 36       |  
|Amortization of senior
  convertible notes discount and deferred charges                                        |  |                           | -       |      |   | 28      |   |   | 198      |  
|Decrease (increase) in accrued
  interest on marketable securities, bank deposits and structured notes          |  |                           | (270    | )    |   | 75      |   |   | (736     | )
|Increase in trade receivables,
  net                                                                            |  |                           | (3,274  | )    |   | (4,907  | ) |   | (3,520   | )
|Decrease (increase) in other
  receivables and prepaid expenses                                                 |  |                           | (940    | )    |   | (1,248  | ) |   | 57       |  
|Decrease (increase) in
  inventories                                                                            |  |                           | 10      |      |   | (3,712  | ) |   | (1,503   | )
|Increase in deferred tax
  assets                                                                               |  |                           | -       |      |   | -       |   |   | (2,033   | )
|Increase in trade
payables                                                                                      |  |                           | 1,795   |      |   | 1,329   |   |   | 1,233    |  
|Increase in other payables and
  accrued expenses                                                               |  |                           | 1,145   |      |   | 3,155   |   |   | 1,914    |  
|Increase in accrued severance
  pay, net                                                                        |  |                           | 20      |      |   | 68      |   |   | 41       |  
|Other                                                                                                           |  |                           | -       |      |   | 98      |   |   | (12      | )
|                                                                                                                |  |                           |         |      |   |         |   |   |          |  
|                                                                                                               
|Net cash provided by (used in)
  operating activities                                                           |  |                           | (6,429  | )    |   | 3,453   |   |   | 13,316   |  
|                                                                                                                |  |                           |         |      |   |         |   |   |          |  
|Cash flows from investing
  activities:                                                                         |  |                           |         |      |   |         |   |   |          |  
|Investments in affiliated
  companies                                                                           |  |                           | (621    | )    |   | (512    | ) |   | (1,318   | )
|Short-term loan to unrelated
  company                                                                          |  |                           | -       |      |   | -       |   |   | (350     | )
|Purchase of property and
  equipment                                                                            |  |                           | (1,997  | )    |   | (4,257  | ) |   | (2,393   | )
|Proceeds from sale of property
  and equipment                                                                  |  |                           | -       |      |   | 6       |   |   | 96       |  
|Investment in short-term bank
  deposits                                                                        |  |                           | -       |      |   | -       |   |   | (33,969  | )
|Proceeds from sale of
  short-term bank deposits                                                                |  |                           | 63,074  |      |   | -       |   |   | 3,969    |  
|Investment in long-term bank
  deposits and structured notes                                                    |  |                           | (50,000 | )    |   | (18,000 | ) |   | (20,000  | )
|Proceeds from structured notes
  called by the issuer                                                           |  |                           | -       |      |   | 18,000  |   |   | 10,000   |  
|Investment in short-term and
  long-term marketable securities                                                  |  |                           | -       |      |   | -       |   |   | (59,060  | )
|Payment for acquisition of
  Universal Audio Server (UAS) (1)                                                 |  |                           | (4,373  | )    |   | (2,500  | ) |   | -        |  
|Payment for acquisition of
  Ai-Logix (2)                                                                       |  |                           | -       |      |   | (8,684  | ) |   | (10,000  | )
|                                                                                                                |  |                           |         |      |   |         |   |   |          |  
|                                                                                                               
|Net cash provided by (used in)
  investing activities                                                           |  |                           | 6,083   |      |   | (15,947 | ) |   | (113,025 | )
|                                                                                                                |  |                           |         |      |   |         |   |   |          |  
|Cash flows from financing
  activities:                                                                         |  |                           |         |      |   |         |   |   |          |  
|Proceeds from issuance of
  senior convertible notes                                                            |  |                           | -       |      |   | 125,000 |   |   | -        |  
|Issuance costs for senior
  convertible notes                                                                   |  |                           | -       |      |   | (394    | ) |   | (84      | )
|Initial purchasers discount in
  respect of senior convertible notes                                            |  |                           | -       |      |   | (4,365  | ) |   | -        |  
|Proceeds from issuance of
  shares upon exercise of options and employee stock purchase plan                    |  |                           | 1,660   |      |   | 10,187  |   |   | 3,918    |  
|Purchase of treasury
stock                                                                                      |  |                           | (215    | )    |   | -       |   |   | -        |  
|                                                                                                                |  |                           |         |      |   |         |   |   |          |  
|                                                                                                               
|Net cash provided by financing
  activities                                                                     |  |                           | 1,445   |      |   | 130,428 |   |   | 3,834    |  
|                                                                                                                |  |                           |         |      |   |         |   |   |          |  
|                                                                                                               
|Increase (decrease) in cash
  and cash equivalents                                                              |  |                           | 1,099   |      |   | 117,934 |   |   | (95,875  | )
|Cash and cash equivalents at
  the beginning of the year                                                        |  |                           | 47,799  |      |   | 48,898  |   |   | 166,832  |  
|                                                                                                                |  |                           |         |      |   |         |   |   |          |  
|                                                                                                               
|Cash and cash equivalents at
  the end of the year                                                              |  | $                         | 48,898  |      | $ | 166,832 |   | $ | 70,957   |  
|                                                                                                                |  |                           |         |      |   |         |   |   |          |  
|                                                                                                               
|Supplemental disclosure of
  cash flow activities:                                                              |  |                           |         |      |   |         |   |   |          |  
|Cash paid during the year for
  income taxes                                                                    |  | $                         | 120     |      | $ | 91      |   | $ | 760      |  
|                                                                                                                |  |                           |         |      |   |         |   |   |          |  
|                                                                                                               
|Cash paid during the year for
  interest                                                                        |  | $                         | -       |      | $ | -       |   | $ | 2,500    |  
|                                                                                                                |  |                           |         |      |   |         |   |   |          |  

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, |       
|    |                                                                                                                          |  |                         |       
|    |                                                                                                                          |  | 2003                    |        | 2004 |   | 2005  | 
|    |                                                                                                                          |  |                         |        |      |   |       | 
|(1) | Payment for acquisition of UAS                                                                                           |  |                         |        |      |   |       |  |   |        | 
|    |                                                                                                                          |  |                         |        |      |   |       |  |   |        | 
|    | Net fair value of assets
  acquired of UAS at the date of acquisition (see also Note 1b):                                |  |                         |        |      |   |       |  |   |        | 
|    | Property and
equipment                                                                                                   |  | $                       | 380    |      | $ | -     |  | $ | -      | 
|    | Technology                                                                                                               |  |                         | 1,173  |      |   | -     |  |   | -      | 
|    | Goodwill                                                                                                                 |  |                         | 4,320  |      |   | 1,000 |  |   | -      | 
|    |                                                                                                                          |  |                         |        |      |   |       |  |   |        | 
|    |                                                                                                                          |  |                         |        |      |   |       |  |   |        | 
|    |                                                                                                                          |  |                         | 5,873  |      |   | 1,000 |  |   | -      | 
|    | Paid (unpaid) accrued
  liability                                                                                        |  |                         | (1,500 | )    |   | 1,500 |  |   | -      | 
|    |                                                                                                                          |  |                         |        |      |   |       |  |   |        | 
|    |                                                                                                                          |  |                         |        |      |   |       |  |   |        | 
|    |                                                                                                                          |  | $                       | 4,373  |      | $ | 2,500 |  | $ | -      | 
|    |                                                                                                                          |  |                         |        |      |   |       |  |   |        | 
|    |                                                                                                                          |  |                         |        |      |   |       |  |   |        | 
|(2) | Payment for acquisition of
  Ai-Logix                                                                                    |  |                         |        |      |   |       |  |   |        | 
|    |                                                                                                                          |  |                         |        |      |   |       |  |   |        | 
|    | Net fair value of assets
acquired
  and liabilities assumed of Ai-Logix at the date of acquisition (see also Note
  1c): |  |                         |        |      |   |       |  |   |        | 
|    | Working capital, net
  (excluding cash and cash equivalents)                                                             |  | $                       | -      |      | $ | 1,440 |  | $ | -      | 
|    | Property and
equipment                                                                                                   |  |                         | -      |      |   | 329   |  |   | -      | 
|    | Technology                                                                                                               |  |                         | -      |      |   | 3,100 |  |   | -      | 
|    | Goodwill                                                                                                                 |  |                         | -      |      |   | 3,815 |  |   | 10,000 | 
|    |                                                                                                                          |  |                         |        |      |   |       |  |   |        | 
|    |                                                                                                                          |  |                         |        |      |   |       |  |   |        | 
|    |                                                                                                                          |  | $                       | -      |      | $ | 8,684 |  | $ | 10,000 | 
|    |                                                                                                                          |  |                         |        |      |   |       |  |   |        | 

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

F - 8

---

---



AUDIOCODES LTD. AND ITS SUBSIDIARIES

|                                          
|------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          
|U.S. dollars in
  thousands               

|            |         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|----------- | ------- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 1:    | GENERAL
|            |        
|            | a.      | Business
  overview:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|            |         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|            |         | AudioCodes
  Ltd. (the Company) and its subsidiaries (together the Group) design, develop
  and market enabling technologies and system products for the transmission of
  voice data and fax communications over packet network. The Groups products
  are designed to enable the new voice infrastructure and are sold to original
  equipment manufacturers, network equipment providers, systems integrators and
  distributors in the telecommunications and networking industries.                                                                                                                                                                                                                                                              
|            |         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|            |         | The Company
  operates through its wholly-owned subsidiaries in the United States, United
  Kingdom, Germany, Argentina, Brazil, India and Korea.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|            |         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|            | b.      | Acquisition
  of the Universal Audio Server (UAS) business from Nortel Networks Limited
  (Nortel):                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|            |         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|            |         | On April 7,
  2003, the Group purchased from Nortel selected assets of its UAS business. As
  part of the transaction, Nortel granted the Group a license to use its UAS
  technology and the Group has undertook to act as an exclusive supplier to
  Nortel for its UAS products over a period of three years from the
  acquisition. In addition, the parties have entered into a development agreement
  in relation to future platforms.                                                                                                                                                                                                                                                                                                              
|            |         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|            |         | The
  consideration for the transaction amounted to $5,500 in cash, of which:
  $2,000 was paid at the closing date, $2,000 was paid nine months after the
  closing date, and $1,500 was paid twelve months after the closing date. Under
  the terms of the acquisition agreement (the Agreement), the Group was also
  required to pay $1,000 as a contingent payment, upon Nortel completing
  product integration under the development agreement. In March 2004,  product integration was completed and the
  $1,000 contingent payment was paid and recorded as part of the acquisition
  cost as additional goodwill in accordance with the provisions of Statement of
  Financial Accounting Standards (SFAS) No. 141, Business Combination.
|            |         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|            |         | The acquisition was accounted for under the purchase method of
  accounting in accordance with SFAS No. 141. The results of UAS operations
  have been included in the consolidated financial statements since the
  acquisition date.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|            |         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|            |         | Pro forma information in accordance with SFAS No. 141 has not been
  provided, since the revenues and net income of the UAS business, were not
  material in relation to total consolidated revenues and net loss.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         

