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

# FORM 20F

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

# OR

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

# For the fiscal year
ended December 31, 2006

# 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 charterand translation of Registrant's name into English)

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

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

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

|Title of each classOrdinary Shares, nominal value NIS 0.01 per share | Name of each exchange on which registeredNasdaq Global Market
|-------------------------------------------------------------------- | -------------------------------------------------------------
|                                                                     |                                                              

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

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

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

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

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

As
of December 31, 2006, the Registrant had outstanding 46,051,867 Ordinary Shares, nominal
value NIS 0.01 per share.

Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of
the Securities Act:

Yes  o  No  x



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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 o
 No x

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

Yes x         No o

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

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

Indicate
by check mark which 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 o No 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,
2004, 2005 and 2006 and consolidated balance sheets data as of December 31, 2005 and 2006
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, 2002 and 2003 and the consolidated balance sheets data as of December 31,
2002, 2003 and 2004 from audited consolidated financial statements that are not included
in this Annual Report.



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(In thousands, except per share data)

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

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

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

- 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 reported a loss for the first
quarter of 2007. We may experience additional losses in the remainder of 2007.

We
experienced lower than expected revenues in the first quarter of 2007 and reported a loss
in that period after reported profits in the previous eleven quarters. We may continue to
report losses in 2007. Our first quarter results were impacted by weakness in our sales in
Israel and the Asia Pacific region and weaker than expected performance by our recent
acquisitions and our sales of our boards business line. Based on market trends in the
boards business line, we do not anticipate recovery of revenues of the boards business
line in 2007 to the level experienced in 2006. We will need to increase sales in these
regions, improve performance at our acquired companies and reduce expenses if we are to be
able to return to profitability.

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

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

- 3 -

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

Part
of our strategy is to pursue acquisitions of, or investments in, businesses and
technologies or to establish joint ventures to expand our business. For example, in April
2003, we purchased a product group from Nortel Networks and in May 2004 we purchased
Ai-Logix Inc., now known as AudioCodes USA Inc. In 2005, we invested in two Israeli-based
companies, MailVision Ltd. and CTI Squared Ltd., and increased our investment in Natural
Speech Communication Ltd. We have recognized losses from the investment in Natural Speech
Communication in our results of operations in each of the past three years.

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

The
negotiation of acquisitions, investments or joint ventures, as well as the integration of
acquired or jointly developed businesses or technologies, could divert our
managements time and resources. Nuera is significantly larger than any other
acquisition we have made. As a result, we have experienced a diversion of our
managements time and resources in connection with the integration and operation of
Nueras business. In addition, the performance of this acquisition contributed to our
reported net loss in the first quarter of 2007.

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

In
addition, acquisitions could result in:

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

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

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

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

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

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

| |  | reduction
of management attention to other parts of the business;
| | - | -----------------------------------------------------------------

| |  | failure
to invest in different areas or alternative investments;
| | - | ----------------------------------------------------------------

| |  | failure
to generate expected financial results or reach business goals; and
| | - | ---------------------------------------------------------------------------

| |  | increased
expenditures on human resources and related costs.
| | - | ------------------------------------------------------------

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

- 4 -

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

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

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. Any future industry downturn may increase our inventories,
decrease our revenues, result in additional pressure on the price of our products and
prolong the time until we are paid, all of which would have a material adverse effect on
the results of our operations and on our cash flow from operations.

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

Our
success is dependent, in part, on the willingness of our customers to transition or
migrate to new products, such as our expanded offering of Mediant and IPmedia products,
the session border controller products that we now offer as a result of our acquisition of
Netrake, 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.

- 5 -

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

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

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

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

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

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

- 6 -

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

Historically,
a substantial portion of our revenue has been derived from large purchases by a small
number of OEMs and network equipment providers, systems integrators and distributors. For
example, our top three customers accounted for approximately 29.0% of our revenues in
2004, 24.8% of our revenues in 2005 and 24.9% of our revenues in 2006. Sales to Nortel
Networks, our largest customer, accounted for 15.2% of our revenues in 2006, compared to
16.3% of our revenues in 2005 and 18.6% of our revenues in 2004. 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.

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.

- 7 -

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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.

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, which merged with LSI Corporation in
April 2007, and Intel have begun, or are expected to begin marketing competing processors.
Our principal competitors in the communications board market are NMS Communications,
Intel, Motorola, Cantata Technology, Aculab and PIKA Technologies, Inc.

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

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

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

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

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

- 8 -

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

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

Our
product offerings range from media gateway building blocks, such as chips and boards, to
media gateways, media servers and session border control products (systems). These
products could compete with products offered by our customers. These customers could
decide to decrease purchases from us because of this competition. This could result in a
material adverse effect on our results of operations.

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

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

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

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

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

- 9 -

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

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

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

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

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

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

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

- 10 -

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

Our
customers expect us to maintain an inventory of products available for purchase off the
shelf subsequent to the initial sales cycle for these products. This may require us to
incur the costs of manufacturing inventory without having a purchase order for the
products. The VoP industry is subject to rapid technological change and volatile customer
demands, which result in a short product commercial life before a product becomes
obsolete. If we are unable to sell products that are produced to hold in inventory, we may
incur write offs and write downs as a result of slow moving items, technological
obsolescence, excess inventories, discontinued products and products with market prices
lower than cost. Write offs and write downs could adversely affect our operating results
and financial condition. We wrote off and wrote down inventory in the amount of $1.2
million in 2004, $1.2 million in 2005 and $1.0 million in 2006.

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.

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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.

We
believe that the frequency of third party intellectual claims is increasing, as patent
holders, including entities that are not in our industry and that purchase patents as an
investment or to monetize such rights by obtaining royalties, use infringement assertions
as a competitive tactic and a source of additional revenue. Any intellectual property
claims against us, even without merit, could cost us a significant amount of money to
defend and divert managements attention away from our business. We may not be able
to secure a license for technology that is used in our products and we may face injunctive
proceedings that prevent distribution and sale of our products even prior to any dispute
being concluded. These proceedings may also have a deterrent effect on purchases by
customers, who may be unsure about our ability to continue to supply their requirements.
We may be forced to repurchase our products and compensate customers that have purchased
such infringing products. We may be forced to redesign the product so that it becomes
non-infringing, which may have an adverse impact on the results of our operations.

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

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

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

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

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.

In
March, 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.

In
May, 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.

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In
May, 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 had to 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. This could adversely affect our business.

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

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

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

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

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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, 32% of our revenues in 2005 and 35% of our revenues
in 2006 outside of the United States and Israel. Part of our strategy is to expand our
penetration in existing foreign markets and to enter new foreign markets. Our ability to
penetrate some international markets may be limited due to different technical standards,
protocols or product requirements in different markets. Expansion of our international
business will require significant management attention and financial resources. Our
international sales and operations are subject to numerous risks inherent in international
business activities, including:

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

| |  | compliance
with foreign laws and regulations;
| | - | ---------------------------------------------

| |  | different
technical standards or product requirements;
| | - | ------------------------------------------------------

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

| |  | foreign
currency fluctuations;
| | - | ------------------------------

| |  | export
control issues;
| | - | ----------------------

| |  | governmental
controls;
| | - | ----------------------

| |  | import
or currency control restrictions;
| | - | ----------------------------------------

| |  | local
taxation;
| | - | ---------------

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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The
success of our business also depends upon our continuing ability to attract and retain
other highly-qualified management, technical, sales and marketing personnel. We need
highly-qualified technical personnel who are capable of developing technologies and
products and providing the technical support required by our customers. We are
experiencing increasing competitive pressure with respect to retaining and hiring
employees in the high technology sector in Israel. If we fail to hire and retain skilled
employees, our business may be adversely affected.

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

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

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

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 increased in 2004 and 2005, but decreased in 2006. The decrease in
our gross profit percentage in 2006 was primarily attributable to amortization expenses
related to the acquisitions of Nuera and Netrake during the third quarter of 2006 and
expenses related to equity-based compensation resulting from the adoption of
SFAS 123(R). Our gross profit percentage could also be negatively affected by an
increase in manufacturing costs, a shift in our sales mix towards our less profitable
products, increased customer demand for longer product warranties and increased cost
pressures as a result of increased competition. Acquisitions of new businesses could also
negatively affect our gross profit percentage, which could cause an adverse effect on our
results of operations.

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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. Customers have requested that we
provide a contractual commitment to support a product for a specified period of time. This
period of time may exceed the working life of the product or extend past the period of
time that we may intend to manufacture or support a product. We are dependent on our
suppliers for the components (hardware and software) needed to provide support and may be
unable to secure the components necessary to satisfy our service commitments. We do not
have long term contracts with our suppliers, and they may not be obligated to provide us
with products or services for any specified period of time. We may need to purchase an
inventory of replacement components and parts in advance in order to try to provide for
their availability when needed. This could result in increased risk of write offs with
respect to our replacement component inventory to the extent that we cannot accurately
predict our future requirements under our customer service contracts. If any of our
component suppliers cease production, cease operations or refuse or fail to make timely
delivery of orders, we may not be able to meet our contractual commitments for product
support. We may be required to supply 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.

We are subject to additional costs
and risks associated with complying with new and increasing regulation of corporate
governance and disclosure standards.

As
a public company, we spend an increased amount of management time and resources to comply
with changing laws, regulations and standards relating to corporate governance and public
disclosure, including the Sarbanes-Oxley Act of 2002, new Securities and Exchange
Commission regulations and NASDAQ Global Market rules. In connection with our compliance
with Section 404 and the other applicable provisions of the Sarbanes-Oxley Act, our
management and other personnel devote a substantial amount of time, and may need to hire
additional accounting and financial staff, to assure that we comply with these
requirements. Compliance may also make some of our activities more time-consuming and
costly. For example, we expect these rules and regulations to make it more difficult and
more expensive for us to obtain director and other liability insurance, and we may be
required to incur substantial costs to maintain current levels of coverage. The additional
management attention and costs relating to compliance with the Sarbanes-Oxley Act could
materially and adversely affect our growth and financial results.

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Risks Relating to Operations in Israel

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

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

We
cannot predict the effect on us of an increase in these hostilities or any future armed
conflict, political instability or violence in the region. Additionally, some of our
officers and employees in Israel are obligated to perform annual military reserve duty and
are subject to being called for additional active duty under emergency circumstances. We
cannot predict the full impact of these conditions on us in the future, particularly if
emergency circumstances or an escalation in the political situation occur. If many of our
employees are called for active duty, our operations in Israel and our business may be
adversely affected. Additionally, a number of countries continue to restrict or ban
business with Israel or Israeli companies, which may limit our ability to make sales in
those countries.

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. This could adversely affect
our results of operations.

A
substantial portion of the cost of our Israeli operations, mainly personnel and
facility-related, is incurred in New Israeli Shekels (NIS). In 2006, approximately 36% of
our costs were incurred in NIS. Our NIS related costs, as expressed in US dollars, are
influenced by the exchange rate between the dollar and the 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.
In recent times, there has been a significant fluctuation including depreciation in the
value of the dollar compared to the NIS. If this continues, we could experience an
increase in the cost of our operations, which are based in dollars in our financial
statements, which could adversely affect our results of operations.

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.

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

We
benefit from certain government programs and tax benefits, particularly as a result of
exemptions and reductions resulting from the approved enterprise status of our
existing production facilities and programs in Israel. Until recently, the designation
required advance approval from the Investment Center of the Israel Ministry of Industry,
Trade and Labor (the Investment Center). To be eligible for these programs and tax
benefits, we must continue to meet conditions relating principally to adherence to the
approved programs and to periodic reporting obligations. We believe that we are currently
in compliance with these requirements. However, if we fail to meet these conditions, we
will be subject to corporate tax at the rate then in effect under Israeli law for such tax
year.

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

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

In
2006, we recognized a grant of $1,111,000 from the Government of Israel, through the
Office of the Chief Scientist, or the OCS, for the financing of a portion of our research
and development expenditures in Israel. The OCS budget has been subject to reductions,
which may affect the availability of funds for these prospective grants and other grants
in the future. As a result, we cannot be certain that we will continue to receive grants
at the same rate, or at all. In addition, the terms of any future OCS grants may be less
favorable than our past grant.

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

In
connection with research and development grants received from the OCS, we must pay
royalties to the OCS on the revenue derived from the sale of products, technologies and
services developed with the grants from the OCS. The terms of the OCS grants and the law
pursuant to which grants are made restrict our ability to manufacture products or transfer
technologies developed outside of Israel if OCS grants funded the development of the
products or technology. An amendment to the relevant law may facilitate the transfer of
technology or know-how developed with the funding of the OCS to third parties outside of
Israel, but any future transfer would still require the approval of the OCS, which may not
be granted, and is likely to involve a material payment to the OCS. This restriction may
limit our ability to enter into agreements for those products or technologies without OCS
approval. We cannot be certain that any approval of the OCS will be obtained on terms that
are acceptable to us, or at all.

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

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

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

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.

- 22 -

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Risks Relating to the Ownership of our Ordinary Shares and our Notes

# The price of our
ordinary shares may fluctuate significantly.

The
market price for our ordinary shares, as well as the prices of shares of other technology
companies, has been volatile. Between January 1, 2005 and June 15, 2007, our share price
has fluctuated from a low of $5.01 to a high of $17.00. The following factors may cause
significant fluctuations in the market price of our ordinary shares:

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

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

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

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

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

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

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

| |  | integration
of acquired businesses, technologies or joint ventures with our products and operations;
| | - | ----------------------------------------------------------------------------------------------------

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

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

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

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

We
have experienced and expect to continue to experience significant fluctuations in our
quarterly results of operations. In some periods, our operating results may be below
public expectations or below revenue levels and operating results reached in prior
quarters or in the corresponding quarters of the previous year. If this occurs, the market
price of our ordinary shares could decline. We lowered our forecast for the first quarter
of 2007 which resulted in a decrease in the price of our ordinary shares.

- 23 -

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

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

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

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

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

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

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

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

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

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

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

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

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

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

- 24 -

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

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

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

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

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

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

U.S. shareholders face certain income tax risks. In any tax year, we could be deemed
          a passive foreign investment company, which could result in adverse U.S. federal
          income tax consequences for U.S. shareholders.

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

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

- 25 -

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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
these risk factors. This relationship may result in greater volatility in the trading
prices of our notes than would be expected for non-convertible debt securities.

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

Our
notes are general, unsecured obligations and are effectively subordinated to any existing
and future secured indebtedness we may have. In addition, our notes are not guaranteed by
our subsidiaries or any future subsidiaries and, accordingly, our notes are effectively
subordinated to the existing and future indebtedness and other liabilities of our
subsidiaries. These liabilities may include indebtedness, trade payables, guarantees,
lease obligations and letter of credit obligations. Therefore, our rights and the rights
of our creditors, including the holders of the notes, to participate in the assets of any
subsidiary upon that subsidiarys liquidation or reorganization will be subject to
the prior claims of the subsidiarys creditors, except to the extent that we may
ourselves be a creditor with recognized claims against the subsidiary. However, even if we
are a creditor of one of our subsidiaries, our claims would still be effectively
subordinated to any security interests in, or mortgages or other liens on, the assets of
that subsidiary and would be subordinate to any indebtedness of the subsidiary senior to
that held by us. As of June 15, 2007, 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.

- 26 -

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---



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

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

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

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

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

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

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

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

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

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

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

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

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

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

- 27 -

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

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

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

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

On
November 9, 2009, November 9, 2014 or November 9, 2019, or upon specified fundamental
changes relating to us, each holder of the notes may require us to purchase for cash all
or a portion of such holders notes at a price equal to 100% of the principal amount,
plus accrued and unpaid interest, if any, on such notes to but excluding the date of
purchase. In addition, in the case of certain fundamental changes occurring before
November 9, 2009, we may be required to pay a make-whole premium to holders of the notes.
We cannot be sure that we will have sufficient financial resources to purchase the notes
for cash, or will be able to raise debt financing if we are required to purchase the notes
at the option of the holders of such notes or upon the occurrence of a fundamental change.
This repurchase requirement may also delay or make it harder for others to obtain control
of us.

- 28 -

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

Major Developments since
January 1, 2006

Acquisition of Nuera Communications, Inc.

In
July, 2006, we completed the acquisition of Nuera Communications, Inc. Nuera was acquired
for a purchase price of $82.5 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 twelve months after
consummation of the transaction. Nuera designs, manufactures and sells packet voice
getaways to communication service providers worldwide. These products can be transmitted
over cable, wireless, copper and fiber networks. Nueras Open Reliable Communications
Architecture, product portfolio of VoIP gateways, softswitches and management systems
provide telephony solutions for cable and DSL networks, international long distance
networks and enterprise networks.

Acquisition of Netrake
Corporation

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

Acquisition of CTI
Squared Ltd.

In
April 2007, we completed our acquisition of CTI Squared Ltd. We exercised an option to
acquire the remaining shares of CTI Squared for a purchase price of $10 million, with $5
million paid in cash at the closing and $5 million payable in cash by February 28, 2008.
CTI Squared is a provider of enhanced messaging and communications platforms to service
providers and enterprises. CTI Squared Ltd.s platforms integrate data and voice
messaging services over internet, intranet, PSTN, cellular, cable and enterprise networks.

- 29 -

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Investment in Other
Companies

Through
December 31, 2006, we had invested an aggregate of $3.3 million in Natural Speech
Communication Ltd., a privately-held company engaged in speech recognition. In addition,
during 2005 and 2006, we made convertible loans in the aggregate amount of $902,000 to
this company. Assuming a full conversion of all outstanding convertible securities to
ordinary shares, we currently own approximately 40.9% of the equity in this company.

In
July, 2005, we invested $707,000 in MailVision Ltd., a privately-held company engaged in
developing and marketing enhanced services platforms for Wireless service providers. As of
December 31, 2006, we owned 19.5% of its ordinary shares. In November 2006, we made a
convertible loan in the amount of $44,000 to this company. The loan bears interest at the
rate of 9% per annum and is convertible into shares of this company.

In
December 2006, we made a convertible loan in the amount of $1,000,000 to Kayote Networks
Inc. , a privately-held company engaged in VoIP interconnectivity and interoperability
services. This loan bears interest at the rate of LIBOR+2% per annum and is due and
payable in December 2007 unless converted into shares of this company.

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.

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 VoIP 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 VoIP expertise with
AudioCodes USAs technology, strategic partnerships and customer base.

- 30 -

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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.

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.

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

# Introduction

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

Packet
networks are data communications networks that transport information, that is usually
compressed and segmented into packets, over IP infrastructure 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.

