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UNITED STATES


SECURITIES AND EXCHANGE COMMISSION


Washington, D.C. 20549





Form 20-F





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

OR

|  |                                                                                                                                       
|- | --------------------------------------------------------------------------------------------------------------------------------------
|x | ANNUAL
  REPORT PURSUANT TO SECTION 13 OR 15(d) OF 
  THE SECURITIES EXCHANGE ACT OF 1934For the fiscal year
  ended December 31, 2005

OR

|  |                                                                                                                                                    
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------
|o | TRANSITION
  REPORT PURSUANT TO SECTION 13 or 15(d) OF 
  THE SECURITIES EXCHANGE ACT OF 1934for the transition
  period from ________ to _________




Commission File Number 0-030668





NOVA MEASURING INSTRUMENTS LTD.(Exact name of
Registrant as specified in its charter)

|                                                |  |                                                
|----------------------------------------------- |  | -----------------------------------------------
|Nova Measuring Instruments Ltd.                 |  | Israel                                         
|(Translation of Registrants name into English) |  | (Jurisdiction of incorporation or organization)



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Weizmann Science Park,
Building 22, 2nd Floor, Ness-Ziona 76100, Israel(Address of principal
executive offices)





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

|                    |  |                                          
|------------------- |  | -----------------------------------------
|Title of each class |  | Name of each exchange on which registered
|                    |  |                                          
|None                |  | None                                     

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


Ordinary
Shares, nominal value NIS 0.01 per share


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

None

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:

15,457,471 Ordinary Shares, NIS 0.01 nominal (par) value per share, as
of December 31, 2005

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

YesoNox

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.

YesoNox

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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.

YesxNoo

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 fileroAccelerated
fileroNon-accelerated filerx

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

Item 17o     Item 18x

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).

YesoNox

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TABLE
OF CONTENTS

|                                                                                   |                                                                                        | Page
|---------------------------------------------------------------------------------- | -------------------------------------------------------------------------------------- | ----
|Introduction                                                                       | 1                                                                                     
|                                                                                   |                                                                                       
|Our Functional Currency                                                            | 1                                                                                     
|                                                                                   |                                                                                       
|Cautionary Statement Regarding
  Forward-Looking Statements                        | 1                                                                                     
|                                                                                   |                                                                                       
|PART I                                                                             | 2                                                                                     
|                                                                                   | Item 1. Identity of Directors,
  Senior Management and Advisors                        | 2   
|                                                                                   | Item 2. Offer Statistics and
  Expected Timetable                                      | 2   
|                                                                                   | Item 3. Key Information                                                                | 2   
|                                                                                   | Item 4. Information on the Company                                                     | 12  
|                                                                                   | Item 5. Operating and Financial
  Review and Prospects                                 | 26  
|                                                                                   | Item 6. Directors, Senior Management
  and Employees                                   | 37  
|                                                                                   | Item 7. Major Shareholder and
  Related Party Transactions                             | 46  
|                                                                                   | Item 8. Financial Information                                                          | 48  
|                                                                                   | Item 9. The Offer and Listing                                                          | 49  
|                                                                                   | Item 10. Additional Information                                                        | 50  
|                                                                                   | Item 11. Quantitative and
  Qualitative Disclosures About Market Risk                  | 65  
|                                                                                   | Item 12. Description of Securities
  Other than Equity Securities                      | 66  
|                                                                                   |                                                                                        |     
|PART II                                                                            | 66                                                                                    
|                                                                                   |                                                                                       
|                                                                                   | Item 13. Defaults, Dividend
  Arrearages and Delinquencies                             | 66  
|                                                                                   | Item 14. Material Modification to
  the Rights of Security Holders and Use of Proceeds | 66  
|                                                                                   |                                                                                        |     
|Item 15. Evaluation of disclosure
  controls and procedures                        | 66                                                                                    
|                                                                                   |                                                                                       
|Item 16. Reserved                                                                  | 67                                                                                    
|                                                                                   |                                                                                       
|Item 16A. Audit Committee Financial
  Expert                                       | 67                                                                                    
|                                                                                   |                                                                                       
|Item 16B. Code of Ethics                                                           | 67                                                                                    
|                                                                                   |                                                                                       
|Item 16C. Principal Accountant Fees
  and Services                                 | 67                                                                                    
|                                                                                   |                                                                                       
|Item 16D. Exemptions from the
  Listing Standards for Audit Committees             | 68                                                                                    
|                                                                                   |                                                                                       
|Item 16E. Purchases of Equity
  Securities by the Issuer and Affiliates Purchasers | 68                                                                                    
|                                                                                   |                                                                                       
|PART III                                                                           | 68                                                                                    
|                                                                                   |                                                                                       
|                                                                                   | Item 17. Financial Statements                                                          | 68  
|                                                                                   | Item
  18. Financial Statements                                                        | 68  
|                                                                                   | Item 19. Exhibits                                                                      | 68  
|                                                                                  
|Signatures                                                                         | 71                                                                                    
|                                                                                   |                                                                                       
|Financial Statements                                                               | F-1                                                                                   

- i -

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Introduction

In
this Annual Report, the Company, Nova, we or our refers to Nova
Measuring Instruments Ltd. and its consolidated subsidiaries, when the context
requires.

The
consolidated financial statements and selected consolidated financial data as
of December 31, 2001, 2002, 2003, 2004 and 2005 and for each of the years in
the five-year period ended December 31, 2005 (the Consolidated Financial
Statements), included in this Annual Report have been prepared in accordance
with accounting principles generally accepted in the United States of America
(U.S. GAAP).

Our Functional Currency

Unless
otherwise indicated, all amounts herein are expressed in United States dollars
(U.S. dollars, dollars, USD, US$ or $).

The
currency of the primary economic environment in which we operate is the U.S.
dollar, since substantially all our revenues to date have been denominated in
U.S. dollars and over 50% of our expenses are in U.S. dollars or in New Israeli
Shekels linked to the dollar. Transactions and balances denominated in dollars
are presented at their original amounts. Non-dollar transactions and balances
have been re-measured into dollars as required by the principles in Statement
No. 52 of the Financial Accounting Standards Board (FASB) of the United States
of America. All exchange gains and losses from such re-measurement are included
in the net financial income when they arise.