F - 9

---

---



AUDIOCODES LTD. AND ITS SUBSIDIARIES

|                                          
|------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          
|U.S. dollars in
  thousands               

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

| |                                     |  |               |       | 
| | ----------------------------------- |  | ------------- | ----- | 
| |                                     |  | April 7, 2003 |      
| |                                     |  |               |      
| |                                     |  |               |       | 
| | Property and equipment              |  | $             | 380   | 
| | Technology (five years useful life) |  |               | 1,173 | 
| | Goodwill *)                         |  |               | 5,320 | 
| |                                     |  |               |       | 
| |                                     |  |               |       | 
| | Total assets acquired               |  | $             | 6,873 | 
| |                                     |  |               |       | 

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

F - 10

---

---



AUDIOCODES LTD. AND ITS SUBSIDIARIES

|                                          
|------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          
|U.S. dollars in
  thousands               

|            |                 |                                                                                                                                                                                                                                                                                                                                                                                                 
|----------- | --------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 1:    | GENERAL (Cont.)
|            |                
|            |                 | The Group paid $10,000 in cash at the closing of the transaction. An additional
  payment of $10,000 in cash was made in March 2005 based on the achievement of
  revenue milestones and additional terms by the Ai-Logix business during 2004
  and 2005. This payment was recorded as part of the acquisition cost as
  additional goodwill in accordance with the provisions of SFAS No. 141.
|            |                 |                                                                                                                                                                                                                                                                                                                                                                                                 
|            |                 | Ai-Logix
  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.                                                                                                                                                                                                                                                                                 
|            |                 |                                                                                                                                                                                                                                                                                                                                                                                                 
|            |                 | Based upon an independent valuation of tangible and intangible assets
  acquired, the Group has allocated the total acquisition cost of Ai-Logixs assets and liabilities, as follows:                                                                                                                                                                                                          

| |                                               |  |              |        |  
| | --------------------------------------------- |  | ------------ | ------ | -
| |                                               |  | May 12, 2004 |       
| |                                               |  |              |        |  
|
| | Trade receivables                             |  | $            | 1,846  |  
| | Inventories                                   |  |              | 1,680  |  
| | Prepaid expenses                              |  |              | 180    |  
| | Property and equipment                        |  |              | 329    |  
| |                                               |  |              |        |  
| |                                               |  |              |        |  
| | Total tangible assets acquired                |  |              | 4,035  |  
| |                                               |  |              |        |  
| |                                               |  |              |        |  
| | Technology (five years useful life)           |  |              | 3,100  |  
| | Goodwill *)                                   |  |              | 13,359 |  
| |                                               |  |              |        |  
| |                                               |  |              |        |  
| | Total intangible assets acquired              |  |              | 16,459 |  
| |                                               |  |              |        |  
| |                                               |  |              |        |  
| | Total tangible and intangible assets acquired |  |              | 20,494 |  
| |                                               |  |              |        |  
| |                                               |  |              |        |  
| | Trade payables                                |  |              | (1,015 | )
| | Accrued expenses                              |  |              | (1,045 | )
| | Other current liabilities                     |  |              | (206   | )
| |                                               |  |              |        |  
| |                                               |  |              |        |  
| | Total liabilities assumed                     |  |              | (2,266 | )
| |                                               |  |              |        |  
| |                                               |  |              |        |  
| | Net assets acquired                           |  | $            | 18,228 |  
| |                                               |  |              |        |  

| |  |                                                                                                                                                                                                                                                                                                                                         |                                                                                                                                                                                                                                                                                                                       
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | *)                                                                                                                                                                                                                                                                                                                                      | During 2005,
  the Company paid an additional payment in the amount of $10,000 out of the
  total acquisition cost which was allocated to goodwill. The goodwill was
  reduced in the amount of $456 upon utilization of preacquisition
  carryforward tax losses in accordance with SFAS No. 141 (see also Note 14).
| |  |                                                                                                                                                                                                                                                                                                                                         |                                                                                                                                                                                                                                                                                                                       
| |  | 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).

F - 11

---

---



AUDIOCODES LTD. AND ITS SUBSIDIARIES

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

|            |                 |                                                                                                                                                                                                                                                                                                                                        
|----------- | --------------- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 1:    | GENERAL (Cont.)
|            |                
|            |                 | 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 market value due to their
  short-term maturity. Property and equipment are presented at current
  replacement cost.                                            
|            |                 |                                                                                                                                                                                                                                                                                                                                        
|            |                 | The value
  assigned to technology amounted to $3,100. The fair value of technology 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
  Ai-Logix been consummated on January 1, 2003 and 2004, respectively, nor does
  it purport to represent the results of operations of the Group for any future
  period.

| |                                         |  |                           |        |      |  
| | --------------------------------------- |  | ------------------------- | ------ | ---- | -
| |                                         |  | Year ended
  December 31, |       
| |                                         |  |                           |       
| |                                         |  | 2003                      |        | 2004 |  
| |                                         |  |                           |        |      |  
| |                                         |  | Unaudited                 |       
| |                                         |  |                           |       
| |                                         |  |                           |       
| | Revenues                                |  | $                         | 57,532 |      | $
| |                                         |  |                           |        |      |  
| |                                         |  |                           |        |      |  
| | Net income
  (loss)                     |  | $                         | (8,045 | )    | $
| |                                         |  |                           |        |      |  
| |                                         |  |                           |        |      |  
| | Basic net
  earnings (loss) per share   |  | $                         | (0.21  | )    | $
| |                                         |  |                           |        |      |  
| |                                         |  |                           |        |      |  
| | Diluted net
  earnings (loss) per share |  | $                         | (0.21  | )    | $
| |                                         |  |                           |        |      |  

| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | d. | The Group is
  dependent upon sole source suppliers for certain key components used in its
  products, including certain digital signal processing chips. Although there
  is a limited number of manufacturers of these particular components,
  management believes that other suppliers could provide similar components at
  comparable terms. A change in suppliers, however, could cause a delay in
  manufacturing and a possible loss of sales, which could adversely affect the
  operating results of the Group and its financial position.
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| | e. | As to a
  major customer data, see Note 17b.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         

F - 12

---

---



AUDIOCODES LTD. AND ITS SUBSIDIARIES

|                                          
|------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          
|U.S. dollars in
  thousands               

|            |                                                                                                                                                              |                                                                                                                                                                                                                                                                                                                                                                                                                       
|----------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------ | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|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 revenues of the Group is generated in U.S. dollars (dollar). In
  addition, a substantial portion of the Groups costs is incurred in dollars.
  The Groups management believes that the dollar is the primary currency of
  the economic environment in which all the Groups entities operate. Thus, the
  functional and reporting currency of each of the Groups entities 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 have been
  eliminated upon consolidation.                                                                                                                                                                                                                    
|            |                                                                                                                                                              |                                                                                                                                                                                                                                                                                                                                                                                                                       
|            | d.                                                                                                                                                           | Cash
  equivalents:                                                                                                                                                                                                                                                                                                                                                                                                   
|            |                                                                                                                                                              |                                                                                                                                                                                                                                                                                                                                                                                                                       
|            |                                                                                                                                                              | Cash equivalents are short-term highly
  liquid investments that are readily convertible into cash with 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 3.23%. The short-term deposits are presented at their cost.
  The accrued interest is included in other receivables and prepaid expenses.                                                                                      
|            |                                                                                                                                                              |                                                                                                                                                                                                                                                                                                                                                                                                                       
|            | 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.                                                                                                                                                                                                                                                      

F - 13

---

---



AUDIOCODES LTD. AND ITS SUBSIDIARIES

|                                          
|------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          
|U.S. dollars in
  thousands               

|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|----------- | --------------------------------------- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 2:    | SIGNIFICANT ACCOUNTING POLICIES (Cont.)
|            |                                        
|            |                                         | 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 operations 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.                                                                                                                                                                                                                                                                                                                                                  
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|            | g.                                      | Inventories:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|            |                                         | Inventories
  are stated at the lower of cost or market value. Cost is determined as
  follows:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|            |                                         | Raw
  materials - using the average cost method.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|            |                                         | Finished
  products  using the average cost 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
  and write-down provisions are provided due to slow moving items,
  technological obsolescence, excess inventories, discontinued products and for
  market prices lower than cost.                                                                                                                                                                                                                                                                                                                                                  
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|            | 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.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|            | i.                                      | Structured
  notes:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|            |                                         | The Group
  accounts for investments in structured notes in accordance with SFAS No. 115,
  Accounting for Certain Investments in Debt and Equity Securities and
  Emerging Issues Task Force (EITF) 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, 2004 and 2005,
  investments in structured notes approximate their market value.

F - 14

---

---



AUDIOCODES LTD. AND ITS SUBSIDIARIES

|                                          
|------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          
|U.S. dollars in
  thousands               

|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                            
|----------- | --------------------------------------- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 2:    | SIGNIFICANT ACCOUNTING POLICIES (Cont.)
|            |                                        
|            | j.                                      | Investment
  in affiliated companies:                                                                                                                                                                                                                                                                                                                                                      
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                            
|            |                                         | The Company
  accounts for its investments in affiliated 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.             
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                            
|            |                                         | Investment
  in affiliated companies represent 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
  the affiliated companies are recognized based on the ownership level of the
  particular investee 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, 2005,
  based on managements most recent analyses, no impairment losses have been
  identified.                                                     
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                            
|            | 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                                                             | 
| | Motor
  vehicles                     |  | 15                                                                 | 
| | Leasehold
  improvements             |  | Over the shorter of the term of the lease or the life of the asset | 

| |    |                                                                                                                                                                                                                                                                                                                               
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | l. | 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.  Accordingly, acquired technology
  is amortized over five years.         
| |    |                                                                                                                                                                                                                                                                                                                               
| |    | 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.