- 31 -

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

| |  | Session
border controllers that enable connectivity, policies and security for real-time sessions
such as VoIP and video when traversing IP to IP networks. In addition, security gateways
that enable secure real-time sessions across WIFI, broadband and wireless networks in
fixed mobile convergence deployments.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Our
products are based upon voice compression and fax detection and processing 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;
| | - | -----------------------------------------------------------

| |  | 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.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------

- 32 -

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Customers
for our products consist of primarily 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 or transmitted
or received over the network. In addition, organizations are increasingly turning to the
use of intranets and private networks to increase productivity and create competitive
advantages. This proliferation of intranets and private networks has further contributed
to the surge in data traffic.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

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| |  | Competition
in the telecommunications industry.Competitive local exchange carriers and
alternative carriers are trying to penetrate the local telecommunications 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 introduction of broadband access technologies alongside
related technologies, such as new voice compression algorithms, quality of service
mechanisms and security and encryption algorithms and protocols, have enabled delivery of
voice over packet to residential and enterprise customers with more reliability, higher
quality and greater security. Examples of such broadband access technologies include:
third generation cellular, WiMax, WiFi, data over cable, digital subscriber line
technologies and fiber networks (FTTx). Packet technologies enable delivery of real time
and non real time services by different service providers that do not necessarily own the
access network or the part of the network through which the subscriber accesses the
network.. This allows for the growth of alternative or virtual service providers that do
not own an access network. Competition by alternative service providers with incumbent
and traditional service providers is causing incumbents to deploy advanced broadband
access technologies and increase their competitiveness by offering bundled services to
their subscribers, such as voice, video and data, and online gaming.In addition,
the emergence of wide band vocoders that use a higher sampling rate than used in legacy
TDM networks allows service providers to offer higher quality voice and music over their
newly established IP network.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | New
services enabled by broadband access. Changes in the regulatory environment affecting
service providers and the availability of new technologies or standards allow service
providers to compete with one another in the provision of additional services over and
above the traditional telephony service of voice, fax and dial-up modem internet
connectivity. New services that could be offered include internet connectivity over
broadband access or access to rich multimedia content such as music, video and games.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Increasing
need for peering between VoIP networks. Service providers and enterprises
are increasingly building out VoIP networks.  As a result, there is an increasing
need to connect between two VoIP networks.  In order to interconnect between two
VoIP networks, service providers and enterprises need session border controllers to
provide connectivity and security.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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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 (e.g., personal computers, compact PCI, ATCA, and IBM BladeCenter) and
workstation platforms for which components are available from a number of suppliers, and
proprietary architecture-based gateways which are built around a custom design of a
telecommunications equipment manufacturer. Voice over IP gateway equipment can be
generally segmented into three classes: carrier class gateways for use in central office
facilities; enterprise gateways for use by corporations and in small offices; and
residential gateways for use 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 VoIP gateway equipment that is installed in core networks must be able
to deliver a higher level of performance than existing switching equipment located at
central offices. The telecommunications providers central offices contain
circuit-switching equipment that typically handles tens of thousands of lines and is built
to meet severe performance criteria relating to reliability, capacity, size, power
consumption and cost.

Connectivity
and Security.In contrast with legacy circuit switched voice and video communications,
Internet Protocol based communications are more susceptible to attacks, interceptions and
fraud by unauthorized entities. In addition, the complexity and relative immaturity of IP
networks and protocols pose significant quality of service and connectivity challenges
when sessions cross between separate IP networks.

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

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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, wire line and cable networks. Our session border controllers target access and
peering networks.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Extensive
feature set. Our products incorporate an extensive set of signal processing functions
and features (such as coders, fax processing and echo cancellation), functionalities
(such as H.323, media gateway control protocol, or MGCP, trunking gateway control
protocol, or TGCP, media gateway control, or Megaco, and session initiated protocol, or
SIP) and implement a complete system. We offer the ability to manage multiple channels of
communications working independently of each other, with each channel capable of
performing all of the functions required for voice compression, fax and modem
transmission, telephone signaling processing and other functions. These functions include
voice, fax or data detection, echo cancellation, telephone tone signal detection 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, session border
controllers and media servers) provides our customers with a range of entry level
products. We believe that these building blocks enable our customers to significantly
shorten their time to market by adding their value added solution.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

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# 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. In 2006, we
launched our nCite session border controller product line as a result of our
acquisition of Netrake. In 2007, we have acquired CTI Squared, which will add application
software to our product portfolio. 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.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | 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 best opportunities for our growth and profitability will come from offering
broad range of highly-integrated network product lines and product features, such as our
continuously updated analog and digital media gateways and products from our recentlyacquired
companies including session boarder controllers, security gateways, messaging platforms
and cable telephony gateways.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

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

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| |  | 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 acquired
Nuera in July 2006, Netrake in August 2006 and CTI Squared in April 2007.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

# 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;
| | - | -----------------------------

| |  | VoIP
communication boards (TrunkPack®);
| | - | ---------------------------------------

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

| |  | voice
and data logging hardware integration board products;
| | - | -----------------------------------------------------------

| |  | 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(TM)               Media Servers);
| | - | -------------------------------------------------------------------------------------------------------------------------------------------

| |  | session
border controllers, or SBCs, that enable connectivity, contain protocol and connectivity
policies, and provide security for real-time sessions such as VoIP and video when
traversing from a public to a private network. In addition, security gateways enable
secure real-time sessions across wifi, broadband and wireless networks in fixed mobile
convergence deployments; and
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | element
management system, or EMS.
| | - | ----------------------------------

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

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

Voice Over Packet
Processors

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

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

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

VoIP Communication
Boards

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

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

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

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Analog Media
Gateways for Toll Bypass Access and Enterprise Applications

MediaPackTM,
our analog and BRI 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 and Cable (MediantTM)

MediantTM
is our family of converged media gateways for wireline, cable, wireless (GSM and CDMA),
fixed-mobile-convergence and enterprise networks. The MediantTM product family
offers scalability and functionality, providing a full suite of standards compliant
control protocols and public switched telephone network, or PSTN, signaling interfaces for
a variety of enterprise, wireline, cable and wireless media gateway applications in most
softswitch controlled environments. This product family is compatible with popular
wireline, cable and wireless voice coders and protocols including code-division multiple
access (CDMA), global system for mobile communications (GSM), CDMA2000 and universal
mobile telecommunications service (UMTS) It builds on our TrunkPack® architecture,
which is installed in millions of lines worldwide. The MediantTM family
provides carriers with a comprehensive line of different sized gateways. Small or
medium-sized gateways enable cost-effective solutions for enterprise or small points of
presence, as well as entry into fast growing new and emerging markets. The large gateway
scales to central office capacities and is designed to meet carriers operational
requirements. The entire MediantTM gateway family shares our same VoIP media
gateway boards, assuring mature, field-proven solutions.

For
the cable market, the MediantTM gateway family complies with packet telephony
standards and is designed for either hybrid or all IP cable network architecture. The
Mediant gateway enables deployment of advanced packet-based cable telephony at multiple
service operators own pace, without costly hardware changes. The MediantTM
gateway can be initially deployed as a V5.2 IP access terminal and then easily migrated by
software upgrade to a cable telephony media gateway with external call management provided
by a softswitch and an SS7 interface to the PSTN.

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

The
IPmediaTM product family is designed to allow OEMs and application partners to
provide sophisticated content and services that create revenue streams and customer
loyalty through the ability to provide additional services. The IPmediaTM
platforms interface both packet 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, 3000, 5000 and 8000 series (IPmediaTM
2000, IPmediaTM 3000, IPmediaTM 5000 and IPmediaTM 8000).

Session Border
Controllers and Security Gateways

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

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

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

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Element Management System

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

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

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.

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.

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

VoIP for Telephony
over Cable Networks

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

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

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

Carrier Grade System
Expertise

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

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# 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, 16.3% of our revenues in 2005 and
15.2% of our revenues in 2006. No other customer accounted for more than 10.0% of our
revenues in 2004, 2005 or 2006.

# 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. Much
of our manufacturing is carried out by third-party subcontractors in Israel. We have
extended our manufacturing capabilities through third party subcontractors in the United
States, Mexico and China. Our internal manufacturing activities consist primarily of the
production of prototypes, test engineering, materials purchasing and inspection, final
product configuration and quality control and assurance.

# Industry Standards and
Government Regulations

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

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

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# Competition

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

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, which merged with LSI Corporation in
April 2007, and Intel have begun, or are expected to begin marketing competing processors.
Our principal competitors in the communications board market are NMS Communications,
Intel, Motorola, Cantata Technology, Acculab and PIKA Technologies, Inc.

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, General Bandwidth, and Commatch (Telrad).

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

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

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

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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
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.

# Intellectual Property
and Proprietary Rights

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

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

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

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

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, except for the proceedings referred to
below related to our Nuera subsidiary.

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

Prior
to the acquisition of Nuera by us, eight former employees of a French subsidiary of Nuera
filed a labor grievance against the subsidiary claiming they were unfairly terminated. The
French subsidiary filed for bankruptcy in 2004 and, in 2005, the court appointed
liquidator sought to hold Nuera liable for the obligations of its French subsidiary. In
June 2006, the court ruled in favor of Nuera that it was not liable for the obligations of
its French subsidiary. In March 2007, the liquidator decided to appeal the judgment. We
believe that Nuera has provided a sufficient allowance with respect to this claim.

|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
 San Diego Inc.,  formerly  known as Nuera  Communications,  Inc. a wholly owned
 subsidiary of AudioCodes Inc., is a Delaware corporation.

AudioCodes
 Texas Inc.,  formerly known as Netrake  Corporation,  a wholly owned  subsidiary of
AudioCodes Inc., is a Delaware corporation.

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

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

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

We
lease our main facilities, located in Airport City, Lod, Israel, which currently occupy
approximately 128,000 square feet for annual lease payments (including management fees) of
approximately $2.0 million. We have entered into an agreement to increase the size of the
property we lease by approximately an additional 74,000 square feet for annual lease
payments (including management fees) of approximately $2.1 million. In addition, we have
entered into an agreement regarding the neighboring property by which a building of
approximately 145,000 square feet will be erected and leased to us for period of eleven
years. This new building is expected to be completed in 2010. We estimate the annual lease
payments (including management fees) to be in the range of $2.0 million and $3.2 million
depending the amount expended by the lessor on the fittings.

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

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

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

None.

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

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

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# Critical Accounting
Policies and Estimates

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

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

Our
management has reviewed these critical accounting policies and related disclosures with
our Audit Committee. See Note 2 to the Consolidated Financial Statements, which contain
additional information regarding our accounting policies and other disclosures required by
US GAAP.

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

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

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

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

| |  | Investment
in affiliated companies;
| | - | -----------------------------------

| |  | Goodwill
and intangible assets;
| | - | -------------------------------

| |  | Income
taxes and valuation allowance; and
| | - | -----------------------------------------

| |  | Stock-based
compensation.
| | - | -------------------------

Revenue Recognition
and Allowance for Sales Returns

We
generate our revenues primarily from the sale of products. We sell our products through a
direct sales force and sales representatives. Our customers include original equipment
manufacturers (OEMs), network equipment providers, systems integrators and distributors in
the telecommunications and networking industries, all of whom are considered end users.

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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 $619,000 in 2004, $545,000 in 2005 and $636,000 in 2006.

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

Allowance for Doubtful
Accounts

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

Inventories

Inventories
are stated at the lower of cost or market value. Cost is determined using the moving
average cost method for raw materials and on the basis of direct manufacturing costs
for finished products. We periodically evaluate the quantities on hand relative to current
and historical selling prices and historical and projected sales volume and technological
obsolescence. Based on these evaluations, inventory write-offs and write-down provisions
are provided to cover risks arising from slow moving items, technological obsolescence,
excess inventories, discontinued products and for market prices lower than cost. We
wrote-off and wrote-down inventory in a total amount of $1.2 million in 2004, $1.2 million
in 2005 and $1.0 million in 2006.

Investment in
Affiliated Companies

Through
December 31, 2006, we had invested an aggregate of $3.3 million in Natural Speech
Communication Ltd., a privately-held company engaged in speech recognition. In addition,
during 2005 and 2006, we made convertible loans in the aggregate amount of $902,000 to
this company. Assuming a full conversion of all interests (and those of the other
shareholders and ourselves) to ordinary shares, we currently own approximately 40.9% 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, 2006, 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 invested $707,000 in MailVision Ltd., a privately-held company. As of
December 31, 2006, we owned 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.
In November 2006, we made a convertible loan in the amount of $ 44,000 to this company.
The loan bears interest at the rate of 9% per annum and is convertible into shares of this
company. As of December 31, 2006, based on managements most recent analyses, no
impairment losses have been identified in connection with this investment.

In
February, 2006, we entered into a share purchase agreement with CTI Squared Ltd. to
acquire 10% of its ordinary shares for a total purchase price in the amount of $1,000,000.
In October 2006, we received a call option to invest an additional $10,000,000 for the
remaining 90% of this companys share capital. As of December 31, 2006, based on
managements most recent analyses, no impairment losses have been identified in
connection with this investment. In April 2007, we exercised the option to acquire the
remaining shares of CTI Squared for a purchase price of $10 million, with $5 million paid
in cash at the closing and $5 million payable in cash by February 28, 2008.

In
December 2006, we made a convertible loan in the amount of $1,000,000 to another
privately-held company. This loan bears interest at the rate of LIBOR+2% per annum and is
due and payable in December 2007 unless converted into shares of this company. As of
December 31, 2006, based on managements most recent analyses, no impairment losses
have been identified in connection with this investment.

Goodwill and
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. Goodwill is tested for
impairment at the reporting unit level by comparing the fair value of the reporting unit
with its carrying value. The process of evaluating the potential impairment of goodwill is
subjective and requires significant judgment during the analysis. We operate in one
operating segment, and this segment comprises our only reporting unit. Fair value is
generally determined using discounted cash flows, market multiples and market
capitalization. Significant estimates used in the fair value methodologies include
estimates of future cash flows, future short-term and long-term growth rates, weighted
average cost of capital and estimates of market multiples of the reportable unit. If these
estimates or their related assumptions change in the future, we may be required to record
impairment charges for our goodwill and intangible assets with an indefinite life.

The
process of evaluating the potential impairment of goodwill is subjective and requires
significant judgment at many points during the analysis. In estimating the fair value of a
reporting unit for the purposes of our annual or periodic analyses, we make estimates and
judgments about the future cash flows of that reporting unit. Although our cash flow
forecasts are based on assumptions that are consistent with our plans and estimates we are
using to manage the underlying businesses, there is significant exercise of judgment
involved in determining the cash flows attributable to a reporting unit over its estimated
remaining useful life. In addition, we make certain judgments about allocating shared
assets to the estimated balance sheets of our reporting units. We also consider our and
our competitors market capitalization on the date we perform the analysis. Changes
in judgment on these assumptions and estimates could result in a goodwill impairment
charge.

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We
allocated the purchase price of the companies we acquired to the tangible and intangible
assets acquired and liabilities assumed, based on their estimated fair values. These
valuations require management to make significant estimations and assumptions, especially
with respect to intangible assets. Critical estimates in valuing intangible assets include
future expected cash flows from the business acquired, technology, trade names and
customer relations. In addition, other factors considered are the brand awareness and
market position of the products sold by the acquired companies and assumptions about the
period of time the technology will continue to be used in the combined companys
product portfolio. Managements estimates of fair value are based on assumptions
believed to be reasonable, but which are inherently uncertain and unpredictable.

If
we did not appropriately allocate these components or we incorrectly estimate the useful
lives of these components, our computation of depreciation and amortization expense may
not appropriately reflect the actual impact of these costs over future periods, which will
affect our net income.

As
of December 31, 2006, the amortized cost of intangible assets in our balance sheet was
$21.2 million. In accordance with SFAS No. 144, the value of those assets as of December
31, 2006, has been reviewed and it was determined that no indicators for impairment
existed.

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
payment was recorded as part of the acquisition cost as additional goodwill during 2005.
Goodwill in connection with the acquisition of AudioCodes USA was reduced in the amount of
$456,000 upon utilization of preacquisition carry forward tax losses in accordance
with SFAS No. 141. In 2006, we recorded $80 million of goodwill in connection with our
acquisition of AudioCodes San Diego, formerly Nuera, and $10.4 million of goodwill in
connection with our acquisition of AudioCodes Texas, formerly Netrake.

Goodwill
in connection with the UAS, AudioCodes USA (formerly Ai-Logix), AudioCodes San Diego
(formerly Nuera) and AudioCodes Texas (formerly Netrake) acquisitions was reviewed for
impairment during the fourth quarter of 2006. No impairment losses have been identified in
connection with these acquisitions.

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Income Taxes and
Valuation Allowance

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

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

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

Stock-based Compensation

Effective
January 1, 2006, we began accounting for stock-based compensation in accordance with
Statement of Financial Accounting Statements Standards No. 123R-Share-Based
Payments. We utilize the Black-Scholes option pricing model to estimate the fair
value of stock-based compensation at the date of grant. The Black-Scholes model requires
subjective assumptions regarding dividend yields, expected volatility, expected life of
options and risk-free interest rates. These assumptions reflect managements best
estimates. Changes in these inputs and assumptions can materially affect the estimate of
fair value and the amount of our stock-based compensation expenses. We recognized $8.7
million of stock-based compensation expense in 2006. As of December 31, 2006, there was
approximately $12.4 million of total unrecognized stock-based compensation expense related
to non-vested stock-based compensation arrangements granted by us. That expense is
expected to be recognized over a weighted-average period of 1.6 years.

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

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

# Overview

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

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

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

Nortel
Networks accounted for 18.6% of our total revenues in 2004, 16.3% of our revenues in 2005
and 15.2% of our revenues in 2006. Our top five customers accounted for 35.7% of our
revenues in 2004, 31.1% of our revenues in 2005 and 29.1% of our revenues in 2006. Based
on our experience, we expect that our largest customers may change from period to period.
If we lose a large customer and fail to add new customers to replace lost revenue our
operating results may be materially adversely affected.

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

| |          | 2004 | 2005 | 2006
| | -------- | ---- | ---- | ----
|
|
|
|
| | Americas |      |      |     
| | Far East |      |      |     
| | Europe   |      |      |     
| | Israel   |      |      |     
| |          |      |      |     
| | Total    |      |      |     
| |          |      |      |     

The
increase in the percentage of our revenues in 2006 from customers located in Europe was
due to demand in Europe increasing at a higher pace compared to the other locations.

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. Our
sales to Nortel accounting for 15.2% of our revenues in 2006 compared to 16.3% of our
revenues in 2005 and 18.6% of our revenues in 2004. We expect that sales to Nortel will
continue to account for a high percentage of our revenues in 2007.

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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.

In
July, 2006, we completed the acquisition of Nuera (renamed AudioCodes San Diego Inc. in
2007). Nuera was acquired for a purchase price of $82.5 million in cash, including
acquisition costs, 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 twelve
months after consummation of the transaction. Nuera provides Voice over Internet Protocol
infrastructure solutions for broadband and long distance networks. This transaction is
significantly larger than our other acquisitions and investments to date. Nuera became a
wholly-owned subsidiary of AudioCodes Inc. and, accordingly, its results of operations
have been included in our consolidated financial statements since the acquisition date.
This acquisition was accounted for under the purchase method of accounting in accordance
with SFAS No. 141. We cannot be sure that we will be successful in integrating
Nueras products, employees and operations into our organization or that we will be
able to operate Nueras business in a profitable manner.

In
August 2006, we acquired Netrake (renamed AudioCodes Texas Inc. in 2007), a provider of
session border controller, or SBC, and security gateway solutions. SBCs enable
connectivity, policies and security for real-time media sessions, such as VoIP, video or
fax, between public or private IP networks. Security gateways enable secure real-time
sessions across wifi, broadband and wireless networks in field mobile onvergence
deployments. We paid $13.8 million in cash, including acquisition costs, to acquire
Netrake. Netrake became a wholly-owned subsidiary of AudioCodes Inc. and, accordingly, its
results of operations have been included in our consolidated financial statements since
the acquisition date. This acquisition was accounted for under the purchase method of
accounting in accordance with SFAS No. 141.

In
April 2007, we completed the acquisition of CTI Squared. We exercised an option to acquire
the remaining shares of CTI Squared for a purchase price of $10 million, with $5 million
paid in cash at the closing and $5 million payable in cash by February 28, 2008. CTI
Squared is a provider of enhanced messaging and communications platforms deployed globally
by service providers and enterprises. CTI Squareds platforms integrate data and
voice messaging services over internet, intranet, PSTN, cellular, cable and enterprise
networks.

We
experienced lower than expected revenues in the first quarter of 2007 and reported a loss
in that period. We may continue to report losses in 2007. Our first quarter results were
impacted by weakness in our sales in Israel and the Asia Pacific region and weaker than
expected performance by our recent acquisitions and sales of our boards business line. We
have begun to implement corrective measures to strengthen our sales in the Asia Pacific
region and to increase sales in the session border controller business line that exhibited
weaker than expected performance. However, based on market trends in the boards business
line, we do not anticipate recovery of revenues of the boards business line in 2007 to the
level experienced in 2006. In addition, we have taken steps to bring our expenses in line
with the anticipated revenues for 2007. Our goal is to increase sales and reduce expenses
to allow us to return to profitability.