Cautionary Statement Regarding Forward-Looking
Statements

Certain
information contained herein, which does not relate to historical financial
information, may be deemed to constitute forward-looking statements within the
meaning of the Private Securities Litigation Reform Act of 1995. The words or
phrases will likely result, are expected to, will continue, is
anticipated, estimate, project, believe, plan, or similar expressions
identify forward looking statements. Such statements, including statements
relating to our anticipated sales, revenues and expenses in 2006, our
expectations with respect to our ability to gain market share, add additional
process equipment manufacturers as partners and to develop and introduce new
products, possible outcomes of the litigation in which we are involved,
possible outcomes of our efforts to consummate and integrate our pending
acquisition or of our efforts to identify, complete and integrate future
acquisition, anticipated growth of the semiconductor industry and metrology
markets and expected changes in the semiconductor industry, are subject to
certain risks and uncertainties that could cause actual results to differ
materially from historical results and those presently anticipated or
projected. We wish to caution readers not to place undue reliance on any such
forward-looking statements, which speak only as of the date made. We cannot
guarantee future results, levels of activity, performance or achievements. We
also undertake no obligation to release publicly any revisions to these
forwardlooking statements to reflect events or circumstances after the date hereof
or to reflect the occurrence of unanticipated events. Among the factors that
could cause our actual results in the future to differ materially from any
opinions or statements expressed with respect to future periods are competitive
industry conditions and the ability to forecast the needs of the semiconductor
industry with respect to the very cyclical nature of the industry and the very
fast pace of technology evolutions. Various other factors that could cause our
actual results to differ materially are set forth in Risk Factors starting on
page 3 and elsewhere herein.

- 1 -

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PART I

Item 1. Identity of Directors, Senior Management and
Advisors

Not
applicable.

Item 2. Offer Statistics and Expected Timetable

Not
applicable.

Item 3. Key Information

Selected
Financial Data

The
following selected consolidated financial data as of December 31, 2004 and 2005
and for the years ended December 31, 2003, 2004 and 2005 have been derived from
our audited Consolidated Financial Statements included elsewhere in this
report. These financial statements have been prepared in accordance with U.S.
GAAP, and audited by our independent registered public accounting firm. The
consolidated selected financial data as of December 31, 2003, 2002 and 2001 and
for the years ended December 31, 2002 and 2001 have been derived from other
consolidated financial statements not included in this Form 20-F that were also
prepared in accordance with U.S. GAAP and audited by our independent registered
public accounting firm. The selected consolidated financial data set forth
below should be read in conjunction with and are qualified by reference to
Item 5, Operating and Financial Review and Prospects and the Consolidated
Financial Statements and notes thereto and other financial information included
elsewhere in this report on Form 20-F.

Summary
of Consolidated Financial Data

|                                                                 |  |                                       |         |      |   |         |   |      |        |      |   |        |   |   |        |  
|---------------------------------------------------------------- |  | ------------------------------------- | ------- | ---- | - | ------- | - | ---- | ------ | ---- | - | ------ | - | - | ------ | -
|                                                                 |  | Year ended December 31,               |        
|                                                                 |  | 2001                                  |         | 2002 |   | 2003    |   | 2004 |        | 2005 |  
|                                                                 |  |                                       |         |      |   |         |   |      |        |      |  
|                                                                
|                                                                 |  | (in thousands, except per share data) |        
|                                                                 |  |                                       |         |      |   |         |   |      |        |      |   |        |   |   |        |  
|Consolidated Statement of
  Operations Data:                     |  |                                       |         |      |   |         |   |      |        |      |   |        |   |   |        |  
|                                                                 |  |                                       |         |      |   |         |   |      |        |      |   |        |   |   |        |  
|Revenues                                                         |  | $                                     | 21,171  |      | $ | 20,371  |   | $    | 26,688 |      | $ | 36,806 |   | $ | 30,142 |  
|                                                                
|Cost of revenues                                                 |  |                                       | 16,470  |      |   | 13,353  |   |      | 16,535 |      |   | 21,111 |   |   | 19,306 |  
|                                                                 |  |                                       |         |      |   |         |   |      |        |      |   |        |   |   |        |  
|Gross profit                                                     |  |                                       | 4,701   |      |   | 7,018   |   |      | 10,153 |      |   | 15,695 |   |   | 10,836 |  
|                                                                 |  |                                       |         |      |   |         |   |      |        |      |   |        |   |   |        |  
|                                                                 |  |                                       |         |      |   |         |   |      |        |      |   |        |   |   |        |  
|Operating
  expenses:                                            |  |                                       |         |      |   |         |   |      |        |      |   |        |   |   |        |  
|Research and
  development expenses, net                         |  |                                       | 13,253  |      |   | 9,894   |   |      | 8,561  |      |   | 8,665  |   |   | 9,301  |  
|                                                                
|Sales and
  marketing expenses                                   |  |                                       | 6,852   |      |   | 6,950   |   |      | 6,534  |      |   | 6,647  |   |   | 6,950  |  
|                                                                
|General and
  administrative expenses                            |  |                                       | 3,032   |      |   | 1,797   |   |      | 1,898  |      |   | 2,331  |   |   | 3,626  |  
|                                                                
|Other operating
  expenses (income)                              |  |                                       | 1,025   |      |   | 1,478   |   |      | (2,203 | )    |   | -      |   |   | -      |  
|                                                                 |  |                                       |         |      |   |         |   |      |        |      |   |        |   |   |        |  
|Total operating expenses                                         |  |                                       | 24,162  |      |   | 20,119  |   |      | 14,790 |      |   | 17,643 |   |   | 19,877 |  
|                                                                 |  |                                       |         |      |   |         |   |      |        |      |   |        |   |   |        |  
|Operating loss                                                   |  |                                       | (19,461 | )    |   | (13,101 | ) |      | (4,637 | )    |   | (1,948 | ) |   | (9,041 | )
|                                                                
|Financing income, net                                            |  |                                       | 2,587   |      |   | 144     |   |      | 425    |      |   | 528    |   |   | 627    |  
|Net loss                                                         |  | $                                     | (16,874 | )    | $ | (12,957 | ) | $    | (4,212 | )    | $ | (1,420 | ) | $ | (8,414 | )
|                                                                 |  |                                       |         |      |   |         |   |      |        |      |   |        |   |   |        |  
|                                                                 |  |                                       |         |      |   |         |   |      |        |      |   |        |   |   |        |  
|Loss per share:                                                  |  |                                       |         |      |   |         |   |      |        |      |   |        |   |   |        |  
|                                                                 |  |                                       |         |      |   |         |   |      |        |      |   |        |   |   |        |  
|Loss per share                                                   |  | $                                     | (1.16   | )    | $ | (0.88   | ) | $    | (0.28  | )    | $ | (0.09  | ) | $ | (0.55  | )
|                                                                 |  |                                       |         |      |   |         |   |      |        |      |   |        |   |   |        |  
|Shares used in calculation of basic and diluted loss
  per share |  |                                       | 14,578  |      |   | 14,786  |   |      | 14,994 |      |   | 15,259 |   |   | 15,437 |  