F - 15

---

---



AUDIOCODES LTD. AND ITS SUBSIDIARIES

|                                          
|------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          
|U.S. dollars in
  thousands               

|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|----------- | --------------------------------------- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 2:    | SIGNIFICANT ACCOUNTING POLICIES (Cont.)
|            |                                        
|            | m.                                      | Impairment
  of long-lived assets:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|            |                                         | The Groups
  long-lived assets and certain identifiable intangibles 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, 2005, no impairment losses have been identified.
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|            |                                         | Effective
  October 1, 2003, as a result of the expected relocation of the Companys
  facilities in Israel, the Group changed the estimated useful life of certain
  leasehold improvements and other equipment to four months. The effect of the
  change in estimated useful life on the net loss and net loss per share for
  the year ended December 31, 2003 was $(689) and $(0.02). The annual expected
  effect of this change of estimated useful life for the following years is
  immaterial.                                                                                                                                                                                                                                                                                     
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|            |                                         | Under SFAS
  No. 144, a long-lived group of assets that is to be abandoned is considered
  disposed of when it ceases to be used. Thus, an entity that intends to
  abandon a group of long-lived assets in operations, should evaluate that
  group of assets as held and used and should determine whether it should
  revise its depreciation estimates to reflect a useful life that is shorter
  than initially expected and a salvage value consistent with the intention to
  abandon.                                                                                                                                                                                                                                                                                              
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|            | n.                                      | Goodwill:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|            |                                         | Goodwill
  represents an excess of costs over the fair value of the net assets of
  businesses acquired under SFAS No. 142, Goodwill and Other Intangible
  Assets.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|            |                                         | 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 2005. The test was based on
  the Groups single operating segment and reporting unit structure.  As of December 31, 2005, no impairment
  losses had been identified.                                                                   
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|            | o.                                      | Revenue
  recognition:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|            |                                         | The
  Group generates its revenues primarily from the sale of products. The Group
  sells its 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.                                                                                                                                                                                                                                                                                                                                                     

F - 16

---

---



AUDIOCODES LTD. AND ITS SUBSIDIARIES

|                                          
|------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          
|U.S. dollars in
  thousands               

|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|----------- | --------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 2:    | SIGNIFICANT ACCOUNTING POLICIES (Cont.)
|            |                                        
|            |                                         | 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 in 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 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 their
  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 $294, $619 and $545 as of December 31, 2003, 2004 and 2005,
  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.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|            | 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
  grants received, are charged to the statement of operations as incurred.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 

F - 17

---

---



AUDIOCODES LTD. AND ITS SUBSIDIARIES

|                                          
|------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          
|U.S. dollars in
  thousands               

|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|----------- | --------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 2:    | SIGNIFICANT ACCOUNTING POLICIES (Cont.)
|            |                                        
|            | 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 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.                                                                                                                                                                                                                                                                               
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|            | 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.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|            |                                         | The majority
  of the Groups cash and cash equivalents, bank deposits and structured notes
  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.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|            |                                         | 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. 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 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 No. 00-27 Application of Issue No. 98-5 to Certain
  Convertible Industries, which is 20 years.

F - 18

---

---



AUDIOCODES LTD. AND ITS SUBSIDIARIES

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

|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|----------- | --------------------------------------- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 2:    | SIGNIFICANT ACCOUNTING POLICIES (Cont.)
|            |                                        
|            | u.                                      | Basic and
  diluted net earnings (loss) per share:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|            |                                         | Basic net
  earnings (loss) per share is computed based on the weighted average number of
  Ordinary shares outstanding during each year. Diluted net earnings (loss) per
  share is 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 (loss) per
  Ordinary share since such securities are anti-dilutive for all periods
  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 (loss) per share was
  7,836,696, 4,972,991 and 8,598,556 for the years ended December 31, 2003,
  2004 and 2005, respectively.
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|            | v.                                      | Accounting
  for stock-based compensation:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|            |                                         | The Group
  has elected to follow APB No. 25, Accounting for Stock Issued to Employees
  and FIN No. 44, Accounting for Certain Transactions Involving Stock
  Compensation, in accounting for its employee stock option plans and its
  non-compensatory Employee Share Purchase Plan (ESPP).  Under APB No. 25, when the exercise price
  of the Companys share options is less than the market price of the
  underlying shares on the date of grant, compensation expense is recognized.                                                                                    
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|            |                                         | The Group
  adopted the disclosure provisions of SFAS No. 148, Accounting for
  Stock-Based Compensation - Transition and Disclosure, which amended certain
  provisions of SFAS No. 123 Accounting for Stock-Based Compensation to
  provide alternative methods of transition for an entity that voluntarily
  changes to the fair value based method of accounting for stock-based employee
  compensation, effective as of the beginning of the prior year. The Group
  continues to apply the provisions of APB No. 25, in accounting for
  stock-based compensation.         
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|            |                                         | Pro forma
  information regarding the Groups net income (loss) and net earnings (loss)
  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:                                                                                                                                                                                                                                                                                                                                         

| |                     |  |         |   |         |    |           |  |    |   | 
| | ------------------- |  | ------- | - | ------- | -- | --------- |  | -- | - | 
| |                     |  | 2003    |   | 2004    |    | 2005      | 
| |                     |  |         |   |         |    |           | 
| |                     |  |         |   |         |    |           |  |    |   | 
| | Dividend yield      |  | 0       | % |         | 0  | %         |  | 0  | % | 
| | Expected volatility |  | 108     | % |         | 87 | %         |  | 75 | % | 
| | Risk-free interest  |  | 3       | % |         | 3  | %         |  | 4  | % | 
| | Expected life       |  | 4 years |   | 4 years |    | 4.5 years | 

F - 19

---

---



AUDIOCODES LTD. AND ITS SUBSIDIARIES

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

|            |                                         |                                                                                                                                                     
|----------- | --------------------------------------- | ----------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 2:    | SIGNIFICANT ACCOUNTING POLICIES (Cont.)
|            |                                        
|            |                                         | The
  Black-Scholes pricing-model was used to estimate the fair value of the ESPP
  compensation. Assumptions are not provided due to immateriality.
|            |                                         |                                                                                                                                                     
|            |                                         | Pro forma
  information under SFAS No. 123 is as follows:                                                                                           

| |                                                                                                                                         |  |                           |         |      |   |        |   |   |        |  
| | --------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------- | ------- | ---- | - | ------ | - | - | ------ | -
| |                                                                                                                                         |  | Year ended
  December 31, |        
| |                                                                                                                                         |  |                           |        
| |                                                                                                                                         |  | 2003                      |         | 2004 |   | 2005   |  
| |                                                                                                                                         |  |                           |         |      |   |        |  
| |                                                                                                                                         |  |                           |         |      |   |        |   |   |        |  
| | Net income (loss) as reported                                                                                                           |  | $                         | (8,434  | )    | $ | 5,006  |   | $ | 13,436 |  
| | Add: stock-based compensation
  expenses determined under the intrinsic value based method included in the
  reported net income (loss) |  |                           | 50      |      |   | 66     |   |   | 36     |  
| | Deduct: stock-based
  compensation expenses determined under the fair value based method for all
  awards                               |  |                           | (10,865 | )    |   | (8,509 | ) |   | (8,869 | )
| |                                                                                                                                         |  |                           |         |      |   |        |   |   |        |  
| |                                                                                                                                         |  |                           |         |      |   |        |   |   |        |  
| | Pro forma net income (loss)                                                                                                             |  | $                         | (19,249 | )    | $ | (3,437 | ) | $ | 4,603  |  
| |                                                                                                                                         |  |                           |         |      |   |        |   |   |        |  
| |                                                                                                                                         |  |                           |         |      |   |        |   |   |        |  
| | Basic net earnings (loss) per
  share as reported                                                                                       |  | $                         | (0.22   | )    | $ | 0.13   |   | $ | 0.33   |  
| |                                                                                                                                         |  |                           |         |      |   |        |   |   |        |  
|
| | Diluted net earnings (loss)
  per share as reported                                                                                     |  | $                         | (0.22   | )    | $ | 0.12   |   | $ | 0.31   |  
| |                                                                                                                                         |  |                           |         |      |   |        |   |   |        |  
|
| | Pro forma basic net earning
  (loss) per share                                                                                          |  | $                         | (0.51   | )    | $ | (0.09  | ) | $ | 0.11   |  
| |                                                                                                                                         |  |                           |         |      |   |        |   |   |        |  
|
| | Pro forma diluted net earning
  (loss) per share                                                                                        |  | $                         | (0.51   | )    | $ | (0.09  | ) | $ | 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.                                                                                                                  
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| | 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 surrender value of these policies and
  includes immaterial profits.                                                                                                                                                                    
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| |    | Severance
  expenses for the years ended December 31, 2003, 2004 and 2005, amounted to
  approximately $1,127, $1,182 and $1,514, respectively.                                                                                                                                                                                                                                                                                                                                                                                  

F - 20

---

---



AUDIOCODES LTD. AND ITS SUBSIDIARIES

|                                          
|------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          
|U.S. dollars in
  thousands               

|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|----------- | --------------------------------------- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 2:    | SIGNIFICANT ACCOUNTING POLICIES (Cont.)
|            |                                        
|            | x.                                      | Advertising
  expenses:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|            |                                         | Advertising
  expenses are charged to the statements of operations as incurred. Advertising
  expenses for the years ended December 31, 2003, 2004 and 2005, amounted to
  $211, $359 and $371, respectively.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|            | y.                                      | 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 and structured notes 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.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|            |                                         | The fair
  value of marketable securities is based on quoted prices and do not differ
  significantly from the carrying amount (see Notes 3 and 6).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|            |                                         | The fair
  value of senior convertible notes is based on quoted market values and
  prevailing market rates, and approximates their carrying amount.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|            |                                         | The fair
  value of foreign currency contracts (used for hedging purposes) is estimated
  by obtaining current quotes from banks.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|            | z.                                      | Derivative
  instruments:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|            |                                         | SFAS No.
  133, Accounting for Derivative Instruments and Hedging Activities, requires
  a company to recognize all of its derivative instruments as either assets or
  liabilities in the statement of financial position at fair value. The
  accounting for changes in the fair value (i.e., gains or losses) of a
  derivative instrument depends on whether it has been designated and qualifies
  as part of a hedging relationship and further, on the type of hedging
  relationship. 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.
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|            |                                         | The Group
  uses derivatives instruments to manage exposures to foreign currency related
  to salary payments denominated in New Israeli Shekel (NIS). The Groups
  objectives for holding derivatives are to minimize risks.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|            |                                         | For those
  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 line item
  associated with the forecasted transaction in the same period or periods
  during which the hedged transaction affects earnings.                                                                                                                                                                                                                                       