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

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

The
increase in demand for Voice over IP, or VoIP, technology has impacted our business during
the last three years. In recent years, the shift from traditional circuit-switched
networks to next generation packet-switched networks continued to gain momentum. As data
traffic becomes the dominant factor in communications, service providers are building and
maintaining converged networks for integrated voice and data services. In developed
countries, traditional and alternative service providers adopt bundled triple play (voice,
video and data) and quadruple play (voice, video, data and mobile) offerings. This trend,
enabled by voice and multimedia over IP, has fueled competition among cable, wireline, ISP
and mobile operators, increasing the pressure for adopting and deploying VoIP networks. In
addition, underdeveloped markets without basic wire line service in countries such as
China and India and certain countries in Eastern Europe are adopting the use of VoIP
technology to deliver voice and data services that were previously unavailable.

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# Results of Operations

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

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

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

Revenues.
          Revenues increased 27.2% to $147.4 million in 2006 from $115.8 million in 2005.
          The increase in revenues was primarily due to an increase of $16.7 million in
          sales in the United States and an increase of $10.7 million in sales in Europe.
          Our results of operation include Nuera beginning in July 2006 and Netrake beginning in
          August 2006. Our increase in revenues in 2006 also reflected the increased
          interest and activity in the market for packet-based VoIP products.

Gross
Profit. Cost of revenues includes the manufacturing cost of hardware, quality
assurance, overhead related to manufacturing activity and technology licensing fees
payable to third parties. Gross profit increased to $86.1 million in 2006 from $68.8
million in 2005. Gross profit as a percentage of revenues decreased to 58.4% in 2005 from
59.4% in 2005. The decrease in our gross profit percentage was primarily attributable to
amortization expenses in 2006 related to the acquisitions of Nuera and Netrake during the
third quarter of 2006. Amortization expense allocated to cost of revenues amounted to $1.2
million in 2006. The decrease in our gross margin was also due to expenses related to
equity-based compensation resulting from the adoption of SFAS 123(R). Equity-based
compensation expenses allocated to cost of revenues amounted to $620,000 in 2006. The
decrease in gross profit percentage was partially offset by the higher sales volume that
allowed us to leverage our manufacturing overhead over a larger sales base. The decrease
in gross profit percentage was also offset by a reduction in manufacturing costs which was
primarily due to a reduction in our raw material costs.

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

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

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

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

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

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

# 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.

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.

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General
and Administrative Expenses. General and administrative expenses consist primarily of
compensation for finance, human resources, general management, rent, network and bad debt
reserve, as well as insurance and professional services expenses. General and
administrative expenses increased 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.

Equity
in Losses of Affiliated Companies, Net. Equity in losses of affiliated companies, net
were $693,000 in 2005 compared to $516,000 in 2004.

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.

# 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.

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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 endedDecember 31, | Israeli inflation rate % | NIS Devaluation Rate % | Israeli inflation adjusted for devaluation %
|---------------------- | ------------------------ | ---------------------- | --------------------------------------------
|
|
|
|
|2004                   | 1.2                      | (1.6)                  | 2.8                                         
|2005                   | 2.4                      | 6.8                    | (4.4)                                       
|2006                   | (0.1)                    | (8.2)                  | 8.1                                         

# Recent Accounting
Pronouncements

In
July 2006, the FASB issued FASB Interpretation No. 48 Accounting for Uncertainty in
Income Taxes an Interpretation of FASB Statement No. 109 (FIN 48). FIN
48 clarifies the accounting for income taxes by prescribing the minimum recognition
threshold a tax position is required to meet before being recognized in the financial
statements. FIN 48 utilizes a two-step approach for evaluating tax positions. Recognition
(step one) occurs when an enterprise concludes that a tax position, based solely on its
technical merits, is more-likely-than-not to be sustained upon examination. Measurement
(step two) is only addressed if step one has been satisfied (i.e., the position is
more-likely-than-not to be sustained). Under step two, the tax benefit is measured as the
largest amount of benefit, determined on a cumulative probability basis that is more-
likely-than-not to be realized upon ultimate settlement.

FIN
48 applies to all tax positions related to income taxes subject to the Financial
Accounting Standard Board Statement No. 109, Accounting for income taxes
(FAS 109). This includes tax positions considered to be routine as
well as those with a high degree of uncertainty. FIN 48 has expanded disclosure
requirements, which include a tabular roll forward of the beginning and ending aggregate
unrecognized tax benefits as well as specific detail related to tax uncertainties for
which it is reasonably possible the amount of unrecognized tax benefit will significantly
increase or decrease within twelve months. These disclosures are required at each annual
reporting period unless a significant change occurs in an interim period. FIN 48 is
effective for fiscal years beginning after December 15, 2006. The cumulative effect of
applying FIN 48 will be reported as an adjustment to the opening balance of retained
earnings. We are currently evaluating the effect of the adoption of FIN 48 on our
financial statements.

In
September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (SFAS No.
157). This statement provides a single definition of fair value, a framework for
measuring fair value, and expanded disclosures concerning fair value. Previously,
different definitions of fair value were contained in various accounting pronouncements
creating inconsistencies in measurement and disclosures. SFAS No. 157 applies under those
previously issued pronouncements that prescribe fair value as the relevant measure of
value, except SFAS No. 123(R) and related interpretations. The statements does not apply
to accounting standard that require or permit measurement similar to fair value but are
not intended to measure fair value. This pronouncement is effective for fiscal years
beginning after November 15, 2007. We are currently evaluating the impact of adopting SFAS
157.

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In
February 2007, the FASB issued SFAS No. 159, The Fair Value Option for
Financial Assets and Financial Liabilities (SFAS No. 159). SFAS
No. 159 permits companies to choose to measure certain financial instruments and
certain other items at fair value. The standard requires that unrealized gains and losses
on items for which the fair value option has been elected be reported in earnings. SFAS
No. 159 is effective for financial statements issued for fiscal years beginning after
November 15, 2007 and interim periods within those fiscal years, although earlier adoption
is permitted. We are currently evaluating the impact that SFAS No. 159 will have on
its consolidated financial statements.

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

We
have financed our operations for the last three years, from our sale of convertible notes,
as well as with cash from operations in those three years. In November 2004, we raised net
proceeds of approximately $120.2 million in a private placement of $125.0 million
aggregate principal amount of our 2.00% Senior Convertible Notes due 2024.

As
of December 31, 2006, we had $133.6 million in cash and cash equivalents, short-term and
long-term marketable securities, short-term and long-term bank deposits and structured
notes, a decrease of approximately $86.7 million from $220.3 million at December 31, 2005.
During 2006, we used $82.5 million of cash in connection with our acquisition of Nuera and
$13.8 million of our cash in connection with our acquisition of Netrake. We may be
required to use an additional $5.0 million of cash in 2007 in connection with the earnout
related to our acquisition of Nuera. We also used $1.0 million of cash in 2006 and $5.0
million of cash in February 2007 in connection with our acquisition of CTI and expect to
use another $5.0 million of cash in February 2008 in connection with this acquisition.

Our
operating activities provided cash in the amount of $6.6 million in 2006, primarily due to
our net income which was partially offset by an increase of $9.8 million in trade
receivables and a decrease of $4.7 million in trade and other payables. Our receivables
increased primarily as a result of higher sales volume as well as longer payment terms
granted by us to our customers. Our payables decreased due to repayment of payable
balances after the acquisitions of Nuera and Netrake. Our operating activities provided
cash in the amount of $13.3 million in 2005, primarily due to our net income which was
partially offset by an increase of $3.5 million in trade receivables and $2.0 million in
deferred tax assets. Our receivables increased as a result of higher sales volume and our
deferred tax assets increased due to the utilization of net operating losses. Our
operating activities provided cash in the amount of $3.5 million in 2004, primarily due to
our net income and an increase of $4.8 million in trade payables and other payables and
accrued expenses, which were partially offset by an increase of $4.9 million in trade
receivables, $3.7 million in inventories and $1.2 million in other receivables and prepaid
expenses. The increase in accounts receivable was primarily a result of higher sales
volume which also caused us to increase our purchases and result in higher accounts
payable. Similarly, our higher sales and sales forecasts resulted in our maintaining
higher inventory levels to support growth while keeping lead-times steady or decreasing.

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---



In
2006, our investing activities used cash in the amount of $61.6 million, primarily due to
our investment in Nuera and Netrake, offset in part by the net proceeds from the maturity
of bank deposits. In 2005, our investing activities used cash in the amount of $113.0
million, primarily due to our investment of a significant portion of the proceeds from our
sale of convertible notes in short-term and long-term marketable securities, short-term
and long-term bank deposits and structured notes and payments in connection with the
acquisition of AudioCodes USA. In 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. Our capital expenditures were $3.1 million in 2006,
$2.4 million in 2005 and $4.3 million in 2004. 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 our working
capital to finance these expenditures.

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

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

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

# Research and
Development

In
order to accommodate the rapidly changing needs of our markets, we place considerable
emphasis on research and development projects designed to improve our existing products
and to develop new ones. We are developing more advanced communications boards, analog and
digital media gateways for carrier and enterprise applications, media servers and session
border controllers. Our platforms will feature increased trunk capacity, new
functionalities, enhanced signaling software and compliance with new control protocols. As
of December 31, 2006, 312 of our employees were engaged primarily in research and
development on a full-time basis. We also employed 10 employees on a part-time basis.

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Our
research and development expenses were $35.4 million in 2006 compared to $24.4 million in
2005 and $20.0 million in 2004. 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, 2006, we had obtained
grants from the OCS aggregating $2.6 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.

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

The
accelerated demand for VoIP technology has impacted our business during the last few
years. Over the past few years, the shift from traditional circuit-switched networks to
next generation packet-switched networks continued to gain momentum. As data traffic
becomes the dominant factor in communications, service providers are building and
maintaining converged networks for integrated voice and data services. In addition,
underdeveloped markets without basic wire line service in countries such as China and
India and certain countries in Eastern Europe are beginning to use VoP technology to
deliver voice and data services that were previously unavailable. In addition, the growth
in broadband access and related technologies has driven the emergence of alternative
service providers. This in turn stimulates competition with incumbent providers,
encouraging them to adopt voice over packet technologies. The entry of new industry
players and the demand for new equipment have impacted our business in the last few years.

In
2006, we continued to experience pressure to shorten our lead times in supplying products
to customers. Some of our customers are implementing demand pull programs by
which they only purchase our product very close to the time, if not simultaneously with
the time, they plan to sell their product. We are increasing our sales efforts in new
markets, such as Latin America, Eastern Europe and Far East. We have introduced new system
level products, and applications in our product lines. We are still experiencing low
visibility into customer demand for our products and our ability to predict our level of
sales.

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

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

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

As
of December 31, 2006, our contractual obligations were as follows (in thousands):

|                             | PAYMENTS DUE BY PERIOD
|---------------------------- | ----------------------
|
|
|
|
|Senior convertible notes     |                       
|Rental and lease commitments |                       
|Other commitments            |                       
|                             |                       
|Total cash obligations       |                       

Our
obligation for accrued severance pay under Israels Severance Pay Law as of December
31, 2006 was $7.9 million, of which $7.2 million was funded through deposits into
severance pay funds, leaving a net obligation of approximately $684,000.

| | 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 15, 2007:

|Name               | Age |  | Position                                                       
|------------------ | --- |  | ---------------------------------------------------------------
|
|
|
|
|Shabtai Adlersberg | 54  |  | Chairman of the Board, President and Chief Executive Officer   
|Nachum Falek       | 36  |  | Vice President, and Chief Financial Officer                    
|Hanan Maoz         | 43  |  | Vice President, Business Operations                            
|Eyal Frishberg     | 48  |  | Vice President, Operations                                     
|Eli Nir            | 40  |  | Vice President, Research and Development                       
|Lior Aldema        | 41  |  | Vice President, Marketing and Product Management               
|Ben Rabinowitz     | 40  |  | Vice President, Marketing and Sales, North America             
|Yehuda Hershkovits | 40  |  | Vice President, Systems                                        
|Tal Dor            | 38  |  | Vice President, Human Resources                                
|Gary Drutin        | 46  |  | Vice President, Sales for Europe, Middle East and Latin America
|Moshe Tal          | 53  |  | President and Chief Executive Officer, AudioCodes USA Inc.     
|David E. Perez     | 45  |  | Vice President, Sales, Asia Pacific                            
|Joseph Tenne       | 51  |  | Director                                                       
|Dr. Eyal Kishon    | 47  |  | Director                                                       
|Doron Nevo         | 51  |  | Director                                                       
|Karen Sarid        | 56  |  | Director                                                       

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

Nachum
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.

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

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.

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

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

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

Gary
Drutin has served as our Vice President Sales for Europe, Middle East and Latin
America since 2005 and previously held the position of Vice President of Channel
Operations and Marketing from 2004 until 2005. From 2001 until 2004, Mr. Drutin was
Country Manager and General Manager for Cisco Israel, Cyprus and Malta and from 1997 until
2001 served as regional sales manager for service providers and enterprises for Cisco
Israel. From 1990 until 1997, he served in sales management roles at Digital Equipment
Corporation Israel. Mr. Drutin holds an M.B.A degree from Tel-Aviv University in
Information Systems and Marketing and a B.Sc. degree in Computer Engineering from the
Technion.

Moshe
Tal joined us in May 2004 in connection with our 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

- 73 -

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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.

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. Prior to that, Dr. Kishon
          served as Chief Technology Officer at Yozma Venture Capital from 1992 to 1993.
          Dr. Kishon serves as a director of Allot Communications Ltd and Celtro Inc.
From           1991 to 1992, Dr. Kishon was a Research Fellow in the Multimedia
Department of           IBM Science & Technology. From 1987 to 1989, Dr. Kishon
worked in the           Robotics Research Department of AT&T Bell Laboratories. Dr.
Kishon holds a           B.A. in Computer Science from the Technion  Israel
Institute of Technology           and an M.Sc. and a Ph.D. in Computer Science from New
York University.

Doron
Nevo has served as one of our directors since 2000.  Mr. Nevo is President and
CEO of KiloLambda Technologies Ltd., an optical subsystems company, which he co-founded in
2001.  From 1999 to 2001, Mr. Nevo was involved in fund raising activities for
Israeli-based startup companies.  From 1996 to 1999, Mr. Nevo served as President and
CEO of NKO, Inc.  Mr. Nevo established NKO in early 1995 as a startup subsidiary of
Clalcom, Ltd. NKO designed and developed a full scale, carrier grade, IP telephony system platform and
established its own IP network.  From 1992 to 1996, Mr. Nevo was President and CEO of
Clalcom Ltd.  Mr. Nevo established Clalcom in 1992 as a telecom service provider in
Israel.  He also serves on the board of a number of companies, including Utility
Wireless Corp. (a manufacturer of radio frequency sub-systems), Elcom Technologies
(manufacturer of Satcom and digital radio synthesizers), Notox, Ltd. (a biotech company),
BioCancell, Inc.and Bank Adanim.  Mr. Nevo holds a B.Sc. in Electrical Engineering
from the Technion  Israel Institute of Technology and an M.Sc. in Telecommunications
Management from Brooklyn Polytechnic.

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Karen
Sarid has served as one of our directors since December 2006. She is the General
Manager, Chief Financial Officer and Chief Operations Officer of Galil Medical Israel, a
medical device company, that develops, manufactures and markets an innovative cryotherapy
platform a position she has held since April 2007. Prior to that, Ms. Sarid was the
General Manager of Orex Computed Radiography Ltd., a company owned by Eastman Kodak Co.
that focuses on radiography systems for the digital x-ray market, a position she held
starting in September 2000. Prior to this, she held the position of Chief Operating
Officer and Chief Financial Officer at Orex. From September 1999 until September 2000, she
was Chief Financial Officer and a member of the Board of Directors of Forsoft Ltd., a
software solutions provider and a subsidiary of the Formula Group. From 1996 until August
1999, Ms. Sarid was Chief Financial Officer and a member of the Board of Directors of ESC
Medical Systems Ltd., a medical laser manufacturer which at the time was traded on the
Nasdaq Stock Market. She was the Chief Financial Officer of LanOptics Ltd. from 1993
through 1996. Ms. Sarid currently serves as a director of Gilat Satellite Networks Ltd.,
LanOptics Ltd. and Oridion Systems Ltd. Ms. Sarid received a B.A. in Economics and
Accounting from Haifa University.

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

The
aggregate direct remuneration paid to the 15 persons who served in the capacity of
director or senior executive officer during the year ended December 31, 2006 was
approximately $2.2 million, including approximately $223,000 which was set aside for
pension and retirement benefits. This does not include amounts expended by us for
automobiles made available to our officers, expenses (including business, travel,
professional and business association dues and expenses) reimbursed to officers and other
fringe benefits commonly reimbursed or paid by companies in Israel.

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

A
summary of our stock option activity and related information for the years ended December
31, 2004, 2005 and 2006 for the 15 persons who served in the capacity of director or
senior executive officer during the year ended December 31, 2006 is as follows:

|                                         | 2004 | 2005 | 2006
|---------------------------------------- | ---- | ---- | ----
|
|
|
|
|Outstanding at the beginning of the year |      |      |     
|Adjustments to opening balance           |      |      |     
|                                         |      |     
|Granted                                  |      |      |     
|Cancelled                                |      |      |     
|Exercised                                |      |      |     
|                                         |      |      |     
|                                         |      |     
|Outstanding at the end of the year       |      |      |     
|                                         |      |      |     

- 75 -

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As
of December 31, 2006, options to purchase 1,451,335 ordinary shares were exercisable by
the 15 persons who served as an officer or director during 2006 at an average exercise
price of $8.99 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, Dr. Eyal Kishon and Karen Sarid are our outside directors. Under the
requirements for listing on the Nasdaq Global Market, we are required to have a majority
of our directors be independent as defined by Nasdaq rules. Doron Nevo, Dr. Eyal Kishon,
Karen Sarid and Joseph 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 the Israeli Companies Law, at least
one of the outside directors appointed by a publicly-traded company must have
financial and accounting expertise. The other outside directors should possess
financial and accounting expertise or professional expertise, as
these terms are defined in regulations promulgated under the Companies Law. This
requirement does not apply to outside directors elected prior to January 2006. All of the
outside directors must serve on the companys statutory audit committee.

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.

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

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 Karen
Sarid. All members of the Nominating Committee are independent under the applicable
Securities and Exchange Commission and Nasdaq Global 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 Joseph Tenne to serve
on the compensation committee of the board of directors.

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

| |                    |           |     
| | ------------------ | --------- | ----
|
|
|
|
| | Vacant             | Class I   | 2007
| | Joseph Tenne       | Class II  | 2008
| | Shabtai Adlersberg | Class III | 2009

We
currently do not have a Class I director.

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

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

We
had the following number of employees as of December 31, 2004, 2005 and 2006 in the areas
set forth in the table below:

|                                               | As of December 31,
|---------------------------------------------- | ------------------
|
|
|
|
|Research and development                       |                   
|Sales & marketing, technical service & support |                   
|Operations                                     |                   
|Management and administration                  |                   
|                                               |                   
|                                               |                   
|                                               |                   

Our
employees were located in the following areas as of December 31, 2004, 2005 and 2006.

|              | As of December 31,
|------------- | ------------------
|
|
|
|
|Israel        |                   
|United States |                   
|Europe        |                   
|Far East      |                   
|Latin America |                   
|              |                   
|              |                   
|              |                   

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The
growth in the number of our employees in 2005 was primarily attributable to an increase in
research and development personnel, increased sales and marketing efforts and in 2006 was
primarily attributable to our acquisitions of Nuera, now known as AudioCodes San Diego,
and Netrake, now known as AudioCodes Texas.

Israeli
labor laws and regulations are applicable to our employees in Israel. These laws
principally concern matters such as paid annual vacation, paid sick days, length of the
workday, pay for overtime, insurance for work-related accidents, severance pay and other
conditions of employment. Israeli law generally requires severance pay, which may be
funded by Managers Insurance, described below, upon the retirement or death of an
employee or termination of employment without cause (as defined under Israeli law).
Furthermore, Israeli employees and employers are required to pay predetermined sums to the
National Insurance Institute, which include payments for national health insurance. The
payments to the National Insurance Institute are approximately 14.8% 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.