- 2 -

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|                                                     |  |                  |        |      |  |        |  |      |        |      |  |        |  |  |        | 
|---------------------------------------------------- |  | ---------------- | ------ | ---- |  | ------ |  | ---- | ------ | ---- |  | ------ |  |  | ------ | 
|                                                     |  | December 31,     |       
|                                                     |  |                  |       
|                                                     |  | 2001             |        | 2002 |  | 2003   |  | 2004 |        | 2005 | 
|                                                     |  |                  |        |      |  |        |  |      |        |      | 
|                                                     |  |                  |        |      |  |        |  |      |        |      |  |        |  |  |        | 
|                                                     |  | (in $ thousands) |       
|                                                     |  |                  |       
|Consolidated Balance Sheet Data:                     |  |                  |        |      |  |        |  |      |        |      |  |        |  |  |        | 
|                                                     |  |                  |        |      |  |        |  |      |        |      |  |        |  |  |        | 
|Working capital                                      |  |                  | 45,529 |      |  | 34,574 |  |      | 30,350 |      |  | 25,709 |  |  | 14,834 | 
|                                                    
|Total assets                                         |  |                  | 59,564 |      |  | 49,008 |  |      | 47,918 |      |  | 49,966 |  |  | 42,339 | 
|                                                    
|Capital stock (including additional paid-in capital) |  |                  | 70,747 |      |  | 71,851 |  |      | 72,709 |      |  | 73,379 |  |  | 73,682 | 
|Shareholders equity                                 |  |                  | 47,006 |      |  | 35,677 |  |      | 32,336 |      |  | 31,581 |  |  | 23,444 | 

Risk
Factors

Risks
Related to Our Business and Our Industry

Because
substantially all our current sales are dependent on a single product line,
factors that adversely affect the pricing and demand for this product line
could substantially reduce our sales.

Although
we have expanded our product offering, we are still currently dependent on a
single integrated process control product line targeting the chemical
mechanical polishing market. We expect revenues from this product line to
continue to account for a substantial portion of our revenues for at least the
next year. As a result, factors adversely affecting the pricing of or demand
for integrated process controls for the chemical mechanical polishing equipment
field, such as competition and technological change, would substantially reduce
our sales.

The
markets we target are highly cyclical and it is difficult to predict the length
and strength of any downturn or expansion period.

The
semiconductor capital equipment market and industries, which are highly
cyclical, experienced in 2004 significant increases in sales and decline of
more than 10% in sales in 2005. During the first quarter of 2006, however, the
market and industries changed direction and exhibited the first signs of an
upturn. Although we rely on market research companies, we cannot predict the
length and strength of the downturns or expansions. Furthermore, we have only a
limited ability to reduce expenses during any industry downturn because of the need
for significant ongoing expenditures related to engineering, research and
development and worldwide customer service and support operations. As a result,
during future downturns, we may incur additional losses greater than those we
incurred in the past.

Our
inability to reduce spending during a protracted slowdown in the semiconductor
industry could reduce our prospects of achieving profitability.

Historically,
we have derived all of our revenues, and we expect to continue to derive all of
our revenues, from sales of our products and related services to the
semiconductor industry. Our business depends in large part upon capital
expenditures by semiconductor manufacturers, which in turn depend upon the
current and anticipated demand for semiconductors. The semiconductor industry
has experienced severe and protracted cyclical downturns and upturns. During
cyclical downturns, we have in the past experienced, and will likely in the
future experience, material reductions in the demand for the type of capital
equipment and process technology that we offer and our sales and revenues might
decline again. In addition, our ability to reduce expenses in response to any
downturn or slowdown in the rate of capital investment by manufacturers in
these industries may be limited because of:

| |   |                                                                             
| | - | ----------------------------------------------------------------------------
| |  | our continuing need to invest in research and
  development,                
| |   |                                                                             
| |  | our capital equipment requirements, and                                     
| |   |                                                                             
| |  | our extensive ongoing customer service and support
  requirements worldwide.

- 3 -

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As a result, we may have difficulty achieving
profitability.

If we do
not respond effectively and on a timely basis to rapid technological change,
our ability to attract and retain customers could be diminished, which would
hurt our sales and ability to remain competitive.

The
semiconductor manufacturing industry is characterized by rapid technological
change, new product introductions and enhancements and evolving industry
standards. Our ability to remain competitive and generate sales revenue will
depend in part upon our ability to develop new and enhanced systems at
competitive prices in a timely and cost-effective manner and to accurately
predict technology transitions. Because new product development commitments
must be made well in advance of sales, new product decisions must anticipate
the future demand for products. If we fail to correctly anticipate future
demand for products, our sales and competitive position will suffer. In
addition, the development of new measurement technologies, new product
introductions or enhancements by our competitors could cause a decline in our
sales or loss of market acceptance of our existing products.

We may
not be able to develop or market new products, which could slow or prevent our
growth.

Our
business plan requires the introduction of several new product lines. Our plans
to introduce process control products for photolithography, etch and other
processes will require development of new capabilities. Some of these projects
are in the early stages of development, and we cannot be certain that we will
be able to develop or bring to market these new product lines or, if we do,
that these products will be well received or profitable. If we are unable to
successfully introduce new product lines, our future growth could be adversely
affected.