F - 21

---

---



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

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

| |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |     | Since the
  amounts of forward transactions do not exceed salary payments, those transactions
  are all highly effective and the results are recorded as payroll expenses, at
  the time that the hedged expense is recorded. When the Group hedges payrolls
  for following periods, then the results as of the balance sheet date are
  recorded in other comprehensive income.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| |     | At December
  31, 2005, the Group expects to reclassify $84 of net gains on derivative
  instruments from accumulated other comprehensive income to income during the
  next nine months due to actual payment of variable interest associated with
  the floating rate debt.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| | aa. | Impact of
  recently issued accounting standards:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| |     | On December
  16, 2004, the Financial Accounting Standards Board (FASB) issued Statement No. 123
(revised 2004), Share-Based
  Payment (SFAS No. 123(R)), which is a revision of SFAS No. 123. Generally,
  the approach in SFAS No. 123(R) is similar to the approach described in SFAS
  No. 123. However, SFAS No. 123 permitted, but did not require, share-based
  payments to employees to be recognized based on their fair values while SFAS
  No. 123(R) requires all share-based payments to employees including grants of
  employee stock options and shares issued under the ESPP to be recognized
  based on their fair values. SFAS No. 123(R) also revises, clarifies and
  expands guidance in several areas, including measuring fair value,
  classifying an award as equity or as a liability and attributing compensation
  cost to reporting periods. SFAS No. 123(R) will be effective for periods
  commencing January 1, 2006. SFAS No. 123(R) permits public companies to adopt
  its requirements using either the modified prospective or modified
  retrospective method. The Company currently expects to adopt SFAS No. 123(R),
  using the modified prospective method of adoption in which compensation cost
  is recognized beginning with the effective date (a) based on the requirements
  of Statement SFAS No. 123(R) for all share-based payments granted after the
  effective date and (b) based on the requirements of SFAS No. 123 for all
  awards granted to employees prior to the effective date of SFAS No. 123(R)
  that remain unvested on the effective date.
| |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| |     | In March
  2005, the Securities and Exchange Commission (SEC) released
SEC Staff
  Accounting Bulletin No. 107, Share-Based Payment (SAB 107). SAB 107
  provides the SEC staffs position regarding the application of SFAS No.
  123(R) and contains interpretive guidance related to the interaction between
  SFAS No. 123(R) and certain SEC rules and regulations, and also provides the
  SEC staffs views regarding the valuation of share-based payment arrangements
  for public companies. SAB 107 highlights the importance of disclosures made
  relating to the accounting for share-based payment transactions. The Company
  is currently reviewing the effect of SAB 107 and SFAS No. 123(R) on its
  financial position, results of operations and cash flows. The Company expects
  that the adoption of SFAS No. 123(R) and SAB 107 will have a material effect
  on its financial position and results of operations.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      

F - 22

---

---



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

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

| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | In November
  2004, the FASB issued SFAS No. 151, Inventory Costs, an Amendment of ARB No.
  43, Chapter 4. SFAS No. 151 amends Accounting Research Bulletin (ARB) No.
  43, Chapter 4, to clarify that abnormal amounts of idle facility expense,
  freight handling costs and wasted materials (spoilage) should be recognized
  as current-period charges. In addition, SFAS No. 151 requires that the
  allocation of fixed production overheads to the costs of conversion be based
  on the normal capacity of the production facilities. SFAS No. 151 is
  effective for inventory costs incurred during fiscal years beginning after
  June 15, 2005. The Company does not expect that the adoption of SFAS No. 151
  will have a material effect on its financial position or results of
  operations.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| | In May 2005,
  the FASB issued SFAS No. 154, Accounting Changes and Error Corrections, a
  replacement of APB No. 20, Accounting Changes and SFAS No. 3, Reporting
  Accounting Changes in Interim Financial Statements. SFAS No. 154 provides
  guidance on the accounting for and reporting of accounting changes and error
  corrections. APB No. 20 previously required that most voluntary changes in
  accounting principles be recognized by including in net income for the period
  of the change, the cumulative effect of changing to the new accounting
  principle. SFAS No. 154 requires retroactive application to prior periods
  financial statements of a voluntary change in accounting principles unless it
  is impracticable. SFAS No. 154 is effective for accounting changes and
  corrections of errors made in fiscal years beginning after December 15, 2005.
  As of December 31, 2005, adoption of SFAS No. 154 will not have a material
  impact on the Companys financial position or results of operation.                                                                                                                                                                                                                                                                                       
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| | In November
  2005, the FASB issued FSP FAS 115-1. The FSP addresses the determination as
  to when an investment is considered impaired, whether that impairment is
  other than temporary, and the measurement of an impairment loss. The FSP also
  includes accounting considerations subsequent to the recognition of other
  than-temporary impairment and requires certain disclosures about unrealized
  losses that have not been recognized as other-than-temporary impairments. The
  guidance in this FSP amends SFAS No. 115, Accounting for Certain Investments
  in Debt and Equity. The FSP replaces the impairment evaluation guidance of
  EITF Issue No. 03-1, The Meaning of Other-Than-Temporary Impairment and Its
  Application to Certain Investments, with references to the existing
  other-than-temporary impairment guidance. The FSP clarifies that an investor
  should recognize an impairment loss no later than when the impairment is
  deemed other-than-temporary, even if a decision to sell an impaired security
  has not been made. The guidance in this FSP is to be applied to reporting
  periods beginning after December 15, 2005. As of December 31, 2005, adoption
  of FSP FAS 115-1 will not have a material impact on the Companys financial
  position or results of operations.

F - 23

---

---



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

|            |                                                                                                                          
|----------- | -------------------------------------------------------------------------------------------------------------------------
|NOTE 3:    | SHORT-TERM MARKETABLE SECURITIES AND ACCRUED INTEREST                                                                    
|            |                                                                                                                          
|            | During 2005,
  the Company invested in marketable debt securities which are classified as
  held-to-maturity investments.

|                                              |  |                   |       |                           |   |                |  |   |       | 
|--------------------------------------------- |  | ----------------- | ----- | ------------------------- | - | -------------- |  | - | ----- | 
|                                              |  | December 31, 2005 |      
|                                              |  |                   |      
|                                              |  | Amortized
  cost  |       | Net
  unrealized
  losses |   | Market
  Value | 
|                                              |  |                   |       |                           |   |                | 
|Held-to-maturity - matures
  within one year: |  |                   |       |                           |   |                |  |   |       | 
|                                              |  |                   |       |                           |   |                |  |   |       | 
|Corporate debentures                          |  | $                 | 8,040 |                           | $ | 53             |  | $ | 7,987 | 
|U.S. government and agencies
  debts          |  |                   | 1,000 |                           |   | 4              |  |   | 996   | 
|Accrued interest                              |  |                   | 823   |                           |   | -              |  |   | 823   | 
|                                              |  |                   |       |                           |   |                |  |   |       | 
|                                             
|                                              |  | $                 | 9,863 |                           | $ | 57             |  | $ | 9,806 | 
|                                              |  |                   |       |                           |   |                |  |   |       | 

|            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|----------- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|            | 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, 2005. In addition, the
  unrealized losses are for periods not longer than twelve months.
|            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|NOTE 4:    | INVENTORIES                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       

|                  |  |              |        |      |   |        | 
|----------------- |  | ------------ | ------ | ---- | - | ------ | 
|                  |  | December 31, |       
|                  |  |              |       
|                  |  | 2004         |        | 2005 |  
|                  |  |              |        |      |  
|                 
|Raw materials     |  | $            | 4,384  |      | $ | 4,598  | 
|Finished products |  |              | 5,675  |      |   | 6,964  | 
|                  |  |              |        |      |   |        | 
|                 
|                  |  | $            | 10,059 |      | $ | 11,562 | 
|                  |  |              |        |      |   |        | 

| |                                                                                                                                                                                                                    
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | In the years
  ended December 31, 2003, 2004 and 2005, the Group wrote-off and wrote-down
  inventory in a total amount of $835, $1,237 and $1,168, respectively. These
  amounts are included in cost of revenues.

F - 24

---

---



AUDIOCODES LTD. AND ITS SUBSIDIARIES

|                                          
|------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          
|U.S. dollars in
  thousands               

|            |                                             
|----------- | --------------------------------------------
|NOTE 5:    | LONG-TERM BANK DEPOSITS AND STRUCTURED NOTES

| |                                                                        
| | -----------------------------------------------------------------------
| | Long-term
  bank deposits and structured notes are composed as follows:

| |                                           |  |                           |  |      |   |      |  |      |     |   |  |   |        |  |   |        | 
| | ----------------------------------------- |  | ------------------------- |  | ---- | - | ---- |  | ---- | --- | - |  | - | ------ |  | - | ------ | 
| |                                           |  | December 31,              | 
| |                                           |  |                           | 
| |                                           |  | 2004                      |  | 2005 |   | 2004 |  | 2005 |    
| |                                           |  |                           |  |      |   |      |  |      |    
| |                                           |  | Weighted average interest |  |      |   |      |  |      |    
| |                                           |  |                           |  |      |   |      |  |      |    
| | Long-term bank deposits (in U.S. dollars) |  |                           |  | 2.7  | % |      |  |      | -   |   |  | $ | 25,195 |  | $ | -      | 
| | Structured notes (1)                      |  |                           |  | 3.8  | % |      |  |      | 3.0 | % |  |   | 25,000 |  |   | 27,781 | 
| |                                           |  |                           |  |      |   |      |  |      |     |   |  |   |        |  |   |        | 
|
| |                                           |  |                           |  |      |   |      |  |      |     |   |  | $ | 50,195 |  | $ | 27,781 | 
| |                                           |  |                           |  |      |   |      |  |      |     |   |  |   |        |  |   |        | 

| |     |                                                                                                                                                                                                                                                                                                                                                                            
| | --- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | (1) | As of
  December 31, 2005, the Group purchased callable structured notes at par value
  totaling $28,000 for settlement during 2006 to 2010 from several banks. Under
  the arrangements with the banks, whether or not the structured notes bear
  interest depends upon the three month to one year LIBOR rate.                                                          
| |     |                                                                                                                                                                                                                                                                                                                                                                            
| |     | For each day
  in which the relevant LIBOR rate is below an agreed annual fixed rate, which
  ranges from 2.5% to 6% the structured notes bear interest at the rate of 3.2%
  to 5.75% per annum. On all other days, the structured notes do not bear any
  interest. As of December 31, 2005, investments in structured notes securities
  approximate their market value.

|            |                                                                                                                         
|----------- | ------------------------------------------------------------------------------------------------------------------------
|NOTE 6:    | LONG-TERM
MARKETABLE SECURITIES                                                                                         
|            |                                                                                                                         
|            | During 2005,
  the Company invests in marketable debt securities which are classified as
  held-to-maturity investments.

| |                                                                  |  |                     |        |                           |   |                |  |   |        | 
| | ---------------------------------------------------------------- |  | ------------------- | ------ | ------------------------- | - | -------------- |  | - | ------ | 
| |                                                                  |  | December
  31, 2005 |       
| |                                                                  |  |                     |       
| |                                                                  |  | Amortized
  cost    |        | Net
  unrealized
  losses |   | Market
  Value | 
| |                                                                  |  |                     |        |                           |   |                | 
| | Held-to-maturity
  - matures after one year through three years: |  |                     |        |                           |   |                |  |   |        | 
| |                                                                  |  |                     |        |                           |   |                |  |   |        | 
| | Corporate
  debentures                                           |  | $                   | 33,792 |                           | $ | 265            |  | $ | 33,527 | 
| | U.S.
  government and agencies debts                             |  |                     | 15,999 |                           |   | 130            |  |   | 15,869 | 
| |                                                                  |  |                     |        |                           |   |                |  |   |        | 
| |                                                                  |  |                     |        |                           |   |                |  |   |        | 
| |                                                                  |  | $                   | 49,791 |                           | $ | 395            |  | $ | 49,396 | 
| |                                                                  |  |                     |        |                           |   |                |  |   |        | 

| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 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, 2005. In addition, the
  unrealized losses are for periods not longer than twelve months.