- 79 -

---

---



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

The
following table sets forth the share ownership and outstanding number of options of our
directors and officers as of June 15, 2007

|Name               | Total Shares Beneficially
Owned | Percentage of Ordinary Shares | Number of Options
|------------------ | ------------------------------- | ----------------------------- | -----------------
|
|
|
|
|Shabtai Adlersberg | 5,120,302                       | 13.4                          | 533,718          
|Nachum Falek       | *                               |                               | *                
|Hanan Maoz         | *                               |                               | *                
|Eyal Frishberg     | *                               |                               | *                
|Eli Nir            | *                               |                               | *                
|Lior Aldema        | *                               |                               | *                
|Ben Rabinowitz     | *                               |                               | *                
|Yehuda Hershkovitz | *                               |                               | *                
|Tal Dor            | *                               |                               | *                
|Gary Drutin        | *                               |                               | *                
|Moshe Tal          | *                               |                               | *                
|David E. Perez     | *                               |                               | *                
|Joseph Tenne       | *                               |                               | *                
|Dr. Eyal Kishon    | *                               |                               | *                
|Doron Nevo         | *                               |                               | *                
|Karen Sarid        | *                               |                               | *                

*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 15, 2007. Shabtai Adlersberg

|Number of Options | Grant Date | Exercise Price | Exercised          | Cancelled | Vesting | Expiration Date
|----------------- | ---------- | -------------- | ------------------ | --------- | ------- | ---------------
|
|
|
|
|                  | 96,000     |                | July 1, 1996       |           |         | $              
|                  | 96,000     |                | July 1, 1998       |           |         | $              
|                  | 100,000    |                | May 23, 2000       |           |         | $              
|                  | 225,000    |                | December 19, 2001  |           |         | $              
|                  | 9,718      |                | August 9, 2002     |           |         | $              
|                  | 275,000    |                | September 23, 2004 |           |         | $              

# Employee Share Plans

We
have Employee Share Purchase Plans and Employee Share Option Plans for the granting of
options to our employees, officers, directors and consultants. Most of these plans are
pursuant to the Israeli Income Tax Ordinance, entitling the beneficiaries who are our
employees to tax benefits under Israeli law. There are various conditions that must be met
in order to qualify for these benefits, including registration of the options in the name
of a trustee for each of the beneficiaries who is granted options. Each option, and any
ordinary shares acquired upon the exercise of the option, must be held by the trustee at
least for a period commencing on the date of grant and ending no later than 30 months
after the date of grant, in accordance with the period of time specified by Section 102 of
Israels Income Tax Ordinance, and deposited in trust with the trustee. There are
similar plans for our U.S. employees, which are designed to comply with the corresponding
provisions of the Internal Revenue Code of 1986, as amended.

- 80 -

---

---



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, 2006, we had issued
1,290,013 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, 2006, options to purchase a total of 6,009,621 shares are outstanding
under the 1997 and 1999 Israeli Plans and options to purchase a total of 2,006,205 shares
are outstanding under the 1997 U.S. Plan. In addition, a reserve of 1,016,000 shares has
been made available for grant under the 1999 Israeli Plan and a reserve of 327,000 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 current practice of our board of directors is to grant options with
exercise prices that equal 100% of the closing price of our ordinary shares on the
applicable date of grant.

- 81 -

---

---



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

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

To
our knowledge, (A) we are not directly or indirectly owned or controlled (i) by another
corporation or (ii) by any foreign government and (B) there are no arrangements, the
operation of which may at a subsequent date result in a change in control of AudioCodes.
The following table sets forth, as of December 31, 2006, 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)                                                  |              |                 
|Leon Bialik(2)                                                         |              |                 
|Soros Fund Management LLC(3)                                           |              |                 
|FMR Corp.(4)                                                           |              |                 
|Kern Capital (5)                                                       |              |                 
|All directors and senior executive officers as a group (16 persons)(6) |              |                 

---

|(1) | Includes
options to purchase 496,218 shares, exercisable within sixty days of
               December 31, 2006.
|--- | ---------------------------------------------------------------------------------------------------------------

|(2) | The
information is derived from a statement on Schedule 13G/A, dated February
               12, 2007of Leon Bialik filed with the Securities and Exchange
               Commission.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) | The
information is derived from a statement on Schedule 13G, dated March 26,
               2007, of Soros Fund Management LLC, George Soros, Robert Soros and
Jonathan                Soros filed with the Securities and Exchange Commission. All of
the shares                beneficially owned are issuable upon conversion of our senior
convertible notes                held by Soros Fund Management. These convertible notes
were acquired subsequent                to December 31, 2006.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(4) | The
information is derived from the joint statement on Schedule 13G/A, dated
               January 10, 2007, 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. The shares beneficially
owned include 534,474 shares                issuable upon conversion of our senior
convertible notes held by FMR.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(5) | The
information is derived from a statement on Schedule 13G, dated February 14,
               2007of Kern Capital Management, Robert E. Kern Jr. and David G.
Kern                filed with the Securities and Exchange Commission.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(6) | Includes
1,451,335 ordinary shares, which may be purchased pursuant to options
               exercisable within sixty days following December 31, 2006.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------

Mr.
          Adlersberg held 13.1% of our ordinary shares as of December 31, 2006, as
          compared to 13.3% of our ordinary shares as of December 31, 2005 and 13.4% of
          our ordinary shares as of December 31, 2004.

Mr.
          Bialik held 9.6% of our ordinary shares as of December 31, 2006 as compared to
          9.9% of our ordinary shares as of December 31, 2005 and December 31, 2004.

FMR
Corp. held 6.4% of our ordinary shares as of December 31, 2006 (including shares issuable
upon conversion of our senior convertible notes), as compared to 14.2% of our ordinary
shares as of December 31, 2005 and 8.2% of our ordinary shares as of December 31, 2004.

Kern
Capital held 5.5% of our ordinary shares as of December 31, 2006 as compared to 6.9% of
our ordinary shares as of December 31, 2005 and 6.7% of our ordinary shares as of December
31, 2004.

- 82 -

---

---



As
of June 15, 2007, 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

INTERESTS OF EXPERTS AND
COUNSEL

Not
applicable.

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

See
Item 18.

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

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

Our
ordinary shares are listed on the Nasdaq Global 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 Nasdaq, 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 Global Market (which was called Nasdaq
National Market until June 30, 2006 when it changed its name to Nasdaq Global Market).

- 83 -

---

---



|Calendar Year | Price Per Share
|------------- | ---------------
|
|
|
|
|2006          |                
|2005          |                
|2004          |                
|2003          |                
|2002          |                

|Calendar Period |  | Price Per Share
|--------------- |  | ---------------
|
|
|
|
|2007            |  |                
|                |  |                
|                |  |                
|2006            |  |                
|                |  |                
|                |  |                
|                |  |                
|                |  |                
|2005            |  |                
|                |  |                
|                |  |                
|                |  |                
|                |  |                

|Calendar Month |  | Price Per Share
|-------------- |  | ---------------
|
|
|
|
|2007           |  |                
|               |  |                
|               |  |                
|               |  |                
|               |  |                
|               |  |                
|2006           |  |                
|               |  |                

- 84 -

---

---



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, 2006, the exchange rate was equal to
approximately 4.225 NIS per U.S. $1.00.

|Calendar Year |  | Price Per Share
|------------- |  | ---------------
|
|
|
|
|2006          |  |                
|2005          |  |                
|2004          |  |                
|2003          |  |                
|2002          |  |                
|              |  |                
|
|
|
|2007          |  |                
|              |  |                
|              |  |                
|2006          |  |                
|              |  |                
|              |  |                
|              |  |                
|              |  |                
|2005          |  |                
|              |  |                
|              |  |                
|              |  |                
|              |  |                
|              |  |                
|
|
|
|              |  |                
|2007          |  |                
|              |  |                
|              |  |                
|              |  |                
|              |  |                
|              |  |                
|2006          |  |                
|              |  |                

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

Not
applicable.

- 85 -

---

---



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

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

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

Not
applicable.

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

Not
applicable.

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

Not
applicable.

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

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

Not
applicable.

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

# Objects and Purposes

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.

- 86 -

---

---



# Amendment of Articles
of Association

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

# Dividends

Under
the Israeli Companies Law, we may pay dividends only out of our profits. The amount of any
dividend to be distributed among shareholders is based on the nominal value of their
shares. Our board of directors has determined that we will not distribute any amounts of
our undistributed tax exempt income as dividend. We intend to reinvest our tax-exempt
income and not to distribute such income as a dividend. Accordingly, no deferred income
taxes have been provided on income attributable to our Approved Enterprise program as the
undistributed tax exempt income is essentially permanent in duration.

# Voting Rights and
Powers

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

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

# Business Combinations

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

# Winding Up

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

# Redeemable Shares

Wemay issue and redeem redeemable shares.

- 87 -

---

---



# Modification of Rights

Subject
to the provisions of our memorandum of association, and without prejudice to any special
rights previously conferred upon the holders of our existing shares, we may, from time to
time, by a resolution approved by the holders of 75% voting power represented at the
meeting in person or by proxy and voting thereon, provide for shares with such preferred
or deferred rights or rights of redemption, or other special rights and/or such
restrictions, whether in regard to dividends, voting repayment of share capital or
otherwise, as may be stipulated in such resolution.

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

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

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

# Shareholders Meetings

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

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.

- 88 -

---

---



# Notice of General
Meetings; Omission to Give Notice

The
provisions of the Companies Law and the related regulations override the provisions of our
articles of association, and provide for notice of a meeting of shareholders to be sent to
each registered shareholder at least 21 days or 35 days in advance of the meeting. Notice
of a meeting of shareholders must also be published in two Israeli newspapers prior to the
record date for the meeting.

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

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

# Limitations on Foreign
Shareholders to Hold or Exercise Voting Rights

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

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

- 89 -

---

---



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. Personal interest does not apply to a
personal interest stemming merely from holding shares in the company.

The
office holder must make the disclosure of his personal interest no later than the first
meeting of the companys board of directors that discusses the particular
transaction. The office holders duty to disclose shall not apply in the event that
the personal interest only results from a personal interest of the office holders
relative in a transaction that is not an extraordinary transaction. 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. Our articles of association do not provide otherwise. Such approval must
determine that the transaction is not adverse to the companys interest. If the
transaction is an extraordinary transaction, or if it concerns exculpation,
indemnification or insurance of an office holder, then it also must be approved by the
companys audit committee and board of directors, and, under certain circumstances,
by the shareholders of the company. An office holder who has a personal interest in a
matter that is considered at a meeting of the board of directors or the audit committee
generally may not be present at this meeting or vote on this matter unless a majority of
the board of directors or the audit committee has a personal interest in the matter. If a
majority of the board of directors or the audit committee has a personal interest in the
transaction, shareholder approval also would be required.

# 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, including a private placement, 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.

- 90 -

---

---



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.

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

Insurance of Office Holders

The
Companies Law permits a company, if permitted by its articles of association, to insure an
office holder in respect of liabilities incurred by the office holder as a result of:

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

| |  | the
breach of his or her duty of loyalty to the company,
| | - | --------------------------------------------------------

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

Indemnification
of Office Holders

Under
the Companies Law, a company can, if permitted by its articles of association, indemnify
an office holder for any of the following obligations or expenses incurred in connection
with his or her acts or omissions as an office holder:

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

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

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

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

Exculpation
of Office Holders

Under
the Companies Law, a company may, if permitted by its articles of association, also
exculpate an office holder in advance, in whole or in part, from liability for damages
sustained by a breach of duty of care to the company.

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

Limitations
on Exculpation, Insurance and Indemnification

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

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Our
articles of association allow us to insure, indemnify and exculpate office holders to the
fullest extent permitted by law, provided such insurance or indemnification is approved in
accordance with law. Pursuant to the Companies Law, exculpation of, procurement of
insurance coverage for, and an undertaking to indemnify or indemnification of, our office
holders must be approved by our audit committee and our board of directors and, if the
office holder is a director, also by our shareholders.

We
have entered into agreements with each of our directors and senior officers to insure,
indemnify and exculpate them 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:

| | n | 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,
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | n | 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:
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | no
financial liability was imposed on the director or senior officer in lieu of criminal
proceedings, or
| | - | --------------------------------------------------------------------------------------------------------

| |  | 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
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | n | 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:
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | in
an action  brought  against the director or senior officer by us, on our behalf or on
behalf of a third                       party,
| | - | ---------------------------------------------------------------------------------------------------------------------------------------

| |  | in
a criminal action in which the director or senior officer is found innocent, or
| | - | ----------------------------------------------------------------------------------

| |  | in
a criminal action in which the director or senior officer is convicted but in which proof
of criminal intent is not required.
| | - | --------------------------------------------------------------------------------------------------------------------------------

We
have entered into agreements with each of our directors and senior officers to insure,
indemnify and exculpate them to the full extent permitted by law against some types of
claims, subject to dollar limits and other limitations. These agreements have been
ratified by our audit committee, board of directors and shareholders. We have acquired
directors and officers liability insurance covering our officers and directors
and the officers and directors of our subsidiaries against certain claims.

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

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

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

In
April 2007, we completed the acquisition of CTI Squared Ltd. We exercised an option to
acquire the remaining shares of CTI Squared Ltd. for a purchase price of $10 million, with
$5 million paid in cash at the closing and $5 million payable in cash by February 28,
2008.

|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.

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Israeli Tax Considerations

# General Corporate Tax
Structure

Israeli
companies were generally subject to corporate tax at the rate of 31% of their taxable
income in 2006. Pursuant to tax reform legislation that came into effect in 2005, the
corporate tax rate is to undergo further staged reductions to 25% by the year 2010. In
order to implement these reductions, the corporate tax rate in Israel is scheduled to
decline to 29% in 2007, 27% in 2008 and 26% in 2009. However, the effective tax rate
payable by a company that derives income from an approved enterprise (as discussed below)
may be considerably less.

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

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

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

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

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We
have elected the alternative package of tax exemptions and reduced tax rates for our
production facilities that have received Approved Enterprise status. Accordingly, income
derived from these facilities is generally entitled to a tax-exemption period of two 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, 2006, 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.

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.

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, 2006, management believes that we meet all of the aforementioned conditions.

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

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

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

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.

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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:

| |  | 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.
| | - | ----------------------------------------------------------

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

# Special Provisions
Relating to Measurement of Taxable Income

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

# Capital Gains Tax

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

However,
as of January 1, 2003, non-Israeli residents are exempt from Israeli capital gains tax on
any gains derived from the sale of shares publicly traded on the TASE, provided such gains
do not derive from a permanent establishment of such shareholders in Israel. Non-Israeli
residents are also exempt from Israeli capital gains tax on any gains derived from the
sale of shares of Israeli companies publicly traded on a recognized stock exchange or
regulated market outside of Israel, provided that such capital gains are not derived from
a permanent establishment in Israel and that such shareholders did not acquire their
shares prior to the issuers initial public offering. However, non-Israeli
corporations will not be entitled to the exemption with respect to gains derived from the
sale of shares of Israeli companies publicly traded on the TASE, if an Israeli resident
(i) has a controlling interest of 25% or more in such non-Israeli corporation, or (ii) is
the beneficiary or is entitled to 25% or more of the revenues or profits of such
non-Israeli corporation, whether directly or indirectly.

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.

United States Tax
Considerations

# United States Federal
Income Taxes

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

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

| |  | a
corporation or other entity  taxable as a corporation  for U.S.  federal income tax
purposes  created or               organized in or under the laws of the U.S. or any
political subdivision thereof;
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

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

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

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

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# Distributions With
Respect to Our Ordinary Shares

For
U.S federal income tax purposes, the amount of a distribution with respect to our ordinary
shares will equal the amount of cash distributed, the fair market value of any property
distributed and the amount of any Israeli taxes withheld on such distribution as described
below under Israeli Tax Considerations  Tax on Dividends. Other than
distributions in liquidation or in redemption of our ordinary shares that are treated as
exchanges, a distribution with respect to our ordinary shares to a U.S. Holder generally
will be treated as a dividend to the extent that the distribution does not exceed our
current and accumulated earnings and profits, as determined for U.S. federal income tax
purposes. The amount of any distribution that exceeds these earnings and profits will be
treated first as a non-taxable return of capital, reducing the U.S. Holders tax
basis in its ordinary shares (but not below zero), and then generally as capital gain from
a deemed sale or exchange of such ordinary shares. Corporate U.S. Holders generally will
not be allowed a deduction under Section 243 of the Code for dividends received on our
ordinary shares and thus will be subject to tax at the rate applicable to their taxable
income. Currently, a noncorporate U.S. Holders qualified dividend income
generally is subject to tax at a rate of 15%. For this purpose, qualified dividend
income generally includes dividends paid by a foreign corporation if, among other
things, the noncorporate U.S. Holder meets certain minimum holding period requirements and
either (a) the stock of such corporation is readily tradable on an established securities
market in the U.S., including the Nasdaq National Market, or (b) such corporation is
eligible for the benefits of a comprehensive income tax treaty with the U.S. which
includes an information exchange program and is determined to be satisfactory by the U.S.
Secretary of the Treasury. The U.S. Secretary of the Treasury has indicated that the
income tax treaty between the U.S. and Israel is satisfactory for this purpose. Dividends
paid by us will not qualify for the 15% U.S. federal income tax rate, however, if we are
treated, for the tax year in which the dividends are paid or the preceding tax year, as a
passive foreign investment company for U.S. federal income tax purposes. See
the discussion below under the heading Passive Foreign Investment Company
Status. U.S. Holders are urged to consult their own tax advisors regarding the U.S.
federal income tax consequences of their receipt of any distributions with respect to our
ordinary shares.

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

- 102 -

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Dividends
received with respect to our ordinary shares will constitute portfolio income
for purposes of the limitation on the use of passive activity losses and, therefore,
generally may not be offset by passive activity losses. Dividends received with respect to
our ordinary shares also generally will be treated as investment income for
purposes of the investment interest deduction limitation contained in Section 163(d) of
the Code, and as foreign-source passive income for U.S. foreign tax credit purposes or, in
the case of a U.S. Holder that is a financial services entity, financial services income.
Subject to certain limitations, U.S. Holders may elect to claim as a foreign tax credit
against their U.S. federal income tax liability any Israeli income tax withheld from
distributions with respect to our ordinary shares which constitute dividends under U.S.
income tax law. A U.S. Holder that does not elect to claim a foreign tax credit may
instead claim a deduction for Israeli income tax withheld, but only if the U.S. Holder
elects to do so with respect to all foreign income taxes in such year. In addition,
special rules may apply to the computation of foreign tax credits relating to
qualified dividend income, as defined above. The calculation of foreign tax
credits and, in the case of a U.S. Holder that elects to deduct foreign income taxes, the
availability of deductions are complex and involve the application of rules that depend on
a U.S. Holders particular circumstances. U.S. Holders are urged to consult their own
tax advisors regarding the availability to them of foreign tax credits or deductions in
respect of any Israeli tax withheld or paid with respect to any dividends which may be
paid with respect to our ordinary shares.

# Disposition of Our
Ordinary Shares

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

A
U.S. Holders tax basis in its ordinary shares generally will be the U.S. dollar
purchase price paid by such U.S. Holder to acquire such ordinary shares. The U.S. dollar
cost of ordinary shares purchased with foreign currency generally will be the U.S. dollar
value of the purchase price on the date of purchase or, in the case of our ordinary shares
that are purchased by a cash basis U.S. Holder (or an accrual basis U.S. Holder that so
elects), on the settlement date for the purchase. Such an election by an accrual basis
U.S. Holder must be applied consistently from year to year and cannot be revoked without
the consent of the U.S. Internal Revenue Service. The holding period of each ordinary
share owned by a U.S. Holder will commence on the day following the date of the U.S.
Holders purchase of such ordinary share and will include the day on which the
ordinary share is sold by such U.S. Holder.