If any
of our systems fail to meet or exceed our internal quality specifications, we
cannot ship them until such time as they have met such specifications. If we
experience significant delays or are unable to ship our products to our customers
as a result of our internal processes, or for any other reason, our business
and reputation may suffer.

Our
products are complex and require technical expertise to design and manufacture.
Various problems occasionally arise during the manufacturing process that may
cause delays and/or impair product quality. We must actively monitor our
manufacturing processes to ensure that our products meet our internal quality
specifications. Any significant delays stemming from the failure of our products
to meet or exceed our internal quality specifications, or for any other
reasons, would delay our shipments. Shipment delays could harm our business,
revenues and reputation in the industry.

New
product lines that we may introduce in the future may contain defects, which
will require us to allocate time and financial resources to correct.

Our
new product lines may contain defects when first introduced. If there are
defects, we will need to divert the attention of our personnel from our product
development efforts to address the detection and correction of the defects. In
the past, no liability claims have been filed against us for damages related to
product defects, and we have not experienced any material delays as a result of
product defects. However, we cannot assure you that we will not incur these
costs or liabilities or experience these lags or delays in the future.
Moreover, the occurrence of such defects, whether caused by our products or the
products of another vendor, may result in significant customer relations
problems and injury to our reputation and may impair the market acceptance of
our products.

We have
had a history of losses and may incur future losses.

Since
our inception in 1993, we have incurred net losses in every year other than in
1998 and 2000 and may incur a net loss in 2006 or in future years. As of
December 31, 2005, we had an accumulated deficit of approximately $50 million.
We plan to continue similar levels of our aggregate product development, sales
and marketing and administrative expenses over the next 12 months. Accordingly,
to achieve profitability in 2006, we will need to significantly increase our
sales. In the future, our sales may not grow and we may not achieve
profitability.

- 4 -

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Because
we have a limited operating history with one product line, our historical
results may not be indicative of our future results, and it is difficult to
evaluate our business and prospects.

Our
first system for chemical mechanical polishing applications was developed and
introduced to the market in October 1995. Because this is the only product line
with which we have significant manufacturing and marketing experience and
because of our focus on the development and introduction of new products, our
past operating results may not be indicative of our future results. Companies
in an early stage of product development frequently have higher risks and
encounter unexpected expenses and difficulties. These risks, expenses and
difficulties apply particularly to us because the semiconductor manufacturing
business is a rapidly evolving market characterized by technological advances.
The uncertainty of our future performance increases the risk that the value of
your investment will decline.

Our
dependence on a single manufacturing facility magnifies the risk of an
interruption in our production capabilities.

We
have only one manufacturing facility, which is located in Ness-Ziona, Israel.
Any event affecting this site, including natural disaster, labor stoppages or
armed conflict, may disrupt or indefinitely discontinue our manufacturing
capabilities and could significantly impair our ability to fulfill orders and
generate revenues, thus negatively impacting our business.

We
experience quarterly fluctuations in our operating results, which may adversely
impact our stock price.

Our
quarterly operating results have fluctuated significantly in the past, and we
expect this trend to continue. A principal reason is that we derive a
substantial portion of our revenue from the sale of a relatively small number
of systems to a relatively small number of customers. As a result, our revenues
and results of operations for any given quarter may decrease due to factors
relating to the timing of orders by, shipments of systems and timing of
recognizing these revenues. Furthermore, our quarterly results are affected by
the highly cyclical nature of the semiconductor capital equipment market and
industries.

We
also have a limited ability to predict revenues for future quarterly periods
and, as a result, face risks of revenue shortfalls. If the number of systems we
actually ship, and thus the amount of revenues we are able to record in any
particular quarter, is below our expectations, the adverse effect may be magnified
by our inability to adjust spending quickly enough to compensate for the
revenue shortfall.

We may
not be able to expand our manufacturing capacity or marketing efforts quickly
enough to support our future growth.

Because
of our small size and our business strategy to aggressively increase our sales,
we anticipate an increased demand on all of our resources. If we do not
accurately estimate our need for personnel, manufacturing capacity or marketing
and customer support, we may not be able to support our future growth.

We
depend on a small number of large customers, and the loss of one or more of
them would lower our revenues.

Our
customer base is highly concentrated among a limited number of large customers,
primarily because the semiconductor industry is dominated by a small number of
large companies. We anticipate that our revenues will continue to depend on a
limited number of major customers, although the companies considered to be our
major customers and the percentage of our revenue represented by each major
customer may vary from period to period. The loss of any of one of our major
customers would adversely affect our sales and revenues. Furthermore, if any of
our customers become insolvent or have difficulties meeting their financial
obligations to us for any reason, we may suffer losses.

- 5 -

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We
operate in an extremely competitive market, and if we fail to compete
effectively, our revenues and market share will decline.

Although
the market for integrated process control systems used in semiconductor
manufacturing is currently concentrated and characterized by relatively few
participants, the semiconductor capital equipment industry is intensely
competitive. We compete with Nanometrics Inc., Therma-Wave Inc. and Rudolph
Technologies Inc., which manufacture and sell integrated process control
systems. In addition, we compete with established manufacturers of conventional
stand-alone measurement equipment, such as KLA-Tencor Corp., and original
semiconductor equipment manufacturers, such as Tokyo Electron Ltd. Established
companies, both domestic and foreign, compete with our product line, and new
competitors are entering our market. Some of our competitors have greater
financial, engineering, manufacturing and marketing resources than we do. If a
particular customer selects a competitors capital equipment, we expect to
experience difficulty in selling to that customer for a significant period of
time. A substantial investment is required by customers to evaluate, test,
select and integrate capital equipment into a production line. As a result,
once a manufacturer has selected a particular vendors capital equipment, we
believe that the manufacturer generally relies upon that equipment for the
specific production line application and frequently will attempt to consolidate
its other capital equipment requirements with the same vendor. Accordingly,
unless our systems offer performance or cost advantages that outweigh a
customers expense of switching to our systems, it will be difficult for us to
achieve significant sales from that customer once it has selected another
vendors system for an application. We believe that our ability to compete
successfully depends on a number of factors both within and outside of our control,
including:

| |   |                                                                             
| | - | ----------------------------------------------------------------------------
| |  | the contribution of our equipment to our customers
  productivity;         
| |   |                                                                             
| |  | our product quality and performance;                                        
| |   |                                                                             
| |  | our global technical service and support;                                   
| |   |                                                                             
| |  | the return on investment (ROI) of our equipment and
  its cost of ownership;
| |   |                                                                             
| |  | the breadth of our product line; and                                        
| |   |                                                                             
| |  | our success in developing and marketing new
  products.                     