F - 25

---

---



AUDIOCODES LTD. AND ITS SUBSIDIARIES

|                                          
|------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          
|U.S. dollars in
  thousands               

|            |                                    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|----------- | ---------------------------------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 7:    | INVESTMENT IN AFFILIATED COMPANIES
|            |                                   
|            | a.                                 | In December
  2000, the Company signed an agreement to invest in an unrelated
  privately-held company (affiliated company). During 2005, the Company
  granted convertible loans in the amount of $ 611. The loans bear no interest
  and shall be convertible into shares. The date of conversion, the type of the
  shares and the number of shares granted will be determined by the board of
  directors of the investee. As of December 31, 2005, the Company holds
  41% of the affiliated companys share capital.

| |                   |                                |                |     |        |   |      |        |  
| | ----------------- | ------------------------------ | -------------- | --- | ------ | - | ---- | ------ | -
| |                   |                                | December
  31, |    
| |                   |                                |                |    
| |                   |                                | 2004           |     | 2005   |  
| |                   |                                |                |     |        |  
| |                   |                                |                |     |        |   |      |       
| | Equity, net (1)   |                                | $              | 487 |        | $ | (232 | )     
| | Convertible loans |                                |                | -   |        |   | 611  |       
| |                   |                                |                |     |        |   |      |       
| |                   |                                |                |     |        |   |      |       
| | Total investments |                                | $              | 487 |        | $ | 379  |       
| |                   |                                |                |     |        |   |      |       
| | (1)               | Net equity
  as follows:       |                |     |        |   |      |        |  
| |                   |                                |                |     |        |   |      |        |  
| |                   | Net equity as of purchase date |                | $   | 93     |   | $    | 93     |  
| |                   | Unamortized goodwill           |                |     | 2,389  |   |      | 2,389  |  
| |                   | Accumulated net losses         |                |     | (1,995 | ) |      | (2,714 | )
| |                   |                                |                |     |        |   |      |        |  
|
| |                   |                                |                | $   | 487    |   | $    | (232   | )
| |                   |                                |                |     |        |   |      |        |  

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

| |                                |  |                |   |      |   |      |  
| | ------------------------------ |  | -------------- | - | ---- | - | ---- | -
| |                                |  | December
  31, |  
| |                                |  |                |  
| |                                |  | 2004           |   | 2005 |  
| |                                |  |                |   |      |  
| |                                |  |                |   |      |   |      |  
| | Net equity as of purchase date |  | $              | - |      | $ | (106 | )
| | Unamortized goodwill           |  |                | - |      |   | 813  |  
| | Accumulated net income         |  |                | - |      |   | 26   |  
| |                                |  |                |   |      |   |      |  
| |                                |  |                |   |      |   |      |  
| | Total
  investment             |  | $              | - |      | $ | 733  |  
| |                                |  |                |   |      |   |      |  

F - 26

---

---



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

|            |                       
|----------- | ----------------------
|NOTE 8:    | PROPERTY AND EQUIPMENT

| |                                      |  |                |        |      |   |        | 
| | ------------------------------------ |  | -------------- | ------ | ---- | - | ------ | 
| |                                      |  | December
  31, |       
| |                                      |  |                |       
| |                                      |  | 2004           |        | 2005 |  
| |                                      |  |                |        |      |  
| | Cost:                                |  |                |        |      |   |        | 
| | Computers
  and peripheral equipment |  | $              | 10,492 |      | $ | 11,767 | 
| | Office
  furniture and equipment     |  |                | 5,244  |      |   | 6,333  | 
| | Motor
  vehicles                     |  |                | 48     |      |   | 48     | 
| | Leasehold
  improvements             |  |                | 1,357  |      |   | 1,289  | 
| |                                      |  |                |        |      |   |        | 
| |                                      |  |                |        |      |   |        | 
| |                                      |  |                | 17,141 |      |   | 19,437 | 
| |                                      |  |                |        |      |   |        | 
| | Accumulated depreciation:            |  |                |        |      |   |        | 
| | Computers
  and peripheral equipment |  |                | 8,004  |      |   | 9,184  | 
| | Office
  furniture and equipment     |  |                | 2,127  |      |   | 3,327  | 
| | Motor
  vehicles                     |  |                | 48     |      |   | 48     | 
| | Leasehold
  improvements             |  |                | 268    |      |   | 384    | 
| |                                      |  |                |        |      |   |        | 
| |                                      |  |                |        |      |   |        | 
| |                                      |  |                | 10,447 |      |   | 12,943 | 
| |                                      |  |                |        |      |   |        | 
| |                                      |  |                |        |      |   |        | 
| | Depreciated cost                     |  | $              | 6,694  |      | $ | 6,494  | 
| |                                      |  |                |        |      |   |        | 

|            |                                                                                                                                       
|----------- | --------------------------------------------------------------------------------------------------------------------------------------
|            | Depreciation
  expenses amounted to $ 2,880, $ 2,352 and $ 2,509 for the years ended
  December 31, 2003, 2004 and 2005, respectively.
|            |                                                                                                                                       
|NOTE 9:    | INTANGIBLE ASSETS, DEFERRED CHARGES AND OTHER                                                                                         

| |    |                           |  |                |       |      |   |       | 
| | -- | ------------------------- |  | -------------- | ----- | ---- | - | ----- | 
| |    |                           |  | December
  31, |      
| |    |                           |  |                |      
| |    |                           |  | 2004           |       | 2005 |  
| |    |                           |  |                |       |      |  
|
| | a. | Cost:                     |  |                |       |      |   |       | 
| |    | Acquired technology       |  | $              | 4,273 |      | $ | 4,273 | 
| |    | Deferred charges          |  |                | 1,644 |      |   | 478   | 
| |    | Other                     |  |                |      |      |   | 200   | 
| |    |                           |  |                |       |      |   |       | 
| |    |                           |  |                |       |      |   |       | 
| |    |                           |  |                | 5,917 |      |   | 4,951 | 
| |    |                           |  |                |       |      |   |       | 
| |    | Accumulated amortization: |  |                |       |      |   |       | 
| |    | Acquired technology       |  |                | 787   |      |   | 1,647 | 
| |    | Deferred charges          |  |                | 3     |      |   | 25    | 
| |    |                           |  |                |       |      |   |       | 
| |    |                           |  |                |       |      |   |       | 
| |    |                           |  |                | 790   |      |   | 1,672 | 
| |    |                           |  |                |       |      |   |       | 
| |    |                           |  |                |       |      |   |       | 
| |    | Amortized cost            |  | $              | 5,127 |      | $ | 3,279 | 
| |    |                           |  |                |       |      |   |       | 

| |    |                                                                                                                                                             
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------
| | b. | Amortization
  expenses related to acquired technology amounted to $160, $627 and $860 for
  the years ended December 31, 2003, 2004 and 2005, respectively.

F - 27

---

---



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

|            |                                                      
|----------- | -----------------------------------------------------
|NOTE 9:    | INTANGIBLE ASSETS, DEFERRED CHARGES AND OTHER (Cont.)

| |    |                                                                                                 
| | -- | ------------------------------------------------------------------------------------------------
| | c. | Expected amortization expenses related
  to acquired technology for the years ended December 31:

| |      |  |   |       | 
| | ---- |  | - | ----- | 
| | 2006 |  | $ | 860   | 
| | 2007 |  |   | 860   | 
| | 2008 |  |   | 673   | 
| | 2009 |  |   | 233   | 
| |      |  |   |       | 
| |      |  |   |       | 
| |      |  | $ | 2,626 | 
| |      |  |   |       | 

| |    |                                                                                                                                             
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------
| | d. | Amortization
  expenses related to deferred charges amounted to $ 3 and $ 22 for the years
  ended December 31, 2004 and 2005, respectively.

|            |                                    
|----------- | -----------------------------------
|NOTE 10:   | OTHER PAYABLES AND ACCRUED EXPENSES

| |                                    |  |                |        |      |   |        | 
| | ---------------------------------- |  | -------------- | ------ | ---- | - | ------ | 
| |                                    |  | December
  31, |       
| |                                    |  |                |       
| |                                    |  | 2004           |        | 2005 |  
| |                                    |  |                |        |      |  
|
| | Employees and payroll accruals     |  | $              | 6,355  |      | $ | 8,088  | 
| | Technology licensing fee provision |  |                | 3,974  |      |   | 2,901  | 
| | Government authorities             |  |                | 874    |      |   | 738    | 
| | Accrued expenses                   |  |                | 5,187  |      |   | 6,568  | 
| | Deferred revenues                  |  |                | 1,430  |      |   | 300    | 
| | Others                             |  |                | 161    |      |   | 25     | 
| |                                    |  |                |        |      |   |        | 
| |                                    |  |                |        |      |   |        | 
| |                                    |  | $              | 17,981 |      | $ | 18,620 | 
| |                                    |  |                |        |      |   |        | 