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

# Passive Foreign
Investment Company Status

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

There
is no definitive method prescribed in the Code, U.S. Treasury Regulations or relevant
administrative or judicial interpretations for determining the value of a foreign
corporations assets for purposes of the Asset Test. While the legislative history of
the U.S. Taxpayer Relief Act of 1997 (the 1997 Act) indicates that for
purposes of the Asset Test, the total value of a publicly-traded foreign
corporations assets generally will be treated as equal to the sum of the aggregate
value of its outstanding stock plus its liabilities, it is unclear whether other
valuation methods could be employed to determine the value of a publicly-traded foreign
corporations assets for purposes of the Asset Test.

- 104 -

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Based
on the composition of our gross income and the composition and value of our gross assets
during 2004, 2005 and 2006, we do not believe that we were a PFIC during any of such tax
years. It is likely, however, that under the asset valuation method described in the
legislative history of the 1997 Act, we would have been classified as a PFIC in 2001, 2002
and 2003 primarily because (a) a significant portion of our assets consisted of the
remaining proceeds of our two public offerings of ordinary shares in 1999, and (b) the
public market valuation of our ordinary shares during such years was relatively low. There
can be no assurance that we will not be deemed a PFIC in any future tax year.

U.S.
          Holders are urged to consult their own tax advisors for guidance as to our
          status as a PFIC in any tax year. For those U.S. Holders who determine that
          we are a PFIC in any tax year and notify us in writing of their request for the
          information required in order to effectuate the QEF Election described below,
we           will promptly make such information available to them.

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

| |  | 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
in its gross income amounts allocated to the current tax year as ordinary income for that
year, pay tax on amounts allocated to each prior tax year in which we were a PFIC at the
highest rate on ordinary income in effect for such prior year and pay an interest charge
on the resulting tax at the rate applicable to deficiencies of U.S. federal income tax.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | The
entire amount of any gain realized by 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
instead would be equal to the decedents basis, if lower.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Although
we generally will be treated as a PFIC as to any U.S. Holder if we are a PFIC for any year
during the U.S. Holders holding period, if we cease to be a PFIC, the U.S. Holder
may avoid the consequences of PFIC classification for subsequent years by electing to
recognize gain based on the unrealized appreciation in its ordinary shares through the
close of the tax year in which we cease to be a PFIC.

- 105 -

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

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

A
U.S. Holder may make a QEF Election with respect to a PFIC for any tax year of the U.S.
Holder. A QEF Election is effective for the tax year in which the election is made and all
subsequent tax years of the U.S. Holder. Procedures exist for both retroactive elections
and the filing of protective statements. A U.S. Holder making the QEF Election must make
the election on or before the due date, as extended, for the filing of its U.S. federal
income tax return for the first tax year to which the election will apply. A U.S. Holder
must make a QEF Election by completing U.S. Internal Revenue Service Form 8621 and
attaching it to its U.S. federal income tax return, and must satisfy additional filing
requirements each year the election remains in effect. Upon a U.S. Holders request,
we will provide to such U.S. Holder the information required to make a QEF Election and to
make subsequent annual filings.

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

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

- 106 -

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# Information Reporting
And Backup Withholding

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

The foregoing discussion of
certain U.S. federal income tax considerations is a general summary only and should not be
considered as income tax advice or relied upon for tax planning purposes. Accordingly,
each U.S. Holder should consult with its own tax adviser regarding U.S. federal, state,
local and non-U.S. income and other tax consequences of the acquisition, ownership and
disposition of our ordinary shares.

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

Not
applicable.

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

Not
applicable.

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

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

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.

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

Not
applicable.

| | 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, 2006. 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
2004, 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, 2004, we recognized a 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 a 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.

During
the year ended December 31, 2006, we recognized a net income of $1,105,000 related to the
forward contracts hedging salary payments. At December 31, 2006, we expected to reclassify
$122,000 of net profit on derivative instruments from accumulated other comprehensive
income to earnings during the next twelve months.

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

Not
applicable.

# PART II

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

Not
applicable.

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

Not
applicable

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

Disclosure
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 chief executive officer and chief 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.

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Managements
Annual Report on Internal Control Over Financial Reporting

Our
management, including our chief executive officer and chief financial officer, is
responsible for establishing and maintaining adequate internal control over our financial
reporting, as such term is defined in Rule 13a-15(f) under the Securities Exchange Act.
Our internal control system was designed to provide reasonable assurance to our management
and our board of directors regarding the reliability of financial reporting and the
preparation and fair presentation of published financial statements for external purposes
in accordance with generally accepted accounting principles. All internal control systems,
no matter how well designed, have inherent limitations. Therefore, even those systems
determined to be effective can provide only reasonable assurances with respect to
financial statement preparation and presentation. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance with the
policies or procedures may decline.

Our
management (with the participation of our chief executive officer and chief financial
officer) conducted an evaluation, pursuant to Rule 13a-15(c) under the Exchange Act, of
the effectiveness, as of the end of the period covered by this Annual Report, of our
internal control over financial reporting based on the criteria set forth in Internal
Control-Integrated Framework issued by the Committee of Sponsoring Organizations of
the Treadway Commission. Based on the results of this evaluation, management assessed the
effectiveness of our internal control over financial reporting as at December 31,
2006 and concluded that our internal control over financial reporting was effective as of
December 31, 2006.

This
Annual Report does not include an attestation report of our registered public accounting
firm regarding internal control over financial reporting. Managements report was not
subject to attestation by our registered public accounting firm pursuant to temporary
rules of the SEC that permit us to provide only managements report in this Annual
Report.

Changes
in Internal Control over Financial Reporting

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.

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| | 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, 2006. The following table presents the aggregate fees for professional audit
services and other services rendered by Kost Forer Gabbay & Kasierer in 2005 and 2006.

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

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

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

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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
2006, 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-48 hereto.

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

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 2.00%                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).*
|---- |  | -----------------------------------------------------------------------------------------------

- 113 -

---

---



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

- 114 -

---

---



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

|4.29 |  | Building
and Tenancy Lease Agreement, dated May 11, 2007, by and between Airport City Ltd. and
AudioCodes Ltd. 
|---- |  | -----------------------------------------------------------------------------------------------------------------

|4.30 |  | Agreement
and Plan of Merger, dated as of July 6, 2006, by and among AudioCodes Ltd., AudioCodes,
 Inc., Violet Acquisition Corp., Netrake                Corporation and Will Kohler, as
Sellers' Representative.
|---- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.31 |  | Series
E Preferred Share Purchase Agreement, dated as of November 13, 2005, by and between CTI
Squared Ltd. and AudioCodes Ltd.
|---- |  | -------------------------------------------------------------------------------------------------------------------------------

|4.32 |  | Amended
and Restated Second Option Agreement,  dated as of October 6, 2006, by and among CTI
Squared Ltd., AudioCodes Ltd. and each of the                other parties thereto.
|---- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.33 |  | Amendment
No. 7 to OEM Purchase and Sale No. 011449 between AudioCodes Ltd. and Nortel Networks
Ltd., dated as of December 15, 2006.
|---- |  | ------------------------------------------------------------------------------------------------------------------------------------

|4.34 |  | Endorsement
and Transfer of Rights  Agreement,  dated March 29, 2007, by and between Nortel Networks
(Sales and Marketing) Ltd. Israel and                AudioCodes Ltd. 
|---- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

- 115 -

---

---



|ExhibitNo. |  | Exhibit
|---------- |  | -------

|14.2 |  | Consent
of Squar, Milner, Peterson, Miranda and Williamson, LLP.
|---- |  | ----------------------------------------------------------------

---

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

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

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

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

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

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

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

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

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

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

|§§§ | Incorporated
herein by reference to Registrants Form 20-F for the fiscal year ended December 31,
2004.
|--- | -------------------------------------------------------------------------------------------------------

|§§§§ | Incorporated
herein by reference to Registrants Form 20-F for the fiscal year ended December 31,
2005.
|---- | -------------------------------------------------------------------------------------------------------

- 116 -

---

---



# SIGNATURES

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

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

Date: June 27, 2007



---

---



# EXHIBIT INDEX

|ExhibitNo. |  | Exhibit
|---------- |  | -------

|4.29 |  | Building
and Tenancy Lease Agreement, dated May 11, 2007, by and between Airport City Ltd. and
AudioCodes Ltd. 
|---- |  | -----------------------------------------------------------------------------------------------------------------

|4.30 |  | Agreement
and Plan of Merger, dated as of July 6, 2006, by and among AudioCodes Ltd., AudioCodes,
 Inc., Violet Acquisition Corp., Netrake                Corporation and Will Kohler, as
Sellers' Representative.
|---- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.31 |  | Series
E Preferred Share Purchase Agreement, dated as of November 13, 2005, by and between CTI
Squared Ltd. and AudioCodes Ltd.
|---- |  | -------------------------------------------------------------------------------------------------------------------------------

|4.32 |  | Amended
and Restated Second Option Agreement,  dated as of October 6, 2006, by and among CTI
Squared Ltd., AudioCodes Ltd. and each of the                other parties thereto.
|---- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.33 |  | Amendment
No. 7 to OEM Purchase and Sale No. 011449 between AudioCodes Ltd. and Nortel Networks
Ltd., dated as of December 15, 2006.
|---- |  | ------------------------------------------------------------------------------------------------------------------------------------

|4.34 |  | Endorsement
and Transfer of Rights  Agreement,  dated March 29, 2007, by and between Nortel Networks
(Sales and Marketing) Ltd. Israel and                AudioCodes Ltd. 
|---- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

|14.2 |  | Consent
of Squar, Milner, Peterson, Miranda and Williamson, LLP.
|---- |  | ----------------------------------------------------------------

---

 English
summary of Hebrew original.



---

---

# SQUAR MILNER[LETTERHEAD]

# REPORT OF INDEPENDENT
REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors
of:Nuera Communications, Inc.

We have audited the consolidated
balance sheet of Nuera Communications, Inc. as of December 31, 2006, and the related
consolidated statements of operations, stockholders deficit and cash flows for the
period July 6, 2006 through December 31, 2006. These financial statements are the
responsibility of the Companys management. Our responsibility is to express an
opinion on this financial statement based on our audit.

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

In our opinion, the consolidated
financial statements referred to above present fairly, in all material respects, the
financial position of Nuera Communications, Inc. as of December 31, 2006 and the results
of its operations and its cash flows for the period July 6, 2006 through December 31, 2006
in conformity with accounting principles generally accepted in the United States of
America.

/s/ Squar, Milner, Peterson, Miranda and Williamson, LLPSQUAR, MILNER, PETERSON, MIRANDA AND WILLIAMSON, LLP

March 7, 2007San Diego,
California



---

---



# AUDIOCODES LTD. AND
ITS SUBSIDIARIES

# CONSOLIDATED FINANCIAL
STATEMENTS

# AS OF DECEMBER 31, 2006

# 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 Income                       | 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-48



---

---



# 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, 2005 and 2006, 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, 2006. These financial
statements are the responsibility of the Companys management. Our responsibility is
to express an opinion on these financial statements based on our audits. We did not audit
the financial statements of a wholly-owned subsidiary, which statements reflect total
assets of 2% as of December 31, 2006, and total revenues of 5% for the period from
July 6, 2006 through December 31, 2006. Those statements were audited by other auditors
whose report has been furnished to us, and our opinion, insofar as it relates to the
amounts included for this subsidiary, is based solely on the report of the other
auditors.

We
conducted our audits in accordance with the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and perform the
audit to obtain reasonable assurance about whether the financial statements are free of
material misstatement. We were not engaged to perform an audit of the Companys
internal control over financial reporting. Our audit included consideration of internal
control over financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purposes 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 and
the report of other auditors provide a reasonable basis for our opinion.

In
our opinion, based on our audits and the report of the other auditors, the consolidated
financial statements referred to above present fairly, in all material respects, the
consolidated financial position of the Company and its subsidiaries at December 31,
2005 and 2006, and the consolidated results of their operations and their cash flows for
each of the three years in the period ended December 31, 2006, in conformity with U.S
generally accepted accounting principles.

As
discussed in Note 2 v to the consolidated financial statement, in 2006 the company adopted
Statement Financial Accounting Statements Standards Board No. 123(Revised 2004)
Share Base Payment.

|                 |                                 
|---------------- | --------------------------------
|
|
|
|
|Tel-Aviv, Israel | KOST FORER GABBAY & KASIERER    
|March 28, 2007   | A Member of Ernst & Young Global

F - 2

---

---



|AUDIOCODES LTD. AND ITS SUBSIDIARIES
|------------------------------------
|                                    
|CONSOLIDATED BALANCE SHEETS         
|                                    
|U.S. dollars in thousands           

|                                                                                                            | December 31,
|----------------------------------------------------------------------------------------------------------- | ------------
|
|
|
|
|ASSETS                                                                                                      |             
|                                                                                                            |             
|CURRENT ASSETS:                                                                                             |             
|Cash and cash equivalents                                                                                   |             
|Short-term bank deposits and structured notes                                                               |             
|Short-term marketable securities and accrued interest                                                       |             
|Trade receivables (net of allowance for doubtful accounts of $ 553 and $ 854 at December 31, 2005 and 2006, |             
|respectively)                                                                                               |             
|Other receivables and prepaid expenses                                                                      |             
|Deferred tax assets                                                                                         |             
|Inventories                                                                                                 |             
|                                                                                                            |             
|                                                                                                            |             
|Total current assets                                                                                        |             
|                                                                                                            |             
|                                                                                                            |             
|LONG-TERM ASSETS:                                                                                           |             
|Long-term bank deposits and structured notes                                                                |             
|Long-term marketable securities                                                                             |             
|Investment in companies                                                                                     |             
|Deferred tax assets                                                                                         |             
|Severance pay funds                                                                                         |             
|                                                                                                            |             
|                                                                                                            |             
|Total long-term assets                                                                                      |             
|                                                                                                            |             
|                                                                                                            |             
|PROPERTY AND EQUIPMENT, NET                                                                                 |             
|                                                                                                            |             
|                                                                                                            |             
|INTANGIBLE ASSETS, DEFERRED CHARGES AND OTHER, NET                                                          |             
|                                                                                                            |             
|                                                                                                            |             
|GOODWILL                                                                                                    |             
|                                                                                                            |             
|                                                                                                            |             
|Total assets                                                                                                |             
|                                                                                                            |             

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 per share data

|                                                                                                           | December 31,
|---------------------------------------------------------------------------------------------------------- | ------------
|
|
|
|
|LIABILITIES AND SHAREHOLDERS' EQUITY                                                                       |             
|                                                                                                           |             
|CURRENT LIABILITIES:                                                                                       |             
|Trade payables                                                                                             |             
|Deferred tax liabilities                                                                                   |             
|Other payables and accrued expenses                                                                        |             
|                                                                                                           |             
|                                                                                                           |             
|Total current liabilities                                                                                  |             
|                                                                                                           |             
|                                                                                                           |             
|LONG-TERM LIABILITIES:                                                                                     |             
|Deferred tax liabilities                                                                                   |             
|Accrued severance pay                                                                                      |             
|Senior convertible notes                                                                                   |             
|                                                                                                           |             
|                                                                                                           |             
|Total long-term liabilities                                                                                |             
|                                                                                                           |             
|                                                                                                           |             
|COMMITMENTS AND CONTINGENT LIABILITIES                                                                     |             
|                                                                                                           |             
|SHAREHOLDERS' EQUITY:                                                                                      |             
|Share capital -                                                                                            |             
|Ordinary shares of NIS 0.01 par value -                                                                    |             
|Authorized: 100,000,000 at December 31, 2005 and 2006; Issued: 44,529,943 shares at December 31, 2005 and  |             
|46,051,867 shares at December 31, 2006; Outstanding: 40,587,804 shares at December 31, 2005 and 42,109,728 |             
|shares at December 31, 2006                                                                                |             
|Additional paid-in capital                                                                                 |             
|Treasury stock                                                                                             |             
|Deferred stock compensation                                                                                |             
|Accumulated other comprehensive income                                                                     |             
|Retained earnings                                                                                          |             
|                                                                                                           |             
|                                                                                                           |             
|Total shareholders' equity                                                                                 |             
|                                                                                                           |             
|                                                                                                           |             
|Total liabilities and shareholders' equity                                                                 |             
|                                                                                                           |             

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

F - 4

---

---



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

|                                                    | Year ended December 31,
|--------------------------------------------------- | -----------------------
|
|
|
|
|Revenues                                            |                        
|Cost of revenues                                    |                        
|                                                    |                        
|                                                    |                        
|Gross profit                                        |                        
|                                                    |                        
|                                                    |                        
|Operating expenses:                                 |                        
|Research and development, net                       |                        
|Selling and marketing                               |                        
|General and administrative                          |                        
|                                                    |                        
|                                                    |                        
|Total operating expenses                            |                        
|                                                    |                        
|                                                    |                        
|Operating income                                    |                        
|Financial income, net                               |                        
|Equity in losses from investments in companies, net |                        
|                                                    |                        
|                                                    |                        
|Income before taxes on income                       |                        
|Taxes on income                                     |                        
|                                                    |                        
|                                                    |                        
|Net income                                          |                        
|                                                    |                        
|                                                    |                        
|Basic net earnings per share                        |                        
|                                                    |                        
|                                                    |                        
|Diluted net earnings per share                      |                        
|                                                    |                        

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, 2004                               |               |                            | $              | 121                         |                                        | $                 | 116,518                           |                           
|                                                            |               |                           
|Issuance of shares upon exercise of options                 |               |                           
|and employee stock purchase plan                            |               |                            |                | 5                           |                                        |                   | 10,182                            |                           
|Amortization of deferred stock compensation                 |               |                            |                | -                           |                                        |                   | -                                 |                           
|Comprehensive income, net:                                  |               |                           
|Unrealized gain on forward contracts, net                   |               |                            |                | -                           |                                        |                   | -                                 |                           
|Net income                                                  |               |                            |                | -                           |                                        |                   | -                                 |                           
|                                                            |               |                            |                |                             |                                        |                   |                                   |                           
|Total comprehensive income, net                             |               |                            |                |                             |                                        |                   |                                   |                           
|                                                            |               |                            |                |                             |                                        |                   |                                   |                           
|Balance as of December 31, 2004                             |               |                            |                | 126                         |                                        |                   | 126,700                           |                           
|                                                            |               |                           
|Issuance of shares upon exercise of options                 |               |                           
|and employee stock purchase plan                            |               |                            |                | 2                           |                                        |                   | 3,916                             |                           
|Amortization of deferred stock compensation                 |               |                            |                | -                           |                                        |                   | -                                 |                           
|Comprehensive income, net:                                  |               |                           
|Unrealized loss on forward contracts, net                   |               |                            |                | -                           |                                        |                   | -                                 |                           
|Net income                                                  |               |                            |                | -                           |                                        |                   | -                                 |                           
|                                                            |               |                            |                |                             |                                        |                   |                                   |                           
|Total comprehensive income, net                             |               |                            |                |                             |                                        |                   |                                   |                           
|                                                            |               |                            |                |                             |                                        |                   |                                   |                           
|Balance as of December 31, 2005                             |               |                            |                | 128                         |                                        |                   | 130,616                           |                           
|                                                            |               |                           
|Issuance of shares upon exercise of options                 |               |                           
|and employee stock purchase plan                            |               |                            |                | 3                           |                                        |                   | 9,178                             |                           
|Amortization of deferred stock compensation                 |               |                            |                | -                           |                                        |                   | 8,707                             |                           
|Excess tax benefit from  net operating     loss utilization |               |                            |                | -                           |                                        |                   | 776                               |                           
|Reclassification of deferred stock compensation             |               |                           
|due to implementation of SFAS 123R                          |               |                            |                | -                           |                                        |                   | (72                               | )                         
|Comprehensive income, net:                                  |               |                           
|Unrealized gain on forward contracts, net                   |               |                            |                | -                           |                                        |                   | -                                 |                           
|Net income                                                  |               |                            |                | -                           |                                        |                   | -                                 |                           
|                                                            |               |                            |                |                             |                                        |                   |                                   |                           
|Total comprehensive income, net                             |               |                            |                |                             |                                        |                   |                                   |                           
|                                                            |               |                            |                |                             |                                        |                   |                                   |                           
|Balance as of December 31, 2006                             |               |                            | $              | 131                         |                                        | $                 | 149,205                           |                           
|                                                            |               |                            |                |                             |                                        |                   |                                   |                           