If
we fail to compete in a timely and cost-effective manner against current or
future competitors, our revenues and market share will decline.

The
ongoing consolidation in our industry may harm us if our competitors are able
to offer a broader range of products and greater customer support than we can
offer.

We
believe that the semiconductor capital equipment market is undergoing
consolidation. A number of suppliers have been acquired by larger equipment
manufacturers. For example, in 2005 Rudolph Technologies Inc. acquired August
Technologies Inc. and in 2006 Nanometrics Inc. acquired Soluris Inc. and signed
an agreement to acquire Accent Technologies. We believe that similar
acquisitions and business combinations involving our competitors and customers
may occur in the future. These acquisitions could adversely impact our
competitive position by enabling our competitors and potential competitors to
expand their product offerings and customer service, which could provide them
an advantage in meeting customers needs, particularly with those customers
that seek to consolidate their capital equipment requirements with a smaller
number of vendors. The greater resources, including financial, marketing and
support resources, of competitors involved in these acquisitions could permit
them to accelerate the development and commercialization of new competitive
products and the marketing of existing competitive products to their larger
installed bases. Accordingly, such business combinations and acquisitions by
competitors or customers could jeopardize our competitive position.

- 6 -

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We may
not be successful in our efforts to consummate and integrate our pending
acquisition of HyperNex Inc. or in our efforts to identify, complete and
integrate future acquisitions, which could disrupt our current business
activities and adversely affect our results of operations or future growth.

On
April 24, 2006 we entered into an Asset Purchase Agreement with HyperNex, Inc.
and its shareholders, providing for the acquisition of substantially all the
assets of HyperNex and the assumption of certain specified liabilities. The
consummation of the acquisition of HyperNex is being delayed because of the
refusal of a key supplier of HyperNex to consent to the assignment of its
contract with HyperNex to Nova. We have commenced litigation against the key
supplier generally asserting that it is unreasonably withholding its consent to
the assignment, contrary to the terms of its contract with HyperNex. The
proceedings are at a very early stage and we cannot predict the outcome of the
litigation. Similarly, we cannot predict whether we will be able to consummate
our pending acquisition of HyperNex. For more information regarding the
HyperNex acquisition see Material Contracts beginning at page 55.

The
pending acquisition of HyperNex and any future acquisition involve many risks,
including the risks of:

| |   |                                                                                 
| | - | --------------------------------------------------------------------------------
| |  | diverting managements attention from our ongoing
  business concerns;          
| |   |                                                                                 
| |  | entering markets in which we have no direct prior
  experience;                 
| |   |                                                                                 
| |  | improperly evaluating new services, products and
  markets;                     
| |   |                                                                                 
| |  | being unable to maintain uniform standards,
  controls, procedures and policies;
| |   |                                                                                 
| |  | being unable to integrate new technologies or
  personnel;                      
| |   |                                                                                 
| |  | incurring the expenses of any undisclosed or
  potential liabilities; and       
| |   |                                                                                 
| |  | the departure of key management and employees.                                  

If
we are unable to successfully complete the acquisition or to effectively
integrate HyperNex or any future acquisitions, our ability to grow our business
or to operate our business effectively could be reduced, and our business,
financial condition and operating results could suffer. Even if we are
successful in completing acquisitions, we cannot assure you that we will be
able to integrate the operations of the acquired business without encountering
difficulty regarding different business strategies with respect to marketing,
integration of personnel with disparate business backgrounds and corporate
cultures, integration of different point-of-sale systems and other technology
and managing relationships with other business partners.

Because
we are small, we depend on a small number of employees who possess both
executive and technical expertise, and the loss of any of these key employees
would hurt our ability to implement our strategy and to compete effectively.

Because
of our small size and our reliance on employees with both executive and
advanced technical skills, our success depends significantly upon the continued
contributions of our officers and key personnel. All of our key management and
technical personnel have expertise, which is in high demand among our
competitors, and the loss of any of these individuals could cause our business
to suffer. We do not maintain life insurance policies for our officers and
directors.

Our
lengthy sales cycle increases our exposure to customer cancellations or delays
in orders, which may result in obsolete inventory and volatile quarterly
revenues.

Sales
of our systems depend, in significant part, upon our customers adding new
manufacturing capacity or expanding existing manufacturing capacity, both of
which involve a significant capital commitment. We may experience delays in
finalizing sales following initial system qualification while a customer
evaluates and approves an initial purchase of our systems. In general, for new
customers or applications, our sales cycle takes between three and 24 months to
complete. During this time, we may expend substantial funds and management
effort, but fail to make any sales. Lengthy sales cycles subject us to a number
of significant risks, including inventory obsolescence and fluctuations in
operating results, over which we have little or no control.

- 7 -

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Because
of the technical nature of our business, our intellectual property is extremely
important to our business, and our inability to protect our intellectual
property would harm our competitive position.

We
have obtained 49 U.S. patents and have 25 U.S. patent applications pending. In
addition, we have obtained 29 non-U.S. patents and have more than 60 non-U.S.
patent applications pending.

We
cannot assure you that:

| |   |                                                                                                                                                                          
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | pending patent applications will be approved;                                                                                                                            
| |   |                                                                                                                                                                          
| |  | any patents will be broad enough to protect our
  technology, will provide us with competitive advantages or will not be
  challenged or invalidated by third parties; or
| |   |                                                                                                                                                                          
| |  | the patents of others will not have an adverse
  effect on our ability to do business.                                                                                   

We
also cannot assure you that others will not independently develop similar
products, duplicate our products or, if patents are issued to us, design around
these patents. Further, because patents may afford less protection under
foreign law than is available under U.S. law, we cannot assure you that any
foreign patents issued to us will adequately protect our proprietary rights.