F - 28

---

---



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

|            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|----------- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 11:   | SENIOR CONVERTIBLE NOTES                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|            | In November
  2004, the Company issued $ 125,000 (including the exercise of the option as
  described below) in an aggregate principal amount of 2% Senior Convertible
  Notes due November 9, 2024 (the Notes). The Company is obligated to pay
  interest on the Notes semi-annually on May 9 and November 9 of each year.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|            | 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, 2005, 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. Due to immateriality, the Company
  did not record separate derivative in the financial statements.                                                                                                                                                                                                                                                                           
|            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|            | The Notes
  were issued with a conversion price equal to $ 18.71 per share, which
  reflected the closing share price on the Nasdaq on the date of the offering,
  which was $ 14.12, plus a premium of 32.5%. In accordance with EITF No.
  00-27, no beneficial conversion feature was recognized or recorded.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|            | The
  additional amount that the Company can be required to pay in respect of the
  withholding taxes was recorded as a liability.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|            | As part of the offering, the Company granted the
  Initial Purchasers an option to purchase at any time during 30 days from the
  date of the offering, up to an additional $ 25,000 principal amount of senior
  convertible notes. The option, in accordance with SFAS No. 133, is not
  embedded and therefore should be measured on a stand-alone basis. On November
  16, 2004, the option was exercised in full. Due to immateriality, the Company
  did not record this option and its exercise in the financial statements.                                                                                                                                                                                                                                                                                                                                                                                                                                                                    

F - 29

---

---



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

|            |                                       
|----------- | --------------------------------------
|NOTE 12:   | 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:

| |                       |  |   |        | 
| | --------------------- |  | - | ------ | 
| | 2006                  |  | $ | 2,530  | 
| | 2007                  |  |   | 2,429  | 
| | 2008                  |  |   | 2,447  | 
| | 2009                  |  |   | 2,466  | 
| | 2010 and
  thereafter |  |   | 8,611  | 
| |                       |  |   |        | 
| |                       |  |   |        | 
| |                       |  | $ | 18,483 | 
| |                       |  |   |        | 

| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |    | Rent
  expenses for the years ended December 31, 2003, 2004 and 2005, were
  approximately $ 1,829, $ 2,927 and $ 2,938, respectively.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| | b. | 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.
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| |    | The Company
  did not repay or accrue royalties for the year ended December 31, 2005,
  relating to such grants.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| |    | As of
  December 31, 2005, the Company had a contingent obligation to pay royalties
  in the amount of approximately $ 1,617.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| | c. | Royalty
  commitments to third parties:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| |    | The Group
  entered into technology licensing fee agreements with third parties. Under
  the agreements, the Group agreed to pay the third parties royalties until
  2008, based on 0.3%-0.9% of the Groups total consolidated revenues.                                                                                                                                                                                                                                                                                                                                                                                          
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| |    | From time to
  time, 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.                                                                                                                                                                                                                                                                                  

F - 30

---

---



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

|            |                      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|----------- | -------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 13:   | SHAREHOLDERS EQUITY
|            |                      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|            | a.                   | Treasury
  stock:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|            |                      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|            |                      | On January
  10, 2001 and on April 28, 2002, the Companys Board of Directors approved a
  share repurchase program pursuant to which the Company is authorized to
  purchase up to an aggregate amount of 4,000,000 of its outstanding Ordinary
  shares. As of December 31, 2005, the Company had purchased 3,942,139 of its
  outstanding Ordinary shares, at a weighted average price per share of
  $ 2.87.                                                                                                                                                                                                                                                                                                                                                        
|            |                      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|            | b.                   | Warrants
  issued to consultants:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|            |                      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|            |                      | During 1999,
  the Company issued warrants to consultants to purchase 4,000 and 50,000
  Ordinary shares of NIS 0.01 par value at an exercise price of $ 9.82 per
  share and $ 18.82 per share, respectively, expiring seven years from the
  date of grant. Warrants to purchase 24,000 Ordinary shares at an exercise
  price of $ 18.82 per share were exercisable immediately, and warrants to
  purchase 30,000 Ordinary shares are exercisable in four equal annual
  installments from the date of grant. During 2001, warrants to purchase 10,000
  Ordinary shares at an exercise price of $ 18.82 were exercised.                                                                                                                                            
|            |                      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|            |                      | As of
  December 31, 2005, 44,000 warrants are outstanding and exercisable at a
  weighted average exercise price of $ 18.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|            |                      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|            | c.                   | Employee
  Stock Purchase Plan:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|            |                      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|            |                      | In May 2001,
  the Companys Board of Directors adopted the Employee Stock Purchase Plan
  (the Purchase Plan), which provides for the issuance of a maximum of 2,000,000
  Ordinary shares. As of December 31, 2005, 1,033,290 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.
|            |                      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|            |                      | During the
  years ended December 31, 2003, 2004 and 2005, 290,605, 208,952 and 257,746
  shares, respectively, were issued under the Purchase Plan for aggregate
  considerations of $ 537, $ 1,332 and $ 2,134, 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
  14,704,523. As of December 31, 2005, 1,536,509 shares are still available for
  future option grants.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|            |                      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|            |                      | Stock
  options granted under the Plans are exercisable usually at the fair market
  value of the Ordinary shares at the date of grant and expire ten or seven
  years from the date of grant. The options generally vest over four or five
  years, from the date of grant. Any options, which are forfeited or cancelled
  before expiration, become available for future grants.                                                                                                                                                                                                                                                                                                                                                                                     

F - 31

---

---



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

|            |                             
|----------- | ----------------------------
|NOTE 13:   | SHAREHOLDERS EQUITY (Cont.)

| |                                                                                                                                                
| | -----------------------------------------------------------------------------------------------------------------------------------------------
| | A summary of
  the Groups stock option activity and related information for the years ended
  December 31, 2003, 2004 and 2005, is as follows:

| |                                              |  |                         |           |                                    |   |                   |  |                                    |            |                   |   |                                       |  |  |           |   |   |       | 
| | -------------------------------------------- |  | ----------------------- | --------- | ---------------------------------- | - | ----------------- |  | ---------------------------------- | ---------- | ----------------- | - | ------------------------------------- |  |  | --------- | - | - | ----- | 
| |                                              |  | Year ended December 31, |          
| |                                              |  |                         |          
| |                                              |  | 2003                    |           | 2004                               |   | 2005              | 
| |                                              |  |                         |           |                                    |   |                   | 
| |                                              |  | Numberof options        |           | Weighted
  average
  exerciseprice |   | Number of options |  | Weighted
  average
  exerciseprice |            | Number of options |   | Weighted
  average
  exercise
  price | 
| |                                              |  |                         |           |                                    |   |                   |  |                                    |            |                   |   |                                       | 
| |                                              |  |                         |           |                                    |   |                   |  |                                    |            |                   |   |                                       |  |  |           |   |   |       | 
| | Outstanding
  at the beginning of the year   |  |                         | 7,202,088 |                                    | $ | 8.21              |  |                                    | 8,425,947  |                   | $ | 7.76                                  |  |  | 7,852,800 |   | $ | 9.46  | 
| | Granted                                      |  |                         | 1,737,500 |                                    | $ | 3.94              |  |                                    | 1,693,000  |                   | $ | 11.96                                 |  |  | 1,029,500 |   | $ | 10.26 | 
| | Exercised                                    |  |                         | (269,742  | )                                  | $ | 4.14              |  |                                    | (1,869,446 | )                 | $ | 4.72                                  |  |  | (466,065  | ) | $ | 3.86  | 
| | Forfeited                                    |  |                         | (243,899  | )                                  | $ | 5.92              |  |                                    | (396,701   | )                 | $ | 6.28                                  |  |  | (525,863  | ) | $ | 17.18 | 
| |                                              |  |                         |           |                                    |   |                   |  |                                    |            |                   |   |                                       |  |  |           |   |   |       | 
| |                                              |  |                         |           |                                    |   |                   |  |                                    |            |                   |   |                                       |  |  |           |   |   |       | 
| | Outstanding
  at the end of the year         |  |                         | 8,425,947 |                                    | $ | 7.76              |  |                                    | 7,852,800  |                   | $ | 9.46                                  |  |  | 7,890,372 |   | $ | 9.38  | 
| |                                              |  |                         |           |                                    |   |                   |  |                                    |            |                   |   |                                       |  |  |           |   |   |       | 
| |                                              |  |                         |           |                                    |   |                   |  |                                    |            |                   |   |                                       |  |  |           |   |   |       | 
| | Options
  exercisable at the end of the year |  |                         | 4,526,834 |                                    | $ | 9.46              |  |                                    | 4,094,213  |                   | $ | 10.98                                 |  |  | 4,819,818 |   | $ | 9.55  | 
| |                                              |  |                         |           |                                    |   |                   |  |                                    |            |                   |   |                                       |  |  |           |   |   |       | 

| |                                                                                                                     
| | --------------------------------------------------------------------------------------------------------------------
| | The options
  outstanding as of December 31, 2005, have been separated into ranges of
  exercise prices, as follows:

| |                             |  |                                                     |           |                                                     |         |                                       |  |                                                      |       |                                                                |  |           |  |   |       | 
| | --------------------------- |  | --------------------------------------------------- | --------- | --------------------------------------------------- | ------- | ------------------------------------- |  | ---------------------------------------------------- | ----- | -------------------------------------------------------------- |  | --------- |  | - | ----- | 
| | Range of
  exercise
  price |  | Options
  outstanding
  as of
  December 31,
  2005 |           | Weighted
  average
  remaining
  contractual
  life |         | Weighted
  average
  exercise
  price |  | Options
  exercisable 
  as of
  December 31,
  2005 |       | Weighted
  average
  exercise price of
  exercisable
  options | 
| |                             |  |                                                     |           |                                                     |         |                                       |  |                                                      |       |                                                                | 
| |                             |  |                                                     |           |                                                     | (Years) |                                       |  |                                                      |       |                                                                |  |           |  |   |      
| |                             |  |                                                     |           |                                                     |         |                                       |  |                                                      |       |                                                                |  |           |  |   |       | 
| | $ 0.61                      |  |                                                     | 121,000   |                                                     |         | 2.16                                  |  | $                                                    | 0.61  |                                                                |  | 121,000   |  | $ | 0.61  | 
| | $ 1.1                       |  |                                                     | 163,600   |                                                     |         | 2.51                                  |  | $                                                    | 1.10  |                                                                |  | 163,600   |  | $ | 1.10  | 
| | $ 1.73-2.51                 |  |                                                     | 808,393   |                                                     |         | 3.81                                  |  | $                                                    | 2.29  |                                                                |  | 553,893   |  | $ | 2.26  | 
| | $ 2.67-4                    |  |                                                     | 590,443   |                                                     |         | 3.38                                  |  | $                                                    | 3.14  |                                                                |  | 405,855   |  | $ | 3.05  | 
| | $ 4.1-6.04                  |  |                                                     | 1,204,680 |                                                     |         | 3.51                                  |  | $                                                    | 4.45  |                                                                |  | 913,847   |  | $ | 4.36  | 
| | $ 6.51-9.24                 |  |                                                     | 1,278,306 |                                                     |         | 2.70                                  |  | $                                                    | 7.63  |                                                                |  | 1,051,556 |  | $ | 7.53  | 
| | $ 9.32-14.76                |  |                                                     | 2,888,750 |                                                     |         | 5.94                                  |  | $                                                    | 11.01 |                                                                |  | 814,242   |  | $ | 10.84 | 
| | $ 15.94-20.38               |  |                                                     | 141,000   |                                                     |         | 2.70                                  |  | $                                                    | 17.74 |                                                                |  | 101,625   |  | $ | 18.44 | 
| | $ 25.5-36.53                |  |                                                     | 670,200   |                                                     |         | 1.30                                  |  | $                                                    | 29.03 |                                                                |  | 670,200   |  | $ | 29.03 | 
| | $ 50.50                     |  |                                                     | 24,000    |                                                     |         | 1.49                                  |  | $                                                    | 50.50 |                                                                |  | 24,000    |  | $ | 50.50 | 
| |                             |  |                                                     |           |                                                     |         |                                       |  |                                                      |       |                                                                |  |           |  |   |       | 
| |                             |  |                                                     |           |                                                     |         |                                       |  |                                                      |       |                                                                |  |           |  |   |       | 
| |                             |  |                                                     | 7,890,372 |                                                     |         |                                       |  | $                                                    | 9.38  |                                                                |  | 4,819,818 |  | $ | 9.55  | 
| |                             |  |                                                     |           |                                                     |         |                                       |  |                                                      |       |                                                                |  |           |  |   |       | 

| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | The Company
  has recorded deferred stock compensation for options issued with an exercise
  price below the fair market value of the Ordinary shares on the date of
  grant. The deferred stock compensation has been amortized and recorded as
  compensation expense ratably over the vesting period of the options.
  Compensation expenses of approximately $50, $66 and $36 were recognized
  during the years ended December 31, 2003, 2004 and 2005, respectively.

F - 32

---

---



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

|            |                             
|----------- | ----------------------------
|NOTE 13:   | SHAREHOLDERS EQUITY (Cont.)

| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                          
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |    | Options
  granted to employees in 2003, 2004 and 2005 have an exercise price equal to
  the fair market value of an Ordinary share at the grant date, except for
  options that were granted in 2003 to certain employees with an exercise price
  less than the share market price at the grant date. The weighted average fair
  values of the options granted during 2003, 2004 and 2005, were $3.77, $7.63
  and $6.27, respectively.
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                          
| | e. | 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 14a.)                                                                                                                                                                                                                                 

|            |                
|----------- | ---------------
|NOTE 14:   | TAXES ON INCOME

| |    |                     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | -- | ------------------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | a. | Israeli
  taxation:
| |    |                     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |    | 1.                  | Measurement
  of taxable income:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |    |                     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |    |                     | Commencing
  in taxable year 2003, 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. Such an elective obligates the Company for three years. Accordingly,
  commencing taxable year 2003, results for tax purposes are measured in terms
  of earnings in dollars. The Company has elected to extend the term of the
  above mentioned tax measurement by another year.                                                                                                                                                                                                                                                                                                                                                                                                                    
| |    |                     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |    | 2.                  | Tax benefits
  under the Law for the Encouragement of Capital Investments, 1959 (the law):                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| |    |                     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |    |                     | The
  Companys production facilities have been granted the status of an Approved
  Enterprise in accordance with the law under four separate investment
  programs. According to the provisions of such Israeli law, the Company has
  been granted the Alternative Benefit Plan, under which the main benefits are
  tax exemption and reduced tax rate. 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 six 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 eligibled for benefits through 2007. Tax
  benefits from the remaining programs are scheduled to gradually expire
  through 2013.

F - 33

---

---



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

|            |                        
|----------- | -----------------------
|NOTE 14:   | TAXES ON INCOME (Cont.)

| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | As of
  December 31, 2005, 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.                                                                                       
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| | The
  entitlement to the above benefits is conditional upon the Company fulfilling
  the conditions stipulated by the above 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,
  2005, 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 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 Beneficiary Enterprise,
  such as provisions generally requiring that at least 25% of the Beneficiary
  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 already granted will remain subject to the provisions of the 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 law has 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.                                             

F - 34

---

---



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

|            |                        
|----------- | -----------------------
|NOTE 14:   | TAXES ON INCOME (Cont.)

| |    |                                                                |                                                                                                                                                                                                                                                                          
| | -- | -------------------------------------------------------------- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |    | 3.                                                             | Net
  operating losses carryforwards:                                                                                                                                                                                                                                    
| |    |                                                                |                                                                                                                                                                                                                                                                          
| |    |                                                                | As of
  December 31, 2005, the Company has accumulated losses for tax purposes in the
  amount of approximately $80 million, which can be carried forward and offset
  most of 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.                   
| |    |                                                                |                                                                                                                                                                                                                                                                          
| |    | 5.                                                             | Tax rates:                                                                                                                                                                                                                                                               
| |    |                                                                |                                                                                                                                                                                                                                                                          
| |    |                                                                | Under an
  amendment to the Israeli Income Tax Ordinance appeal on July 25, 2005, a
  gradual decrease in the corporate tax rate in Israel will be in effect as
  follows: in 2006 - 31%, 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, |       
| |  |          |  |                           |       
| |  |          |  | 2003                      |        | 2004 |   | 2005  | 
| |  |          |  |                           |        |      |   |       | 
| |  |          |  |                           |        |      |   |       |  |   |        | 
| |  | Domestic |  | $                         | (7,338 | )    | $ | 2,303 |  | $ | 6,694  | 
| |  | Foreign  |  |                           | (1,096 | )    |   | 2,976 |  |   | 7,541  | 
| |  |          |  |                           |        |      |   |       |  |   |        | 
| |  |          |  |                           |        |      |   |       |  |   |        | 
| |  |          |  | $                         | (8,434 | )    | $ | 5,279 |  | $ | 14,235 | 
| |  |          |  |                           |        |      |   |       |  |   |        | 

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

| |  |                               |  |   |   |  |   |     |  |   |        |  
| |  | ----------------------------- |  | - | - |  | - | --- |  | - | ------ | -
| |  | Current taxes                 |  | $ | - |  | $ | 273 |  | $ | 3,048  |  
| |  | Tax in respect of prior years |  |   | - |  |   | -   |  |   | 240    |  
| |  | Deferred taxes *)             |  |   | - |  |   | -   |  |   | (2,489 | )
| |  |                               |  |   |   |  |   |     |  |   |        |  
| |  |                               |  |   |   |  |   |     |  |   |        |  
| |  |                               |  | $ | - |  | $ | 273 |  | $ | 799    |  
| |  |                               |  |   |   |  |   |     |  |   |        |  

| |  |    |                                                                                                                                                                                                           
| |  | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | *) | Including
  $456 of the total deferred tax assets upon utilization of pre-acquisition
  carryforward tax losses derived from acquisition of Ai-Logix in accordance
  with SFAS No. 141 (See also Note 1c).

| |  |          |  |                         |   |      |   |      |  |   |        |  
| |  | -------- |  | ----------------------- | - | ---- | - | ---- |  | - | ------ | -
| |  |          |  | Year ended December 31, |  
| |  |          |  |                         |  
| |  |          |  | 2003                    |   | 2004 |   | 2005 | 
| |  |          |  |                         |   |      |   |      | 
| |  |          |  |                         |   |      |   |      |  |   |        |  
| |  | Domestic |  | $                       | - |      | $ | -    |  | $ | 2,167  |  
| |  | Foreign  |  |                         | - |      |   | 273  |  |   | (1,368 | )
| |  |          |  |                         |   |      |   |      |  |   |        |  
| |  |          |  |                         |   |      |   |      |  |   |        |  
| |  |          |  | $                       | - |      | $ | 273  |  | $ | 799    |  
| |  |          |  |                         |   |      |   |      |  |   |        |  

F - 35

---

---



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

|            |                        
|----------- | -----------------------
|NOTE 14:   | 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, |        
| |  |                                                      |  |                |        
| |  |                                                      |  | 2004           |         | 2005 |  
| |  |                                                      |  |                |         |      |  
| |  | Deferred
  tax assets:                               |  |                |         |      |   |         |  
| |  | Net
  operating loss carryforwards                   |  | $              | 40,475  |      | $ | 34,616  |  
| |  | Reserves
  and allowances                            |  |                | 6,544   |      |   | 7,071   |  
| |  |                                                      |  |                |         |      |   |         |  
| |  |                                                      |  |                |         |      |   |         |  
| |  | Net
  deferred tax assets before valuation allowance |  |                | 47,019  |      |   | 41,687  |  
| |  | Valuation
  allowance                                |  |                | (47,019 | )    |   | (39,198 | )
| |  |                                                      |  |                |         |      |   |         |  
| |  |                                                      |  |                |         |      |   |         |  
| |  | Net
  deferred tax assets                            |  | $              | -       |      | $ | 2,489   |  
| |  |                                                      |  |                |         |      |   |         |  
| |  |                                                      |  |                |         |      |   |         |  
| |  | Domestic                                             |  | $              | -       |      | $ | 2,489   |  
| |  |                                                      |  |                |         |      |   |         |  

| |  |                                                                                                                                                                                                                                                                                                                                                                                       
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | The
  Companys U.S. subsidiaries have estimated total available carryforward tax
  losses of approximately $22 million to offset against future taxable profit
  between 2015 and 2024. As of December 31, 2005, the Company recorded a
  deferred tax asset of $2,489 relating to the available net carryforward 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.                                                                       
| |  |                                                                                                                                                                                                                                                                                                                                                                                       
| |  | The Company
  has provided valuation allowances in respect of deferred tax assets resulting
  from tax benefits related to employee stock option exercises, which will be
  credited to additional paid-in capital when realized. Management currently
  believes that it is more likely than not that those deferred tax deductions
  will not be realized in the foreseeable future.