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,
|------------------------------------------------------------------------------------------- | -----------------------
|
|
|
|
|Cash flows from operating activities:                                                       |                        
|Net income                                                                                  |                        
|Adjustments required to reconcile net income  to net cash provided by operating activities: |                        
|Depreciation and amortization                                                               |                        
|Amortization of marketable securities premiums and accretion of discounts, net              |                        
|Equity in losses of affiliated companies, net                                               |                        
|Stock-based compensation expenses                                                           |                        
|Amortization of senior convertible notes discount and deferred charges                      |                        
|Decrease (increase) in accrued interest on marketable securities,                           |                        
|bank deposits and structured notes                                                          |                        
|Increase in deferred tax assets, net                                                        |                        
|Increase in trade receivables, net                                                          |                        
|Decrease (increase) in other receivables and prepaid expenses                               |                        
|Increase in inventories                                                                     |                        
|Increase (decrease) in trade payables                                                       |                        
|Increase (decrease) in other payables and accrued expenses                                  |                        
|Increase in accrued severance pay, net                                                      |                        
|Other                                                                                       |                        
|                                                                                            |                        
|                                                                                            |                        
|Net cash provided by operating activities                                                   |                        
|                                                                                            |                        
|                                                                                            |                        
|Cash flows from investing activities:                                                       |                        
|Investments in affiliated companies                                                         |                        
|Short-term loan to unrelated company                                                        |                        
|Purchase of property and equipment                                                          |                        
|Proceeds from sale of property and equipment                                                |                        
|Investment in short-term and long-term bank deposits                                        |                        
|Proceeds from sale of short-term bank deposits                                              |                        
|Investment in structured notes                                                              |                        
|Proceeds from structured notes called by the issuer                                         |                        
|Investment in short-term and long-term marketable securities                                |                        
|Proceeds from marketable securities held to maturity                                        |                        
|Proceeds from sale of held-to-maturity marketable securities                                |                        
|Payment for acquisition of Universal Audio Server ("UAS") (1)                               |                        
|Payment for acquisition of AudioCodes USA Inc. (2)                                          |                        
|Payment for acquisition of Nuera Communication Inc. (3)                                     |                        
|Payment for acquisition of Netrake Corporation Inc. (4)                                     |                        
|                                                                                            |                        
|                                                                                            |                        
|Net cash used in investing activities                                                       |                        
|                                                                                            |                        
|                                                                                            |                        
|Cash flows from financing activities:                                                       |                        
|Proceeds from issuance of senior convertible notes                                          |                        
|Issuance costs for senior convertible notes                                                 |                        
|Initial purchasers discount in respect of senior convertible notes                          |                        
|Proceeds from issuance of shares upon exercise of options and employee stock purchase plan  |                        
|                                                                                            |                        
|                                                                                            |                        
|Net cash provided by financing activities                                                   |                        
|                                                                                            |                        
|                                                                                            |                        
|Increase (decrease) in cash and cash equivalents                                            |                        
|Cash and cash equivalents at the beginning of the year                                      |                        
|                                                                                            |                        
|                                                                                            |                        
|Cash and cash equivalents at the end of the year                                            |                        
|                                                                                            |                        

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,
|--------------------------------------------------------------------------------------- | -----------------------
|
|
|
|
|(1)    Payment for acquisition of UAS                                                   |                        
|Net fair value of assets acquired of UAS at the date of acquisition:                    |                        
|Goodwill                                                                                |                        
|Paid accrued liability                                                                  |                        
|                                                                                        |                        
|                                                                                        |                        
|                                                                                        |                        
|                                                                                        |                        
|                                                                                        |                        
|(2)    Payment for acquisition of AudioCodes USA Inc.                                   |                        
|Net fair value of assets acquired and liabilities assumed of AudioCodes USA Inc. at the |                        
|date of acquisition (see also Note 1b):                                                 |                        
|Working capital, net (excluding cash and cash equivalents)                              |                        
|Property and equipment                                                                  |                        
|Technology                                                                              |                        
|Goodwill                                                                                |                        
|                                                                                        |                        
|                                                                                        |                        
|                                                                                        |                        
|                                                                                        |                        
|                                                                                        |                        
|(3)    Payment for acquisition of Nuera Communication Inc.                              |                        
|Net fair value of assets acquired and liabilities assumed of Nuera at the date of       |                        
|acquisition (see also Note 1c):                                                         |                        
|Working capital, net (excluding cash and cash equivalents)                              |                        
|Technology                                                                              |                        
|Backlog                                                                                 |                        
|Customer relationship                                                                   |                        
|Trade name                                                                              |                        
|Deferred tax liability                                                                  |                        
|Existing contracts                                                                      |                        
|Deferred tax assets                                                                     |                        
|Goodwill                                                                                |                        
|                                                                                        |                        
|                                                                                        |                        
|                                                                                        |                        
|                                                                                        |                        
|                                                                                        |                        
|(4)    Payment for acquisition of Netrake Corporation Inc.                              |                        
|Net fair value of assets acquired and liabilities assumed of Netrake at the date of     |                        
|acquisition (see also Note 1d)                                                          |                        
|Working capital, net (excluding cash and cash equivalents)                              |                        
|Core technology                                                                         |                        
|Backlog                                                                                 |                        
|Deferred tax liability                                                                  |                        
|Goodwill                                                                                |                        
|                                                                                        |                        
|                                                                                        |                        
|                                                                                        |                        
|                                                                                        |                        
|(5)    Supplemental disclosure of cash flow activities:                                 |                        
|Cash paid during the year for income taxes                                              |                        
|                                                                                        |                        
|                                                                                        |                        
|Cash paid during the year for interest                                                  |                        
|                                                                                        |                        

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, except share and per share data

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

| | a. | Business
overview:
| | -- | ------------------

| | AudioCodes
Ltd. (the Company) and its subsidiaries (together the Group)
designs, develops and markets Voice over Packet (VOP) technology, voice network products,
and applications to original equipment manufacturers, network equipment providers,
service providers and system integrators worldwide.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company operates through its wholly-owned subsidiaries in the United States, United
Kingdom, France, Germany, Argentina, Brazil, India, Japan and Korea.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------

| | b. | Acquisition
of AudioCodes USA Inc. (Formerly known as AI-Logix Inc.)
| | -- | --------------------------------------------------------------------

| | On
May 12, 2004, the Group acquired all of the outstanding common stock of AudioCodes USA
Inc., a provider of advanced voice and data recording hardware integration cards for the
call recording and voice or data logging industry.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 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 AudioCodes USA Inc. business during 2004 and 2005. This payment
was 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
results of AudioCodes USA Inc. have been included in the consolidated financial
statements of the Group since the acquisition date.
| | ---------------------------------------------------------------------------------------------------------------------------------------

F - 9

---

---



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

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

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

| |                                               | May 12, 2004
| | --------------------------------------------- | ------------
|
|
|
|
| | Trade receivables                             |             
| | Inventories                                   |             
| | Prepaid expenses                              |             
| | Property and equipment                        |             
| |                                               |             
| |                                               |             
| | Total tangible assets acquired                |             
| |                                               |             
| |                                               |             
| | Technology (five years useful life)           |             
| | Goodwill                                      |             
| |                                               |             
| |                                               |             
| | Total intangible assets acquired              |             
| |                                               |             
| |                                               |             
| | Total tangible and intangible assets acquired |             
| |                                               |             
| |                                               |             
| | Trade payables                                |             
| | Accrued expenses                              |             
| | Other current liabilities                     |             
| |                                               |             
| |                                               |             
| | Total liabilities assumed                     |             
| |                                               |             
| |                                               |             
| | Net assets acquired                           |             
| |                                               |             

| | Goodwill
includes, but is not limited to, the synergistic value and potential competitive benefits
that could be realized by the Company from the acquisition. Goodwill is not deductible
for tax purposes. In accordance with SFAS No. 142, goodwill arising from this acquisition
will not be amortized (see also Note 2n).
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
value assigned to tangible assets, intangible assets and liabilities has been determined
as follows:
| | --------------------------------------------------------------------------------------------------------

| | Current
assets and liabilities are recorded at their carrying amounts. The carrying amounts of
current assets and liabilities were reasonable proxies for their market value due to
their short-term maturity. Property and equipment are presented at current replacement
cost. 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 AudioCodes USA Inc. been
consummated on January 1, 2004, nor does it purport to represent the results of
operations of the Group for any future period.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 10

---

---



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

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

| |                                | Year ended
December 31,
2004
| | ------------------------------ | ----------------------------
|
|
|
|
| | Revenues                       |                             
| |                                |                             
| |                                |                             
| | Net income                     |                             
| |                                |                             
| |                                |                             
| | Basic net earnings per share   |                             
| |                                |                             
| |                                |                             
| | Diluted net earnings per share |                             
| |                                |                             

| | c. | Acquisition
of Nuera Communication Inc.:
| | -- | ----------------------------------------

| | On
July 6, 2006, the Group acquired all of the outstanding common stock of Nuera
Communication Inc, a leading provider of Voice over Internet Protocol (VoIP)
infrastructure solutions for broadband and long distance with an extensive client base in
North America as well as in Asia and Europe.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Group paid $ 82,520 in cash at the closing of the transaction including acquisition costs
in the amount of $2,376.
| | ----------------------------------------------------------------------------------------------------------------------

| | Nuera
 Communication  Inc. became a wholly-owned  subsidiary of AudioCodes Inc. and
accordingly,  its results                      of  operations  have  been  included  in
the  consolidated  financial  statements  of  the  Group  since  the
                     acquisition date.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | This
acquisition was accounted for under the purchase method of accounting in accordance with
SFAS No. 141.
| | -----------------------------------------------------------------------------------------------------------

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

F - 11

---

---



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

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

| |                                                | July 6, 2006
| | ---------------------------------------------- | ------------
|
|
|
|
| | Trade receivables                              |             
| | Inventories                                    |             
| | Other receivables and prepaid expenses         |             
| | Deferred tax asset                             |             
| | Property and equipment                         |             
| |                                                |             
| |                                                |             
| | Total tangible assets acquired                 |             
| |                                                |             
| |                                                |             
| | Technology (five years useful life)            |             
| | Backlog (one year useful life)                 |             
| | Customer relationship (nine years useful life) |             
| | Existing contracts (three years useful life)   |             
| | Trade name (three years useful life)           |             
| | Goodwill                                       |             
| |                                                |             
| |                                                |             
| | Total intangible assets acquired               |             
| |                                                |             
| | Total tangible and intangible assets acquired  |             
| |                                                |             
| |                                                |             
| | Trade payables                                 |             
| | Deferred tax liability                         |             
| | Other current liabilities and accrued expenses |             
| |                                                |             
| |                                                |             
| | Total liabilities assumed                      |             
| |                                                |             
| |                                                |             
| | Net assets acquired                            |             
| |                                                |             

| | Goodwill
includes, but is not limited to, the synergistic value and potential competitive benefits
that could be realized by the Company from the acquisition. Goodwill is not deductible
for tax purposes. In accordance with SFAS No. 142, goodwill arising from this acquisition
will not be amortized (see also Note 2n).
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
value assigned to tangible assets, intangible assets and liabilities has been determined
as follows:
| | --------------------------------------------------------------------------------------------------------

| | Deferred
tax liabilities in the amount of $6,176 were recorded for the difference between the
assigned values and the tax bases of the intangible assets acquired in the acquisition.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 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 fair value of intangible assets was determined using the income approach.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 12

---

---



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

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

| | 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 Nuera Communication Inc.
been consummated on January 1, 2005, nor does it purport to represent the results of
operations of the Group for any future period.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |                                       | Year ended December 31,
| | ------------------------------------- | -----------------------
|
|
|
|
| | Revenues                              |                        
| |                                       |                        
| |                                       |                        
| | Net income (loss)                     |                        
| |                                       |                        
| |                                       |                        
| | Basic net earnings (loss) per share   |                        
| |                                       |                        
| |                                       |                        
| | Diluted net earnings (loss) per share |                        
| |                                       |                        

| | d. | Acquisition
of Netrake Corporation Inc.:
| | -- | ----------------------------------------

| | On
August 14, 2006, the Group acquired all of the outstanding common stock of Netrake
Corporation Inc, a leading provider of Session Border Controller (SBC) and Security
Gateway solutions. SBCS enable connectivity, policies and security for real-time
applications such as VoIP and video when traversing IP to IP networks. Security Gateways
enable secure real-time session across wifi, broadband and wireless networks in Field
Mobile Convergence (FMC) deployments.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Group paid $13,836 in cash at the closing of the transaction including acquisition costs
in the amount of $649.
| | -------------------------------------------------------------------------------------------------------------------

| | Netrake
Corporation Inc. became a wholly-owned subsidiary of AudioCodes Inc. and accordingly, its
results of operations have been included in the consolidated financial statements of the
Group since the acquisition date.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | This
acquisition was accounted for under the purchase method of accounting in accordance with
SFAS No. 141.
| | -----------------------------------------------------------------------------------------------------------

F - 13

---

---



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

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

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

| |                                                | August 14, 2006
| | ---------------------------------------------- | ---------------
|
|
|
|
| | Trade receivables                              |                
| | Inventories                                    |                
| | Other receivables and prepaid expenses         |                
| |                                                |                
| |                                                |                
| | Property and equipment                         |                
| |                                                |                
| |                                                |                
| | Total tangible assets acquired                 |                
| |                                                |                
| |                                                |                
| | Technology (five years useful life)            |                
| | Backlog (one year useful life)                 |                
| | Goodwill                                       |                
| |                                                |                
| |                                                |                
| | Total intangible assets acquired               |                
| |                                                |                
| |                                                |                
| | Total tangible and intangible assets acquired  |                
| |                                                |                
| |                                                |                
| | Trade payables                                 |                
| | Deferred tax liability                         |                
| | Other current liabilities and accrued expenses |                
| |                                                |                
| |                                                |                
| | Total liabilities assumed                      |                
| |                                                |                
| |                                                |                
| | Net assets acquired                            |                
| |                                                |                

| | Goodwill
includes, but is not limited to, the synergistic value and potential competitive benefits
that could be realized by the Company from the acquisition. Goodwill is not deductible
for tax purposes. In accordance with SFAS No. 142, goodwill arising from this acquisition
will not be amortized (see also Note 2n).
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
value assigned to tangible assets, intangible assets and liabilities has been determined
as follows:
| | --------------------------------------------------------------------------------------------------------

| | Deferred
tax liabilities in the amount of $2,310 were recorded for the difference between the
assigned values and the tax bases of the intangible assets acquired in the acquisition.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 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 fair value of intangible assets was determined using the income approach.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 14

---

---



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

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

| | 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 Netrake Corporation Inc.
been consummated on January 1, 2005, nor does it purport to represent the results of
operations of the Group for any future period.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |                            | Year ended December 31,
| | -------------------------- | -----------------------
|
|
|
|
| | Revenues                   |                        
| |                            |                        
| |                            |                        
| | Net loss                   |                        
| |                            |                        
| |                            |                        
| | Basic net loss per share   |                        
| |                            |                        
| |                            |                        
| | Diluted net loss per share |                        
| |                            |                        

| | e. | The
Group is dependent upon sole source suppliers for certain key components           used
in its products, including certain digital signal processing chips.           Although
there 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.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | f. | As
to a major customer data, see Note 16b.
| | -- | ------------------------------------------

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

F - 15

---

---



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

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

| | 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 5.18%. 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.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Management
determines the appropriate classification of its investments in marketable debt
securities at the time of purchase and evaluates such determinations at each balance
sheet date. Debt securities are classified as held-to-maturity since the Company has the
intent and ability to hold the securities to maturity and, accordingly, debt securities
are stated at amortized cost.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
amortized cost of held-to-maturity securities is adjusted for amortization of premiums
and accretion of discounts to maturity. Such amortization and interest are included in
the consolidated statement of income as financial income or expenses, as appropriate. The
accrued interest on short-term and long-term marketable securities is included in the
balance of short-term marketable securities.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 16

---

---



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

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

| | 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. The deposits are in U.S. dollars and
bear interest at an average rate of 5.10%. The Long-term deposits are presented at their
cost. The accrued interest is included in other receivables and prepaid expenses.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 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) Issue No. 96-12, Recognition of Interest Income and
Balance Sheet Classification of Structure Notes. Management determines the
appropriate classification of its investments in debt securities at the time of purchase
and reevaluates such determinations at each balance sheet date. Debt securities are
classified as held-to-maturity when the Group has the intent and ability to hold these
securities to maturity and are stated at amortized cost. As of December 31, 2005 and
2006, investments in structured notes approximate their market value.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | j. | Investment
in companies:
| | -- | ------------------------

| | The
Company accounts for its investments in companies in which it has the ability to exercise
significant influence over the operating and financial policies, using the equity method
of accounting in accordance with the requirements of Accounting Principle Board (APB)
No. 18, The Equity Method of Accounting for Investments in Common Stock. If
the Company does not have the ability to exercise significant influence over operating
and financial policies of these companies, the investment in these companies is stated at
cost.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Investment
in companies represents investments in Ordinary shares, Preferred shares and convertible
loans. The Company applies EITF No. 99-10, Percentage Used to Determine the Amount
of Equity Method Losses. Accordingly, losses of such companies are recognized based
on the ownership level of the particular security held by the investor.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 17

---

---



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

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

| | The
Companys investments are reviewed for impairment whenever events or changes in
circumstances indicate that the carrying amount of the investment may not be recoverable,
in accordance with APB No. 18. As of December 31, 2006, 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 Goodwill and Other Intangible
Assets. Amortization is calculated by the straight-line method over the estimated
useful lives of the assets as follows:
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

| | Cost
incurred in respect of issuance of senior convertible notes are deferred and amortized
using the effective interest method and classified as a component of interest expense,
over the period from issuance to maturity, which is 20 years, in accordance with APB No.
21 Interest on Receivables and Payables.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 18

---

---



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

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

| | 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, 2006, no impairment losses have been identified.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

| | 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 2006. The test was based on
the Groups single operating segment and reporting unit structure. As of December 31,
2006, no impairment losses had been identified.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | o. | Revenue
recognition:
| | -- | --------------------

| | The
Group generates its revenues primarily from the sale of products, through a direct sales
force and sales representatives. The Groups products are delivered to its
customers, which include original equipment manufacturers, network equipment providers,
systems integrators and distributors in the telecommunications and networking industries,
all of whom are considered end-users.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 19

---

---



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

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

| | 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 the total price paid for products they have purchased over a
period of three months for other products. The Group maintains a provision for product
returns and exchanges based on its experience with historical sales returns, analysis of
credit memo data and other known factors, in accordance with SFAS No. 48, Revenue
Recognition When Right of Return Exists. The provision was deducted from revenues
and amounted to $619, $545 and $636 as of December 31, 2004, 2005 and 2006, 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 income as
incurred.
| | -----------------------------------------------------------------------------------------------------------

| | r. | Income
taxes:
| | -- | -------------

| | The
Group accounts for income taxes in accordance with SFAS No. 109, Accounting for
Income Taxes. This Statement prescribes the use of the asset and liability method
whereby account balances of deferred tax assets and liabilities are determined based on
differences between financial reporting and tax bases of assets and liabilities and are
measured using the enacted tax rates and laws that will be in effect when the differences
are expected to reverse. The Group provides a valuation allowance, if necessary, to
reduce deferred tax assets to their estimated realizable value.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 20