In
addition to patent protection, we also rely upon trade secret protection,
employee and third-party nondisclosure agreements and other intellectual
property protection methods to protect our confidential and proprietary
information. Despite these efforts, we cannot be certain that others will not
otherwise gain access to our trade secrets or disclose our technology.

Furthermore,
we may be required to institute legal proceedings to protect our intellectual
property. If such legal proceedings are resolved adversely to us, our
competitive position and/or results of operations could be harmed. For
additional information on our intellectual property, including information
regarding a patent infringement lawsuit we commenced against Nanometrics Inc.,
and information regarding a patent infringement lawsuit Nanometrics commenced
against us, see Intellectual Property starting on page 21 of this report.

There
has been significant litigation involving intellectual property rights in the
semiconductor and related industries and similar litigation involving Nova
could force us to divert resources to defend against this litigation or deter
our customers from purchasing our systems.

We
have been, and may in the future be, notified of allegations that we may be
infringing intellectual property rights possessed by others. In addition, we
may be required to commence legal proceedings against third parties, which may
be infringing our intellectual property, in order to defend our intellectual
property. In the future, protracted litigation and expense may be incurred to
defend ourselves against alleged infringement of third party rights or to
defend our intellectual property against infringement by third parties. Adverse
determinations in that type of litigation could:

| |   |                                                                                                                        
| | - | -----------------------------------------------------------------------------------------------------------------------
| |  | result in our loss of proprietary rights;                                                                              
| |   |                                                                                                                        
| |  | subject us to significant liabilities, including
  treble damages in some instances;                                   
| |   |                                                                                                                        
| |  | require us to seek licenses from third parties,
  which licenses may not be available on reasonable terms or at all; or
| |   |                                                                                                                        
| |  | prevent us from selling our products.                                                                                  

- 8 -

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Any
litigation of this type, even if we are ultimately successful, could result in
substantial cost and diversion of time and effort by our management, which by
itself could have a negative impact on our profit margin, competitive position
and ability to develop and market new and existing products. For additional
information on our intellectual property, including information regarding a
civil action we commenced against Nanometrics Inc., and information regarding a
civil action Nanometrics commenced against us, see Intellectual Property
starting on page 21 of this report.

We depend on a limited number of suppliers,
and in some cases a sole supplier. Any disruption or termination of these
supply channels may adversely affect our ability to manufacture our products
and to deliver them to our customers.

We
purchase components, subassemblies and services from a limited number of
suppliers and occasionally from a single source. Disruption or termination of
these sources could occur, and these disruptions could have at least a
temporary adverse effect on our operations. To date, we have not experienced
any material disruption or termination of our supply sources. A prolonged
inability on our part to obtain components included in our systems on a
cost-effective basis could adversely impact our ability to deliver products on
a timely basis, which could harm our sales and customer relationships.

We are dependent on international sales,
which expose us to foreign political and economic risks that could impede our
plans for expansion and growth.

Our
principal customers are located in the United States, Japan, Taiwan and South
Korea and we produce our products in Israel. International operations expose us
to a variety of risks that could seriously impact our financial condition and
impede our growth. For instance, trade restrictions, changes in tariffs and
import and export license requirements could adversely affect our ability to
sell our products in the countries adopting or changing those restrictions,
tariffs or requirements. This could reduce our sales by a material amount.

Because we derive a significant portion of
our revenues from sales in Asia, our sales could be hurt by the instability of
Asian economies.

A
number of Asian countries have experienced political and economic instability.
For instance, Taiwan and China have had a number of disputes, as have North and
South Korea, and Japan has for a number of years experienced significant
economic instability. We have a subsidiary in Taiwan and we have significant
customers in Japan and South Korea. An outbreak of hostilities or other
political upheaval or economic downturns in these or other Asian countries
would likely harm the operations of our customers in these countries, causing
our sales to suffer.

A large number of our ordinary shares
continue to be owned by a relatively small number of shareholders, whose future
sales of our stock, if substantial, may depress our share price.

If
our principal shareholders sell substantial amounts of our ordinary shares,
including shares issued upon the exercise of outstanding options, the market
price of our ordinary shares may fall. As of December 31, 2005 we had
15,457,471 ordinary shares outstanding, of which 10,975,051 shares were held by
nine shareholders.

Because four of our shareholders
control approximately 51.6% of our ordinary shares, they can control the
outcome of matters submitted to a vote of our shareholders, including the
election of directors.

As
of April 30, 2006, four of our shareholders controlled approximately eight
million, or 51.6%, of our ordinary shares. As a result, and although we are
currently not aware of any voting agreement between such shareholders, if these
shareholders voted together or in the same manner, they would have the ability
to control the outcome of corporate actions requiring an ordinary majority vote
of shareholders as set in the Companys articles of association. Even if these
four shareholders do not vote together, each has the ability to influence the
outcome of corporate actions requiring the vote of shareholders as set in the
Companys article of association. For additional information on our major
shareholders, see Major shareholders on page 46.

- 9 -

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Risks Related to Operations in Israel

Potential political, economic and military
instability in Israel may adversely affect our growth and revenues.

Our
principal offices and manufacturing facilities and many of our suppliers are
located in Israel. Although most of our sales are currently being made outside
Israel, political, economic and military conditions in Israel directly affect
our operations. Since the establishment of the State of Israel in 1948, a
number of armed conflicts have taken place between Israel and its Arab
neighbors. Conflicts between Israel and Palestinian militant groups have been
ongoing. A state of hostility, varying in degree and intensity, has led to
security and economic problems for Israel. The resumption of hostilities in the
region, and the on-going tension in the region, have a negative effect on the
stability of the region which might have negative effect on our business and
harm our growth and revenues. For further detail see Political and economic
conditions in Israel starting on page 36.

Our operations may be disrupted by the
obligation of key personnel to perform military service.

Some
of our executive officers and employees in Israel are obligated to perform up
to 36 days of military reserve duty annually. This time-period may be extended
by the Military Chief of General Staff and the approval of the Minister of
Defense or by a directive of the Minister of Defense in the event of a declared
national emergency. Our operations could be disrupted by the absence for a
significant period of one or more of our executive officers or key employees
due to military service. To date, our operations have not been materially
disrupted as a result of these military service obligations, and no executive
officer or key employee was recruited for any significant time period. Any
disruption in our operations due to such obligations would adversely affect our
ability to produce and market our existing products and to develop and market
future products.