F - 36

---

---



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

|            |                         |                                                                                                                                                                                                                                            
|----------- | ----------------------- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 14:   | 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 operations is as follows:

| |                                                                                                                   |                                                                               |                           |        |      |   |        |      | 
| | ----------------------------------------------------------------------------------------------------------------- | ----------------------------------------------------------------------------- | ------------------------- | ------ | ---- | - | ------ | ---- | 
| |                                                                                                                   |                                                                               | Year ended
  December 31, |       
| |                                                                                                                   |                                                                               |                           |       
| |                                                                                                                   |                                                                               | 2004                      |        | 2005 |  
| |                                                                                                                   |                                                                               |                           |        |      |  
| | Income before taxes, as
  reported in the consolidated statements of income                                       |                                                                               | $                         | 5,279  |      | $ | 14,235 |     
| |                                                                                                                   |                                                                               |                           |        |      |   |        |     
| |                                                                                                                   |                                                                               |                           |        |      |   |        |     
| | Statutory tax rate                                                                                                |                                                                               |                           | 35     | %    |   | 34     | %   
| |                                                                                                                   |                                                                               |                           |        |      |   |        |     
| |                                                                                                                   |                                                                               |                           |        |      |   |        |     
| | Theoretical tax expenses on the
  above amount at the Israeli statutory tax rate                                  |                                                                               |                           | 1,848  |      |   | 4,840  |     
| | Deferred taxes resulting from
  Approved Enterprise benefits for which a valuation allowance was provided
  (1) |                                                                               |                           | (4,335 | )    |   | (3,543 | )   
| | Tax adjustment in respect of
  different tax rate of foreign subsidiaries                                         |                                                                               |                           | -      |      |   | (84    | )   
| | Non-deductible expenses                                                                                           |                                                                               |                           | 1,355  |      |   | 1,663  |     
| | Deferred taxes on losses for
  which a valuation allowance was provided                                           |                                                                               |                           | 1,223  |      |   | (4,278 | )   
| | Inter-company charges                                                                                             |                                                                               |                           | -      |      |   | 1,725  |     
| | Equity in losses of affiliated
  companies, net                                                                   |                                                                               |                           | 182    |      |   | 236    |     
| | Income taxes in respect of
  prior years                                                                          |                                                                               |                           | -      |      |   | 240    |     
| |                                                                                                                   |                                                                               |                           |        |      |   |        |     
| |                                                                                                                   |                                                                               |                           |        |      |   |        |     
| | Actual tax expense                                                                                                |                                                                               | $                         | 273    |      | $ | 799    |     
| |                                                                                                                   |                                                                               |                           |        |      |   |        |     
| |                                                                                                                   |                                                                               |                           |        |      |   |        |     
| | (1)                                                                                                               | Per share amounts (basic) of
  the tax benefit resulting from the exemption   |                           | $      | 0.11 |   | $      | 0.09 | 
| |                                                                                                                   |                                                                               |                           |        |      |   |        |     
| |                                                                                                                   | Per share amounts (diluted) of
  the tax benefit resulting from the exemption |                           | $      | 0.10 |   | $      | 0.08 | 
| |                                                                                                                   |                                                                               |                           |        |      |   |        |     

F - 37

---

---



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

|            |                                                  
|----------- | -------------------------------------------------
|NOTE 15:   | BASIC AND DILUTED NET
  EARNINGS (LOSS) PER SHARE

| |                                                                                                                         |  |                           |            |      |   |            |  |   |            | 
| | ----------------------------------------------------------------------------------------------------------------------- |  | ------------------------- | ---------- | ---- | - | ---------- |  | - | ---------- | 
| |                                                                                                                         |  | Year ended
  December 31, |           
| |                                                                                                                         |  |                           |           
| |                                                                                                                         |  | 2003                      |            | 2004 |   | 2005       | 
| |                                                                                                                         |  |                           |            |      |   |            | 
| | Numerator:                                                                                                              |  |                           |            |      |   |            |  |   |            | 
| |                                                                                                                         |  |                           |            |      |   |            |  |   |            | 
| | Net
  income (loss) available to shareholders of Ordinary  Shares                                                       |  | $                         | (8,434     | )    | $ | 5,006      |  | $ | 13,436     | 
| |                                                                                                                         |  |                           |            |      |   |            |  |   |            | 
| | Denominator:                                                                                                            |  |                           |            |      |   |            |  |   |            | 
| |                                                                                                                         |  |                           |            |      |   |            |  |   |            | 
| | Denominator
  for basic earnings (loss) per share -
  weighted average number of Ordinary shares, net of treasury stock |  |                           | 37,509,000 |      |   | 38,613,597 |  |   | 40,295,591 | 
| | Effect
  of dilutive securities:                                                                                        |  |                           |            |      |   |            |  |   |            | 
| | Employee
  stock options and ESPP                                                                                       |  |                           | * ) -      |      |   | 3,993,000  |  |   | 2,790,110  | 
| | Senior
  convertible notes                                                                                              |  |                           | -          |      |   | *)  -      |  |   | * ) -      | 
| |                                                                                                                         |  |                           |            |      |   |            |  |   |            | 
| | Denominator
  for diluted net earnings (loss) per share -
  adjusted weighted average number of shares                  |  |                           | 37,509,000 |      |   | 42,606,597 |  |   | 43,085,701 | 
| |                                                                                                                         |  |                           |            |      |   |            |  |   |            | 

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

|            |                                   
|----------- | ----------------------------------
|NOTE 16:   | FINANCIAL INCOME
  (EXPENSES), NET

| |                                                                                  |  |                           |       |      |   |       |   |   |        |  
| | -------------------------------------------------------------------------------- |  | ------------------------- | ----- | ---- | - | ----- | - | - | ------ | -
| |                                                                                  |  | Year ended
  December 31, |      
| |                                                                                  |  |                           |      
| |                                                                                  |  | 2003                      |       | 2004 |   | 2005  |  
| |                                                                                  |  |                           |       |      |   |       |  
| |                                                                                  |  |                           |       |      |   |       |   |   |        |  
| | Financial
  expenses:                                                            |  |                           |       |      |   |       |   |   |        |  
| | Foreign
  currency translation differences                                       |  | $                         | (396  | )    | $ | (403  | ) | $ | (438   | )
| | Interest                                                                         |  |                           | -     |      |   | (381  | ) |   | (3,357 | )
| | Amortization
  of marketable securities premiums and accretion of discounts, net |  |                           | -     |      |   | -     |   |   | (143   | )
| | Others                                                                           |  |                           | (105  | )    |   | (94   | ) |   | (155   | )
| |                                                                                  |  |                           |       |      |   |       |   |   |        |  
| |                                                                                  |  |                           |       |      |   |       |   |   |        |  
| |                                                                                  |  |                           | (501  | )    |   | (878  | ) |   | (4,093 | )
| |                                                                                  |  |                           |       |      |   |       |   |   |        |  
| | Financial
  income:                                                              |  |                           |       |      |   |       |   |   |        |  
| | Foreign
  currency translation differences                                       |  |                           | 376   |      |   | 310   |   |   | 447    |  
| | Interest                                                                         |  |                           | 2,008 |      |   | 2,726 |   |   | 6,103  |  
| | Others                                                                           |  |                           | -     |      |   | 7     |   |   | -      |  
| |                                                                                  |  |                           |       |      |   |       |   |   |        |  
| |                                                                                  |  |                           |       |      |   |       |   |   |        |  
| |                                                                                  |  |                           | 2,384 |      |   | 3,043 |   |   | 6,550  |  
| |                                                                                  |  |                           |       |      |   |       |   |   |        |  
| |                                                                                  |  |                           |       |      |   |       |   |   |        |  
| |                                                                                  |  | $                         | 1,883 |      | $ | 2,165 |   | $ | 2,457  |  
| |                                                                                  |  |                           |       |      |   |       |   |   |        |  

F - 38

---

---



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

|            |                                           
|----------- | ------------------------------------------
|NOTE 17:   | 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, 2003, 2004
  and 2005 and long-lived assets as of December 31, 2003, 2004 and 2005.                                                                                                                                                                                                                        

| |          |  |                  |        |                        |   |                  |  |                        |        |                  |   |                     |  |   |         |  |   |        | 
| | -------- |  | ---------------- | ------ | ---------------------- | - | ---------------- |  | ---------------------- | ------ | ---------------- | - | ------------------- |  | - | ------- |  | - | ------ | 
| |          |  | 2003             |        | 2004                   |   | 2005             | 
| |          |  |                  |        |                        |   |                  | 
| |          |  | Total
  revenues |        | Long-
  lived
  assets |   | Total
  revenues |  | Long-
  lived
  assets |        | Total
  revenues |   | Long-
  livedassets | 
| |          |  |                  |        |                        |   |                  |  |                        |        |                  |   |                     | 
| |          |  |                  |        |                        |   |                  |  |                        |        |                  |   |                     |  |   |         |  |   |        | 
| | Israel   |  | $                | 2,984  |                        | $ | 3,811            |  | $                      | 8,332  |                  | $ | 7,357               |  | $ | 12,235  |  | $ | 6,248  | 
| | Americas |  |                  | 25,179 |                        |   | 6,086            |  |                        | 51,573 |                  |   | 13,594              |  |   | 66,622  |  |   | 22,193 | 
| | Europe   |  |                  | 5,587  |                        |   | -                |  |                        | 10,972 |                  |   | 5                   |  |   | 22,434  |  |   | 7      | 
| | Far East |  |                  | 10,478 |                        |   | -                |  |                        | 11,879 |                  |   | -                   |  |   | 14,536  |  |   | 4      | 
| |          |  |                  |        |                        |   |                  |  |                        |        |                  |   |                     |  |   |         |  |   |        | 
| |          |  |                  |        |                        |   |                  |  |                        |        |                  |   |                     |  |   |         |  |   |        | 
| |          |  | $                | 44,228 |                        | $ | 9,897            |  | $                      | 82,756 |                  | $ | 20,956              |  | $ | 115,827 |  | $ | 28,452 | 
| |          |  |                  |        |                        |   |                  |  |                        |        |                  |   |                     |  |   |         |  |   |        | 

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

| |            |  |                           |     |      |  |      |  |  |     | 
| | ---------- |  | ------------------------- | --- | ---- |  | ---- |  |  | --- | 
| |            |  | Year ended
  December 31, |    
| |            |  |                           |    
| |            |  | 2003                      |     | 2004 |  | 2005 | 
| |            |  |                           |     |      |  |      | 
| |            |  |                           |     |      |  |      |  |  |     | 
| | Customer A |  |                           | 14% |      |  | 19%  |  |  | 16% | 

| |    |                                                                                                               
| | -- | --------------------------------------------------------------------------------------------------------------
| | 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, |       
| |            |  |                           |       
| |            |  | 2003                      |        | 2004 |   | 2005   | 
| |            |  |                           |        |      |   |        | 
| |            |  |                           |        |      |   |        |  |   |         | 
| | Technology |  | $                         | 28,507 |      | $ | 48,500 |  | $ | 62,287  | 
| | Networking |  |                           | 15,721 |      |   | 34,256 |  |   | 53,540  | 
| |            |  |                           |        |      |   |        |  |   |         | 
| |            |  |                           |        |      |   |        |  |   |         | 
| |            |  | $                         | 44,228 |      | $ | 82,756 |  | $ | 115,827 | 
| |            |  |                           |        |      |   |        |  |   |         | 

F - 39

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