---

---



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

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

| | 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 Issue No. 00-27 Application of Issue No. 98-5 to Certain Convertible Industries,
which is 20 years.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | u. | Basic
and diluted net earnings per share:
| | -- | -----------------------------------------

| | Basic
net earnings per share are computed based on the weighted average number of Ordinary
shares outstanding during each year. Diluted net earnings per share are computed based on
the weighted average number of Ordinary shares outstanding during each year, plus
potential dilutive Ordinary shares considered outstanding during the year, in accordance
with SFAS No. 128, Earnings Per Share.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 21

---

---



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

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

| | Senior
convertible notes and certain outstanding stock options and warrants have been excluded
from the calculation of the diluted net earnings per Ordinary share since such securities
are anti-dilutive for all years presented. The total weighted average number of shares
related to the senior convertible notes and outstanding options and warrants that have
been excluded from the calculations of diluted net earnings per share was 4,972,991,
8,598,556 and 9,924,624 for the years ended December 31, 2004, 2005 and 2006,
respectively.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | v. | Equity-based
compensation expenses:
| | -- | -----------------------------------

| | On
January 1, 2006, the Company adopted SFAS No. 123 (revised 2004), Share-Based
Payment (SFAS No. 123(R)) which requires the measurement and
recognition of compensation expense based on estimated fair values for all share-based
payment awards made to employees and directors. SFAS No. 123(R) supersedes APB No. 25,
Accounting for Stock Issued to Employees , for periods beginning in fiscal
year 2006. In March 2005, the Securities and Exchange Commission issued SAB No. 107
relating to SFAS No. 123(R). The Company has applied the provisions of SAB No. 107 in its
adoption of SFAS No. 123(R).
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | SFAS
No. 123(R) requires companies to estimate the fair value of equity-based payment awards
on the date of grant using an option-pricing model. The value of the portion of the award
that is ultimately expected to vest is recognized as an expense in the Companys
consolidated income statements over the requisite service periods.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Prior
to the adoption of SFAS No. 123(R), the Company accounted for equity-based awards to
employees and directors using the intrinsic value method in accordance with APB No. 25 as
allowed under SFAS No. 123, Accounting for Stock-Based Compensation. The Company
recognized compensation expenses, which had graded vesting, based on the accelerated
attribution method over the requisite service period of each of the awards. Forfeitures
were accounted for as occurred. During 2004 and 2005 the Company recorded compensation
expenses in the amount of $66 and $36, respectively.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company adopted SFAS No. 123(R) using the modified prospective transition method, which
requires the application of the accounting standard starting from January 1, 2006, the
first day of the Companys fiscal year 2006. Under that transition method,
compensation cost recognized in the year ended December 31, 2006, includes: (a)
compensation cost for all share-based payments granted prior to, but not yet vested as of
January 1, 2006, based on the grant date fair value estimated in accordance with the
original provisions of SFAS No. 123, and (b) compensation cost for all share-based
payments granted subsequent to January 1, 2006, based on the grant-date fair value
estimated in accordance with the provisions of SFAS No. 123(R). Results for prior periods
have not been restated.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 22

---

---



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

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

| | The
Company recognizes compensation expenses for the value of its awards based on the
accelerated method over the requisite service period of each of the awards, net of
estimated forfeitures. SFAS No. 123(R) requires forfeitures to be estimated at the time
of grant and revised, if necessary, in subsequent periods if actual forfeitures differ
from those estimates. Estimated forfeitures are based on actual historical pre-vesting
forfeitures.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
effect of adopting SFAS No. 123(R) on January 1, 2006, was a decrease in the Companys
income before taxes on income and net income for the year ended December 31, 2006, of
$8,707 with a corresponding decrease in the basic and diluted net earnings per share of
$0.21 and $0.19 respectively.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

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

| | The
Black-Scholes pricing-model was used to estimate the fair value of the Employee Stock
Purchase Plan (ESPP) compensation. Assumptions are not provided due to
immateriality.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Pro
forma information under SFAS No. 123 is as follows:
| | -------------------------------------------------------

| |                                                                                            | Year ended December 31,
| | ------------------------------------------------------------------------------------------ | -----------------------
|
|
|
|
| | Net income as reported                                                                     |                        
| | Add: stock-based compensation expenses determined under the intrinsic value based method   |                        
| | included in the reported net income                                                        |                        
| | Deduct: stock-based compensation expenses determined under the fair value based method for |                        
| | all awards                                                                                 |                        
| |                                                                                            |                        
| |                                                                                            |                        
| | Pro forma net income (loss)                                                                |                        
| |                                                                                            |                        
| |                                                                                            |                        
| | Basic net earnings per share as reported                                                   |                        
| |                                                                                            |                        
| | Diluted net earnings per share as reported                                                 |                        
| |                                                                                            |                        
| |                                                                                            |                        
| | Pro forma basic net earning (loss) per share                                               |                        
| |                                                                                            |                        
| |                                                                                            |                        
| | Pro forma diluted net earning (loss) per share                                             |                        
| |                                                                                            |                        

F - 23

---

---



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

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

| | As
of December 31, 2006, the total unrecognized estimated compensation cost related to
non-vested stock options granted prior to that date was $12,381, which is expected to be
recognized over a weighted-average period of 1.6 years. The total intrinsic value of
stock options exercised during 2006 was $4,790. The Company recorded cash received from
the exercise of stock options of $6,515 during the year ended December 31, 2006.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
weighted-average estimated fair value of employee stock options and Employee Stock
Purchase Plan granted during the 12 months ended December 31, 2006, was $ 5.81, per share
using the Black-Scholes option pricing formula with the following weighted-average
assumptions (annualized percentages):
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |                     | Year ended
December 31,
2006
| | ------------------- | ----------------------------
|
|
|
|
| | Dividend yield      | 0%                          
| | Expected volatility | 61.9%                       
| | Risk-free interest  | 4.6%                        
| | Expected life       | 4.8 years                   

| | The
Company is required to assume a dividend yield as an input in the Black-Scholes model.
The dividend yield assumption is based on the Companys historical experience and
expectation of future dividend payouts and may be subject to substantial change in the
future. The dividend yield used for the twelve months ended December 31, 2006 was 0%.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
computation of volatility uses historical volatility derived from the companys
exchange traded shares. As a result of the above-mentioned calculations, the
weighted-average volatility used for the twelve months ended December 31, 2006 was 61.9%.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
risk-free interest rate assumption is the implied yield currently available on United
States treasury zero-coupon issues with a remaining term equal to the expected life term
of the Companys options. Weighted average interest rate used for the twelve months
ended December 31, 2006 was 4.6%.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company determined the expected life of the options according to the simplified method,
average of vesting and the contractual term of the Companys stock options. Expected
life used for the twelve months ended December 31, 2006 was 4.8 years.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 24

---

---



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

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

| | The
Companys aggregate compensation cost for the twelve months ended December 31, 2006
totaled $8,707 thousand. The total income tax benefit recognized in the income statement
for the twelve months ended December 31, 2006 was $0, for the Companys
equity-based compensation arrangements.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
total equity-based compensation expense related to all of the Companys equity-based
awards, recognized for twelve months ended December 31, 2006, was comprised as follows:
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |                                                      | Year ended
December 31,
2006
| | ---------------------------------------------------- | ----------------------------
|
|
|
|
| | Cost of goods sold                                   |                             
| | Research and development                             |                             
| | Selling and Marketing                                |                             
| | General and administrative                           |                             
| |                                                      |                             
| |                                                      |                             
| | Total equity-based compensation expense before taxes |                             
| |                                                      |                             

| | 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
pay expenses for the years ended December 31, 2004, 2005 and 2006, amounted to
approximately $1,182, $1,514 and $1,766, respectively.
| | -----------------------------------------------------------------------------------------------------------------------------------------------

F - 25

---

---



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

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

| | x. | Employees
benefit plan
| | -- | ----------------------

| | The
Company has four 401(K) defined contribution plans covering certain employees in the U.S.
All eligible employees may elect to contribute up to 100%, but generally not greater than
$ 15 per year ($20 including catch-up contributions for eligible participants over the
age of 50), of their annual compensation to the plan through salary deferrals, subject to
IRS limits. Effective from January 1, 2006 the Company matches employees contributions to
the plan up to limit of 3.75% of their eligible compensation, subject to IRS limits. In
2006 the Company matched contributions in the amount of $ 271.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | y. | Advertising
expenses:
| | -- | ---------------------

| | Advertising
expenses are charged to the statements of operations as incurred. Advertising expenses
for the years ended December 31, 2004, 2005 and 2006, amounted to $359, $371 and $402,
respectively.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | z. | Fair
value of financial instruments:
| | -- | ------------------------------------

| | The
following methods and assumptions were used by the Group in estimating its fair value
disclosures for financial instruments:
| | --------------------------------------------------------------------------------------------------------------------------------

| | The
carrying amounts of cash and cash equivalents, trade receivables and trade payables
approximate their fair value due to the short-term maturity of such instruments.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
carrying amounts of bank deposits 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 Note 4).
| | ----------------------------------------------------------------------------------------------------------------------------------------

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

F - 26

---

---



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

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

| | aa. | 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 also
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 derivative 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.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 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 hedge against the risk of overall changes in cash flows resulting from forecasted
foreign currency salary payments during the year. The Company has instituted a foreign
currency cash flow hedging program. The Company hedges portions of its forecasted
expenses denominated in NIS with forward and put and call options (zero  cost
collar). These option contracts are designated as cash flow hedges, as defined by SFAS
No. 133 and Derivative Implementation Group No. G20. Cash Flow Hedges Assessing and
Measuring the Effectiveness of a Purchased option Used in a Cash Flow Hedge. (DIG 20)
and are all effective.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | At
December 31, 2006, the Group expects to reclassify $122 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.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 27

---

---



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

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

| | ab. | Impact
of recently issued accounting standards:
| | --- | -----------------------------------------------

| | 1. | FIN
No 48
| | -- | ---------

| | In
July 2006, the FASB issued FASB Interpretation No. 48 Accounting for Uncertainty in
Income Taxes an Interpretation of FASB Statement No. 109 (FIN No 48).
FIN No 48 clarifies the accounting for income taxes by prescribing the minimum
recognition threshold a tax position is required to meet before being recognized in the
financial statements. FIN 48 utilizes a two-step approach for evaluating tax positions.
Recognition (step one) occurs when an enterprise concludes that a tax position, based
solely on its technical merits, is more-likely-than-not to be sustained upon examination.
Measurement (step two) is only addressed if step one has been satisfied (i.e., the
position is more-likely-than-not to be sustained). Under step two, the tax benefit is
measured as the largest amount of benefit, determined on a cumulative probability basis
that is more-likely-than-not to be realized upon ultimate settlement.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | FIN
No 48 applies to all tax positions related to income taxes subject to the FASB No. 109,
Accounting for income taxes. This includes tax positions considered to be
routine as well as those with a high degree of uncertainty.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | FIN
No 48 has expanded disclosure requirements which include a tabular roll forward of the
beginning and ending aggregate unrecognized tax benefits as well as specific detail
related to tax uncertainties for which it is reasonably possible the amount of
unrecognized tax benefit will significantly increase or decrease within twelve months.
These disclosures are required at each annual reporting period unless a significant
change occurs in an interim period.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | FIN
No 48 is effective for fiscal years beginning after December 15, 2006. The cumulative
effect of applying FIN No 48 will be reported as an adjustment to the opening balance of
retained earnings.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company is currently evaluating the effect of the adoption of FIN 48 on its financial
statements.
| | -----------------------------------------------------------------------------------------------------

F - 28

---

---



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

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

| | 2. | SFAS
No. 157
| | -- | ------------

| | In
September 2006, the FASB issued SFAS No. 157, Fair Value Measurements . This statement
provides a single definition of fair value, a framework for measuring fair value, and
expanded disclosures concerning fair value. Previously, different definitions of fair
value were contained in various accounting pronouncements creating inconsistencies in
measurement and disclosures. SFAS No. 157 applies under those previously issued
pronouncements that prescribe fair value as the relevant measure of value, except SFAS
No. 123(R) and related interpretations. The statement does not apply to accounting
standards that require or permit measurement similar to fair value but are not intended
to measure fair value. This pronouncement is effective for fiscal years beginning after
November 15, 2007. The Company is currently evaluating the impact of adopting SFAS No 157.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 3. | SFAS
No. 159
| | -- | ------------

| | In
February 2007, the FASB issued SFAS No. 159, The Fair Value Option for
Financial Assets and Financial Liabilities. SFAS No. 159 permits companies to
choose to measure certain financial instruments and certain other items at fair value.
The standard requires that unrealized gains and losses on items for which the fair value
option has been elected be reported in earnings. SFAS No. 159 is effective for
financial statements issued for fiscal years beginning after November 15, 2007 and
interim periods within those fiscal years, although earlier adoption is permitted. The
Company is currently evaluating the impact that SFAS No. 159 will have on its
consolidated financial statements.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|NOTE 3: |  | BANK DEPOSITS AND STRUCTURED NOTES
|------- | - | ----------------------------------

| | Bank
deposits and structured notes are composed as follows:
| | -----------------------------------------------------------

| |                                            | December 31,
| | ------------------------------------------ | ------------
|
|
|
|
| | Short-term bank deposits (in U.S. dollars) |             
| | Structured notes (1)                       |             
| |                                            |             
| |                                            |             
| |                                            |             
| |                                            |             
| | Long-term bank deposits (in U.S. dollars)  |             
| | Structured notes (2)                       |             
| |                                            |             
| |                                            |             
| |                                            |             
| |                                            |             
| |                                            |             
| |                                            |             
| |                                            |             

F - 29

---

---



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

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

| | (1) | As
of December 31, 2006, the Group has callable structured notes at par value
          totaling $ 18,000 for settlement during 2007 from several banks. Under the
          arrangements with the banks, whether or not the structured notes bear interest
          depends upon the rate of the three months to one year LIBOR.
| | --- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | For
each day in which the relevant LIBOR rate is below an agreed annual fixed rate, which
ranges from 2.5% to 4.5% the structured notes bear interest at the rate of 3.2% to 4.5%
per annum. On all other days, the structured notes do not bear any interest. As of
December 31, 2006, investments in structured notes securities approximate their market
value.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (2) | As
of December 31, 2006, the Group has callable structured notes at par value
          totaling $10,000
for settlement during 2010. Under the arrangements with the bank, whether or not the
structured notes bear interest depends upon the six month LIBOR rate.
| | --- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | For
each day in which the relevant LIBOR rate is below an agreed annual fixed rate, which
ranges from 5.25% to 6% the structured notes bear interest at the rate of 5.75% per
annum. On all other days, the structured notes bear interest at the rate of 2.5%. As of
December 31, 2006, investments in structured notes securities approximate their market
value.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|NOTE 4: |  | MARKETABLE SECURITIES AND ACCRUED INTEREST
|------- | - | ------------------------------------------

| | The
following is a summery of held to maturity marketable securities.
| | ---------------------------------------------------------------------

| |                                    | December 31,
| | ---------------------------------- | ------------
|
|
|
|
| | Corporate debentures:              |             
| | Maturing within one year           |             
| | Maturing within one to three years |             
| |                                    |             
| |                                    |             
| |                                    |             
| |                                    |             
| |                                    |             
| | U.S. Government and agencies debts |             
| | Maturing within one year           |             
| | Maturing within one to three years |             
| |                                    |             
| |                                    |             
| |                                    |             
| |                                    |             
| | Accrued interest                   |             
| |                                    |             
| |                                    |             
| |                                    |             
| |                                    |             

F - 30

---

---



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

|NOTE 4: |  | MARKETABLE SECURITIES AND ACCRUED INTEREST (Cont.)
|------- | - | --------------------------------------------------

| | 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, 2006.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Out
of the unrecognized loss as of December 31, 2006, $174 is outstanding more than twelve
months and $133 are less than twelve months.
| | ---------------------------------------------------------------------------------------------------------------------------------------

| | The
Company sold held-to-maturity marketable securities during the year ended December 31,
2006 in the amount of $ 979. The marketable securities were sold before their
maturity, due to deterioration in their credit rating. As a result of the sale, the
Company recorded an immaterial loss during the period.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

| |                   | December 31,
| | ----------------- | ------------
|
|
|
|
| | Raw materials     |             
| | Finished products |             
| |                   |             
| |                   |             
| |                   |             
| |                   |             

| | In
the years ended December 31, 2004, 2005 and 2006, the Group increased its reserve for
obsolete inventory in a total amount of $1,237 $1,168 and $981 respectively. These amounts
are included in cost of revenues.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 31

---

---



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

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

| | a. | In
December 2000, the Company signed an agreement to invest in an unrelated
          privately-held company (investee). During 2005 and 2006, the
Company           granted convertible loans in the amount of $902 to the investee. The
loans bear           no interest and are 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, 2006, the
Company holds 40.9%           of the investees share capital.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |                                       | December 31,
| | ------------------------------------- | ------------
|
|
|
|
| | Equity, net (1)                       |             
| | Convertible loans                     |             
| |                                       |             
| |                                       |             
| | Total investments                     |             
| |                                       |             
| |                                       |             
| | (1)            Net equity as follows: |             
| |                                       |             
| | Net equity as of purchase date        |             
| | Unamortized goodwill                  |             
| | Accumulated net losses                |             
| |                                       |             
| |                                       |             
| |                                       |             
| |                                       |             

| | 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.
          In November 2006, the Company granted convertible loan in the amount of $ 44.
          The loan bears interest at the rate of 9% per annum and is convertible into
          shares.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |                                | December 31,
| | ------------------------------ | ------------
|
|
|
|
| | Net equity as of purchase date |             
| | Unamortized goodwill           |             
| | Accumulated net income (loss)  |             
| |                                |             
| |                                |             
| | Total investment               |             
| |                                |             

F - 32

---

---



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

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

| | c. | In
February, 2006, the Company signed a share purchase agreement with another
          unrelated privately-held company to acquire 10% of its Ordinary shares for a
          total purchase price in the amount of $1,000. The Company received in October
          2006 a call option to invest an additional $10,000 for the remaining 90% of the
          unrelated privately-held companys share capital. The option is valid
until           January 31, 2007. In November, 2006 the Company granted the unrelated
          privately-held company a credit line of $500 payable within 18 months. The loan
          bears interest at the rate of 180 day LIBOR plus 3.0% per annum. In the event
          that the Company consummates an equity investment in the unrelated
          privately-held company the principal amount of the loan would automatically be
          applied to pay a portion of the purchase price for the equity investment.
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | d. | In
December 2006, the Company granted convertible loan in the amount of $ 1,000           to
another unrelated privately-held company. The loan bears LIBOR+2% per annum
          interest and shall be due and payable in December 2007 unless converted into
          shares. Upon affiliated company consummating a single or series of equity
          financial transactions no later then the repayment date, the Company shall be
          entitled to convert the loan amount for the lowest price per share paid by the
          investors participating in the financing. In addition, the Company received
          warrants valid until the consummation of an exit transaction to purchase in
          consideration for 40% of the principle amount ($400), in consideration of
          $941.91 per share unless the investee consummated the financing by the
repayment           date, then the price would be equal to the price per share paid by
the Company.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

| |                                    | December 31,
| | ---------------------------------- | ------------
|
|
|
|
| | Cost:                              |             
| | Computers and peripheral equipment |             
| | Office furniture and equipment     |             
| | Motor vehicles                     |             
| | Leasehold improvements             |             
| |                                    |             
| |                                    |             
| |                                    |             
| |                                    |             
| | Accumulated depreciation:          |             
| | Computers and peripheral equipment |             
| | Office furniture and equipment     |             
| | Motor vehicles                     |             
| | Leasehold improvements             |             
| |                                    |             
| |                                    |             
| |                                    |             
| |                                    |             
| |                                    |             
| | Depreciated cost                   |             
| |                                    |             

| | Depreciation
expenses amounted to $2,352, $2,509 and $2,920 for the years ended December 31, 2004,
2005 and 2006, respectively.
| | -------------------------------------------------------------------------------------------------------------------------------