Because most of our revenues are generated in
U.S. dollars, but a significant portion of our expenses is incurred in New
Israeli Shekels, our profit margin may be seriously harmed by inflation and
currency fluctuations.

We
generate most of our revenues in U.S. dollars, but incur a significant portion
of our expenses in New Israeli Shekels, commonly referred to as NIS. As a
result, we are exposed to risk to the extent that the rate of inflation in
Israel exceeds the rate of devaluation of the NIS in relation to the dollar or
if the timing of this devaluation lags behind inflation in Israel with respect
to such expenses that might increase as a result of inflation in Israel. In
that event, the dollar cost of our operations in Israel will increase and our
dollar measured results of operations will be adversely affected. Our
operations also could be adversely affected if we are unable to hedge against
currency fluctuations in the future. Accordingly, we may enter into currency
hedging transactions to decrease the risk of financial exposure from
fluctuations in the exchange rate of the dollar against the NIS. These
measures, however, may not adequately protect us from material adverse effects
due to the impact of inflation in Israel.

We participate in government programs under
which we receive tax and other benefits. These programs impose restrictions on
our ability to use the technologies developed under these programs. In
addition, the reduction or termination of these programs would increase our
costs.

We
receive conditional grants from the Office of the Chief Scientist of the
Israeli Ministry of Industry, Trade and Labor for research and development
programs that meet specified criteria. We are also eligible to receive tax
benefits under Israeli law for capital investments that are designated as
approved enterprises. To maintain our eligibility for these programs and tax
benefits, we must continue to meet certain conditions, including paying
royalties related to grants received and making specified investments in fixed
assets. Some of these programs also restrict our ability to manufacture
particular products and transfer particular technology, which was developed as
part of the approved enterprises outside of Israel, by requiring approval of
the research and development committee nominated by the Office of the Chief
Scientist of the Israeli Ministry of Industry, Trade and Labor under applicable
law. Such approval may be given only if the recipient abides by all the
provisions of the law and related regulations. Approval to manufacture products
outside of Israel or consent to the transfer of technology, if requested, might
not be granted.

- 10 -

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If
we fail to comply with these conditions in the future, the benefits received
could be cancelled. We could also be required to pay increased taxes or refund
any benefits previously received, adjusted for inflation and interest. In 2003,
2004 and 2005, we recorded an aggregate of $2.3 million, $1.9 million and $1.9
million, respectively, in conditional grants under Israeli government programs.
As of December 31, 2005, our contingent liability to the Office of the Chief
Scientist for grants received was approximately $5.7 million. See also Note 7A
to our consolidated financial statements contained elsewhere in this report. From
time to time, we submit requests for new grants from the Office of the Chief
Scientist and for expansion of our approved enterprise programs. These requests
might not be approved. The Israeli government has reduced the benefits
available under these programs in recent years and has indicated that it may
reduce or eliminate these benefits in the future. The termination or reduction
of these grants or tax benefits could harm our business, financial condition
and results of operations. In addition, if we increase our activities outside
Israel due to, for example, future acquisitions, our increased activities
generally will not be eligible for inclusion in Israeli tax benefit programs.
Accordingly, our effective corporate tax rate could increase significantly in
the future.

Any shareholder with a cause of action
against us as a result of buying, selling or holding our ordinary shares may
have difficulty asserting a claim under U.S. securities laws or enforcing a
U.S. judgment against us or our officers, directors or Israeli auditors.

We
are organized under the laws of the State of Israel, and we maintain most of
our operations in Israel. Most of our officers and directors as well as our
Israeli auditors reside outside of the United States and a substantial portion
of our assets and the assets of these persons are located outside the United
States. Therefore, if you wish to enforce a judgment obtained in the United
States against us, or our officers, directors and auditors, you will probably
have to file a claim in an Israeli court. Additionally, you might not be able
to bring civil actions under U.S. securities laws if you file a lawsuit in
Israel. We have been advised by our Israeli counsel that Israeli courts
generally enforce a final executory judgment of a U.S. court for liquidated
amounts in civil matters after a hearing in Israel. If a foreign judgment is
enforced by an Israeli court, it will be payable in Israeli currency. However,
payment in the local currency of the country where the foreign judgment was
given shall be acceptable, subject to applicable foreign currency restrictions.

Our shares are listed for trade on more than
one stock exchange, and this may result in price variations.

Our
ordinary shares are listed for trading on the Nasdaq National Market and on the
Tel Aviv Stock Exchange. This may result in price variations. Our ordinary
shares are traded on these markets in different currencies, U.S. dollars on the
Nasdaq and New Israeli Shekels on the Tel Aviv Stock Exchange. These markets
have different opening times and close on different days. Different trading
times and differences in exchange rates, among other factors, may result in our
shares being traded at a price differential on these two markets. In addition,
market influences in one market may influence the price at which our shares are
traded on the other.

We may be classified as a passive foreign
investment Company and, as a result, our U.S. shareholders may suffer adverse
tax consequences

Generally,
if for any taxable year 75% or more of our gross income is passive income, or
at least 50% of our assets are held for the production of, or produce, passive
income, we may be characterized as a passive foreign investment company for
U.S. federal income tax purposes. Our passive income would not include income
derived from the sale of our products, but would include amounts derived by
reason of a temporary investment of any cash amounts. This characterization
could result in adverse U.S. tax consequences to our shareholders, including
having gain realized on the sale of our shares be treated as ordinary income,
as opposed to capital gain income, and having potentially punitive interest
charges applied to such sales proceed. U.S. shareholders should consult with their
own U.S. tax advisors with respect to the U.S. tax consequences of investing in
our ordinary shares.

We
believe that in 2005 we were not a passive foreign investment company.
Nonetheless, because of the difficulty determining the value of our assets,
there is a risk that we were a passive foreign investment company in 2005.
Currently we expect that we will not be a passive foreign investment company in
2006. However, passive foreign investment company status is determined as of
the end of the full tax year and is dependent on a number of factors, including
the value of a corporations assets and the amount and type of its gross
income. Therefore, there can be no assurances that we will not become a passive
foreign investment company for the current fiscal year ending on December 31,
2006 or any future year. For a discussion on how we might be characterized as a
passive foreign investment company and related tax consequences, please see the
section of this annual report entitled U.S. Taxation  Passive Foreign
Investment Companies.