F - 33

---

---



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

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

| |    |                                    | December 31,
| | -- | ---------------------------------- | ------------
|
|
|
|
| | a. | Cost:                              |             
| |    | Acquired technology                |             
| |    | Customer relationship              |             
| |    | Trade name                         |             
| |    | Existing contracts for maintenance |             
| |    | Backlog                            |             
| |    | Deferred charges                   |             
| |    | Other                              |             
| |    |                                    |             
| |    |                                    |             
| |    |                                    |             
| |    |                                    |             
| |    | Accumulated amortization:          |             
| |    | Acquired technology                |             
| |    | Customer relationship              |             
| |    | Trade name                         |             
| |    | Existing contracts for maintenance |             
| |    | Backlog                            |             
| |    | Deferred charges                   |             
| |    |                                    |             
| |    |                                    |             
| |    |                                    |             
| |    |                                    |             
| |    |                                    |             
| |    | Amortized cost                     |             
| |    |                                    |             

| | b. | Amortization
expenses amounted to $627, $860 and $2,623 for the years ended           December 31,
2004, 2005 and 2006, respectively.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------

| | c. | Amortization
expenses related to deferred charges amounted to $3, $22 and $20           for the years
ended December 31, 2004, 2005 and 2006, respectively.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------

| | d. | Expected
amortization expenses for the years ended December 31:
| | -- | ---------------------------------------------------------------

| |           | 
| | --------- | 
|
|
|
|
| | 2007      | 
| | 2008      | 
| | 2009      | 
| | 2010      | 
| | 2011      | 
| | 2012-2016 | 
| |           | 
| |           | 
| |           | 
| |           | 

F - 34

---

---



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

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

| |                                    | December 31,
| | ---------------------------------- | ------------
|
|
|
|
| | Employees and payroll accruals     |             
| | Technology licensing fee provision |             
| | Government authorities             |             
| | Accrued expenses                   |             
| | Deferred revenues                  |             
| | Others                             |             
| |                                    |             
| |                                    |             
| |                                    |             
| |                                    |             

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

| | In
November 2004, the Company issued an aggregate of $125,000 (including the exercise of the
option as described below) of 2% Senior Convertible Notes due November 9, 2024 (the
Notes). The Company is obligated to pay interest on the Notes semi-annually on May
9 and November 9 of each year.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Notes are convertible, at the option of the holders at any time before the maturity date,
into Ordinary shares of the Company at a conversion rate of 53.4474 Ordinary shares per
$1 principal amount of Notes, representing a conversion price of approximately $18.71 per
share. The Notes are subject to redemption at any time on or after November 9, 2009, in
whole or in part, at the option of the Company, at a redemption price of 100% of the
principal amount plus accrued and unpaid interest. The Notes are subject to repurchase,
at the holders option, on November 9, 2009, November 9, 2014 or November 9,
2019, at a repurchase price equal to 100% of the principal amount plus accrued and unpaid
interest, if any, on such repurchase date. The Company can choose to
pay the repurchase price in cash, Ordinary shares or a combination of cash and Ordinary
shares. As of December 31, 2006, 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.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 35

---

---



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

|NOTE 10: |  | SENIOR CONVERTIBLE NOTES (Cont.)
|-------- | - | --------------------------------

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

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

| | a. | Lease
commitments:
| | -- | ------------------

| | The
Groups facilities are rented under several lease agreements in Israel and the U.S.
for periods ending in 2013.
| | -------------------------------------------------------------------------------------------------------------------

| | Future
minimum rental commitments under non-cancelable operating leases for the years ended
December 31, are as follows:
| | ------------------------------------------------------------------------------------------------------------------------

| |                     | 
| | ------------------- | 
|
|
|
|
| | 2007                | 
| | 2008                | 
| | 2009                | 
| | 2010                | 
| | 2011                | 
| | 2012 and thereafter | 
| |                     | 
| |                     | 
| |                     | 
| |                     | 

| | Rent
expenses for the years ended December 31, 2004, 2005 and 2006, were approximately $2,927,
$2,938 and $3,087, respectively.
| | -------------------------------------------------------------------------------------------------------------------------------

| | b. | Other
commitments:
| | -- | ------------------

| | The
Company is obligated under certain agreements with its suppliers to purchase goods and
under an agreement with its manufacturing subcontractor to purchase excess inventory. Non
Cancelable obligations as of December 31, 2006, were approximately as follows:
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |      | 
| | ---- | 
|
|
|
|
| | 2007 | 
| | 2008 | 
| |      | 
| |      | 
| |      | 
| |      | 

F - 36

---

---



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

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

| | c. | Royalty
commitment to the Office of the Chief Scientist of Israel           (OCS):
| | -- | ------------------------------------------------------------------------------------

| | Under
the research and development agreements of the Company with the OCS and pursuant to
applicable laws, the Company is required to pay royalties at the rate of 3%-4.5% of sales
of products developed with funds provided by the OCS, up to an amount equal to 100% of
the OCS research and development grants received, linked to the U.S. dollar plus interest
on the unpaid amount received based on the 12-month LIBOR rate applicable to dollar
deposits. The Company is obligated to repay the Israeli Government for the grants
received only to the extent that there are sales of the funded products.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
of December 31, 2006, the Company has a contingent obligation to pay royalties in the
amount of approximately $ 2,728.
| | -------------------------------------------------------------------------------------------------------------------------

| | d. | 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.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | e. | Legal
proceedings
| | -- | -----------------

| | 1. | Prior
to the acquisition of Nuera by the Group, one of Nueras customers
               had been named as a defendant in a patent infringement suit involving
technology                the customer purchased from Nuera. In the suit, the plaintiff
alleged that the                customer uses devices to offer services that infringe
upon a patent the                plaintiff owns. The customer has sought indemnification
from Nuera pursuant to                the terms of a purchase agreement between Nuera and
the Company relating to the                allegedly infringing technology at issue.
According to the estimate of the                management, Nuera has provided an
allowance in respect of the above claim.
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 37

---

---



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

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

| | 2. | Prior
to the acquisition of Nuera by the Group, eight former employees of a
               French subsidiary of Nuera filed a labor grievance against the subsidiary
               claiming they were unfairly terminated. The French subsidiary filed for
               bankruptcy in 2004 and, in 2005, the court appointed liquidator sought to
hold                Nuera liable for the obligations of its French subsidiary. In June
2006, the                court ruled in favor of Nuera that it was not liable for the
obligations of its                French subsidiary. In March 2006, the liquidator
decided to appeal the                judgement. According to the estimate of the
management, Nuera has provided an                allowance in respect of the above claim.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|NOTE 12: |  | 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,
2006, 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:
| | -- | -------------------------------

| | Between
1999 and 2001, 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, 2006, 34,000 warrants are outstanding and exercisable at a weighted
average exercise price of $18.82
| | -----------------------------------------------------------------------------------------------------------------------

F - 38

---

---



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

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

| | 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, 2006, 709,987 shares are still available for future issuance.
Eligible employees can have up to 15% of their wages, up to certain maximums, used to
purchase Ordinary shares. The Purchase Plan is implemented with purchases every six
months occurring on January 31 and July 31 of each year. The price of the Ordinary shares
purchased under the Purchase Plan is equal to 85% of the lower of the fair market value
of the Ordinary shares on the commencement date of each offering period or on the
semi-annual purchase date. The Purchase Plan is considered as a compensatory plan.
Therefore the Company recorded compensation expense in accordance to SFAS 123R (Note 12
d.).
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | During
the years ended December 31, 2004, 2005 and 2006, 208,952, 257,746 and 323,303 shares,
respectively, were issued under the Purchase Plan for aggregate considerations of $1,332,
$2,134 and $2,665, 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 15,945,828. As
of December 31, 2006, 1,497,740 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 usually expire seven or ten years from the date
of grant. The options generally vest over four or five years, from the date of grant. Any
options, which are forfeited or cancelled before expiration, become available for future
grants.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 39

---

---



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

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

| | A
summary of the Groups stock option activity and related information for the years
ended December 31, 2006, is as follows:
| | ----------------------------------------------------------------------------------------------------------------------------

| |                                  | Number of
options | Weighted-average
exercise price | Weighted- average
remaining
contractual term
(in years) | Aggregate
intrinsic value
| | -------------------------------- | ----------------- | ------------------------------- | ------------------------------------------------------- | -------------------------
|
|
|
|
| | Outstanding at December 31, 2005 |                   |                                 |                                                         | 7,890,372                
| | Granted                          |                   |                                 |                                                         | 1,789,000                
| | Exercised                        |                   |                                 |                                                         | (1,198,621               
| | Forfeited                        |                   |                                 |                                                         | (498,925                 
| |                                  |                   |                                 |                                                         |                          
| |                                  |                   |                                
| | Outstanding at December 31,2006  |                   |                                 |                                                         | 7,981,826                
| |                                  |                   |                                 |                                                         |                          
| |                                  |                   |                                
| | Exercisable at December 31,2006  |                   |                                 |                                                         | 4,535,767                
| |                                  |                   |                                 |                                                         |                          
| |                                  |                   |                                
| | Vested and expected to vest      |                   |                                 |                                                         | 7,607,019                
| |                                  |                   |                                 |                                                         |                          

| | The
weighted-average grant-date fair value of options granted during the twelve months ended
December 31, 2006 was $5.81. The aggregate intrinsic value in the table above represents
the total intrinsic value (the difference between the Companys closing stock price
on the last trading day of fiscal 2006 and the exercise price, multiplied by the number
of in-the-money options) that would have been received by the option holders had all
option holders exercised their options on December 31, 2006. This amount changes based on
the fair market value of the Companys shares. Total intrinsic value of options
exercised for the twelve months ended December 31, 2006 was $4,790. As of December 31,
2006, there was $12,381 of total unrecognized compensation cost related to non-vested
share-based compensation arrangements granted under the Companys stock option
plans. That cost is expected to be recognized over a weighted-average period of 1.6
years. Total fair value of options vested for the twelve months ended December 31, 2006
was $5,866.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 40

---

---



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

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

| | The
options outstanding as of December 31, 2006, have been separated into ranges of exercise
prices, as follows:
| | ----------------------------------------------------------------------------------------------------------------

| | Range of
exercise
price | Options outstanding
as of
December 31,
2006 | Weighted
average
remaining
contractual
life | Weighted
average
exercise
price | Options exercisable
as of
December 31,
2006 | Weighted
average
exercise price of
exercisable
options
| | ----------------------- | ------------------------------------------- | ------------------------------------------- | ------------------------------- | ------------------------------------------- | ------------------------------------------------------
|
|
|
|
| | $        0.61           |                                             |                                             |                                 | 101,000                                     |                                                       
| | $         1.1           |                                             |                                             |                                 | 146,400                                     |                                                       
| | $ 1.73-2.51             |                                             |                                             |                                 | 548,693                                     |                                                       
| | $ 2.67-4                |                                             |                                             |                                 | 487,701                                     |                                                       
| | $ 4.1-6.04              |                                             |                                             |                                 | 936,004                                     |                                                       
| | $ 6.51-9.24             |                                             |                                             |                                 | 840,828                                     |                                                       
| | $ 9.32-14.76            |                                             |                                             |                                 | 4,247,700                                   |                                                       
| | $ 15.94-20.38           |                                             |                                             |                                 | 52,500                                      |                                                       
| | $ 25.5-36.53            |                                             |                                             |                                 | 597,000                                     |                                                       
| | $       50.50           |                                             |                                             |                                 | 24,000                                      |                                                       
| |                         |                                             |                                             |                                 |                                             |                                                       
| |                         |                                             |                                            
| |                         |                                             |                                             |                                 | 7,981,826                                   |                                                       
| |                         |                                             |                                             |                                 |                                             |                                                       

| | The
weighted average fair values of the options granted during 2004, 2005 and 2006, were
$7.63, $6.27 and $5.81, 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 13a.)
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|NOTE 13: |  | 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.
| | ----------------------------------------------------------------------------------------------

F - 41

---

---



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

|NOTE 13: |  | TAXES ON INCOME (Cont.)
|-------- | - | -----------------------

| | 2. | Tax
benefits under the Law for the Encouragement of Capital Investments, 1959           (the
Investment Law):
| | -- | ---------------------------------------------------------------------------------------------------------------

| | The
Companys production facilities have been granted the status of an Approved
Enterprise in accordance with the Investment Law under four separate investment
programs. According to the provisions of such Israeli Investment Law, the Company has
been granted the Alternative Benefit Plan, under which the main benefits are
tax 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 eligible
for benefits through 2007. Tax benefits from the remaining programs are scheduled to
gradually expire through 2013.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
of December 31, 2006, 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 Investment Law, regulations published thereunder and the
certificate of approval for the specific investments in Approved Enterprises.
In the event of failure to comply with these conditions, the benefits may be canceled and
the Company may be required to refund the amount of the benefits, in whole or in part,
including interest. As of December 31, 2006, 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.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------

F - 42

---

---



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

|NOTE 13: |  | TAXES ON INCOME (Cont.)
|-------- | - | -----------------------

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

| | However,
the Investment Law provides that terms and benefits included in any certificate of
approval already granted will remain subject to the provisions of the Investment Law as
they were on the date of such approval. Therefore, the Companys existing Approved
Enterprises will generally not be subject to the provisions of the Amendment. As a
result of the Amendment, tax-exempt income generated under the provisions of the
Investment Law 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. As of December 31, 2006 there were no taxable income
attributable to the Privileged Enterprise.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 3. | Net
operating losses carry forward:
| | -- | -----------------------------------

| | As
of December 31, 2006, the Company has accumulated losses for tax purposes in the amount
of approximately $68,000, 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 enacted 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%.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 43

---

---



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

|NOTE 13: |  | TAXES ON INCOME (Cont.)
|-------- | - | -----------------------

| | b. | Income
before taxes on income comprised as following:
| | -- | -----------------------------------------------------

| |          | Year ended December 31,
| | -------- | -----------------------
|
|
|
|
| | Domestic |                        
| | Foreign  |                        
| |          |                        
| |          |                        
| |          |                        
| |          |                        

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

| |                | Year ended December 31,
| | -------------- | -----------------------
|
|
| | Current taxes  |                        
| | Deferred taxes |                        
| |                |                        
| |                |                        
| |                |                        
| |                |                        

| |          | Year ended December 31,
| | -------- | -----------------------
|
|
| | Domestic |                        
| | Foreign  |                        
| |          |                        
| |          |                        
| |          |                        
| |          |                        

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

F - 44

---

---



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

|NOTE 13: |  | TAXES ON INCOME (Cont.)
|-------- | - | -----------------------

| |                                                      | December 31,
| | ---------------------------------------------------- | ------------
|
|
|
|
| | Deferred tax assets:                                 |             
| | Net operating loss carry forward                     |             
| | Reserves and allowances                              |             
| |                                                      |             
| |                                                      |             
| | Deferred tax assets before valuation allowance       |             
| | Valuation allowance                                  |             
| |                                                      |             
| |                                                      |             
| | Deferred tax assets *)                               |             
| | Deferred tax liability, related to intangible assets |             
| |                                                      |             
| | Deferred tax asset (liabilities), net                |             
| |                                                      |             
| |                                                      |             
| | Foreign:                                             |             
| | Current deferred tax assets                          |             
| | Current deferred tax liability                       |             
| | Non current deferred tax asset                       |             
| | Non current deferred tax liability                   |             
| |                                                      |             
| |                                                      |             
| |                                                      |             
| |                                                      |             

| | *) | Including
$638 of the total deferred tax assets upon utilization of           pre-acquisition carry
forward tax losses derived from acquisition of AudioCodes           USA Inc. in
accordance with SFAS No. 141.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Companys U.S. subsidiaries have estimated total available carry forward tax losses
of approximately $ 60,000 to offset against future taxable income between 2015 and
2024. As of December 31, 2006, the Company recorded a deferred tax asset of $ 3,742
relating to the available net carry forward tax losses.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Utilization
of U.S. net operating losses may be subject to substantial annual limitations due to the
change in ownership provisions of the Internal Revenue Code of 1986 and
similar state provisions. The annual limitation may result in the expiration of net
operating losses before utilization.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 45

---

---



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

|NOTE 13: |  | TAXES ON INCOME (Cont.)
|-------- | - | -----------------------

| | e. | Reconciliation
of the theoretical tax expenses:
| | -- | -----------------------------------------------

| | A
reconciliation between the theoretical tax expense, assuming all income is taxed at the
statutory tax rate applicable to income of the Company and the actual tax expense as
reported in the statement of income is as follows:
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |                                                                             | Year ended December 31,
| | --------------------------------------------------------------------------- | -----------------------
|
|
|
|
| | Income before taxes, as reported in the consolidated statements of          |                        
| | income                                                                      |                        
| |                                                                             |                        
| |                                                                             |                        
| | Statutory tax rate                                                          |                        
| |                                                                             |                        
| |                                                                             |                        
| | Theoretical tax expenses on the above amount at the Israeli statutory       |                        
| | tax rate                                                                    |                        
| | Income taxed at rate other than the Israeli statutory tax rate (1)          |                        
| | Non-deductible expenses including equity based compensation expenses        |                        
| | Deferred taxes on losses for which a valuation allowance was provided       |                        
| | Utilization of operation losses carry forward                               |                        
| | State and Federal taxes                                                     |                        
| | Inter-company charges                                                       |                        
| | Other individually immaterial income tax item                               |                        
| |                                                                             |                        
| |                                                                             |                        
| | Actual tax expense                                                          |                        
| |                                                                             |                        
| |                                                                             |                        
| | (1)         Per share amounts (basic) of the tax benefit resulting from the |                        
| | exemption                                                                   |                        
| |                                                                             |                        
| | Per share amounts (diluted) of the tax benefit resulting from               |                        
| | the exemption                                                               |                        
| |                                                                             |                        

F - 46

---

---



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

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

| |                                                                    | Year ended December 31,
| | ------------------------------------------------------------------ | -----------------------
|
|
|
|
| | Numerator:                                                         |                        
| |                                                                    |                        
| | Net income available to shareholders of Ordinary Shares            |                        
| |                                                                    |                        
| |                                                                    |                        
| | Denominator:                                                       |                        
| |                                                                    |                        
| | Denominator for basic earnings per share - weighted average number |                        
| | of Ordinary shares, net of treasury stock                          |                        
| | Effect of dilutive securities:                                     |                        
| | Employee stock options and ESPP                                    |                        
| | Senior convertible notes                                           |                        
| |                                                                    |                        
| | Denominator for diluted net earnings per share - adjusted weighted |                        
| | average number of shares                                           |                        
| |                                                                    |                        

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

|NOTE 15: |  | FINANCIAL INCOME (EXPENSES), NET
|-------- | - | --------------------------------

| |                                                    | Year ended December 31,
| | -------------------------------------------------- | -----------------------
|
|
|
|
| | Financial expenses:                                |                        
| | Foreign currency transaction differences, net      |                        
| | Interest                                           |                        
| | Amortization of marketable securities premiums and |                        
| | accretion of discounts, net                        |                        
| | Others                                             |                        
| |                                                    |                        
| |                                                    |                        
| |                                                    |                        
| |                                                    |                        
| | Financial income:                                  |                        
| | Interest and others                                |                        
| |                                                    |                        
| |                                                    |                        
| |                                                    |                        
| |                                                    |                        
| |                                                    |                        
| |                                                    |                        
| |                                                    |                        

F - 47

---

---



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

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

| | 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, 2004, 2005 and 2006
and long-lived assets as of December 31, 2004, 2005 and 2006.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------

| |          | 2004 | 2005 | 2006
| | -------- | ---- | ---- | ----
|
|
|
|
| | Israel   |      |      | $   
| | Americas |      |      |     
| | Europe   |      |      |     
| | Far East |      |      |     
| |          |      |      |     
| |          |      |     
| |          |      |      | $   
| |          |      |      |     

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

| |            | Year ended December 31,
| | ---------- | -----------------------
|
|
|
|
| | Customer A |                        

| | 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,
| | ---------- | -----------------------
|
|
|
|
| | Technology |                        
| | Networking |                        
| |            |                        
| |            |                        
| |            |                        
| |            |                        

F - 48

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---