- 11 -

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Item 4. Information
on the Company

History and
Development of the Company

Nova
Measuring Instruments Ltd. was incorporated in May 1993 under the laws of the
State of Israel. We commenced operations in October 1993 to design, develop and
produce integrated process control systems for use in the manufacture of
semiconductors, also known as integrated circuits or chips. In October 1995, we
began manufacturing and marketing
systems for chemical mechanical polishing processes. We have since expanded our product offering to include systems designed
for chemical vapor deposition, lithography and etch, and are continuing
to develop new products and additional applications for our current products.
These new offerings have not yet contributed a material amount to our sales.

In
April 2000, we conducted an initial public offering pursuant to which we sold
3,000,000 ordinary shares for consideration of $54 million and net proceeds of
$49.2 million. In connection with the public offering, our shares were listed
for trading on the Nasdaq National Market.

In
June 2002, we listed our shares in the Tel-Aviv Stock Exchange in Israel,
pursuant to legislation which enables Israeli companies whose shares are traded
on certain stock exchanges outside of Israel to be registered on the Tel Aviv
Stock Exchange, while reporting, in substance, according to the provision of
the relevant foreign securities law applicable to the company. The Israeli
securities laws prescribe that as condition precedent to a company being
eligible to register its shares for trade on the Tel Aviv Stock Exchange, the
companys capital must consist of a single class of shares with equal voting
rights with respect their par value. Accordingly, all of our series E shares
were converted into ordinary shares in May 2002. This conversion was approved
by the Tel Aviv District Court on May 2002 and our Articles of Association were
amended accordingly.

We
have four wholly owned subsidiaries in the U.S., Japan, Taiwan and Netherlands.
These subsidiaries are engaged in marketing activities and provide technical
support to our customers.

Our
main office, research and development and production facilities are located in
Israel at the Weizmann Science Park, Building 22, 2nd Floor, Ness-Ziona. Our
telephone number at our main office is +1-972-8-938-7505. Our agent for service
of process in the U.S. is Mr. David Gitlin, of Wolf, Block, Schorr and
Solis-Cohen LLP, 1650 Arch Street, 22nd Floor, Philadelphia, PA 19103.

Overview

We
are a worldwide leading designer, developer and producer of integrated process
control metrology systems used in the manufacture of semiconductors and a
leading designer, manufacturer and producer of stand-alone process control
metrology systems. Metrology systems measure various thin film properties,
critical circuit dimensions and layer-to-layer circuit alignment, known as
overlay, during various steps in the semiconductor manufacturing process, allowing
semiconductor manufacturers to increase quality, productivity and yields, lower
their manufacturing costs and increase their profitability. We supply our
metrology systems to major semiconductor manufacturers worldwide, either
directly or through process equipment manufacturers. Of the 20 semiconductor
manufacturers that had the highest capital equipment expenditures in 2005, 18
use our systems. The majority of our metrology systems are sold to process
equipment manufacturers. These process equipment manufacturers integrate our
metrology systems into their process equipment which is then sold to the
semiconductor manufacturers. Our systems were first installed in 1995 and,
since that time, we have sold more than 1,350 metrology systems.

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The
semiconductor manufacturing process starts with a silicon wafer that has been
highly polished on one side to a mirror finish, upon which circuits are
constructed. To construct the circuits, a series of layers of thin films that
act as conductors, semiconductors or insulators are applied to the polished
side of the wafer. During the manufacturing process, these film layers are
subjected to processes which remove portions of the film layers, create circuit
patterns and perform other functions. The semiconductor manufacturing process
requires exacting steps and strict control of equipment performance and process
sequences. Tight control can be achieved through monitoring silicon wafers and
measuring relevant parameters after each process step with metrology tools such
as those we produce.

Prior
to the introduction of our integrated metrology systems, process control was
achieved through stand-alone measurement equipment. Stand-alone measurement
equipment requires semiconductor manufacturers to interrupt the manufacturing
process sequence, remove sample silicon wafers from the process equipment and
place the silicon wafers on the stand-alone measuring or inspection tool. In
contrast, our integrated metrology approach is based upon patented measuring
methods that enable us to produce optical measuring systems that are small
enough to be integrated directly inside many types of semiconductor process
equipment. We believe our integrated approach offers considerable advantages
over the conventional stand-alone approach to metrology control, enabling
manufacturers using our integrated equipment to reduce costs and to improve
production efficiency, yield and quality.

We
have emphasized our integrated metrology solutions in the past and intend to
continue to do so. However, we also produce stand-alone metrology systems. We
plan to leverage our technology, methods, metrology expertise and market
position in the integrated metrology field to expand our offerings of
stand-alone metrology systems. Our long-term strategy is focused on advanced
metrology and process control solutions where our integrated process control
products and stand alone products are compatible or complementary.

Demand
for metrology systems, whether integrated or stand-alone, is driven by capital
equipment purchases by semiconductor manufacturers, which in turn are driven by
worldwide demand for semiconductors. Industry data indicates that the worldwide
demand for semiconductors is growing. We believe that this growth in demand
will drive demand for process control equipment, including metrology systems,
as semiconductor manufacturers add capacity. Demand for metrology systems will
also be driven by the increasing cost to manufacture semiconductors, which are
becoming larger and more complex, and the demands of semiconductor
manufacturers for process equipment that provides better film uniformity,
increased dimensional control, tool-to-tool matching and within-tool
uniformity.

Our Market

Growth
of the Semiconductor Industry and the Metrology Market

The
use of semiconductor devices continues to increase. Semiconductors are no
longer used solely in personal computers and computer systems, but also in
wireless communications, Internet infrastructure, Internet access devices,
automobiles, portable electronic devices and other advanced consumer
electronics. As a result of the increasing demand for semiconductors, the
semiconductor industry has experienced significant growth over the past eight
to 10 years, despite a severe downturn between 2000 and 2003. According to the
Semiconductor Industry Association, worldwide sales of semiconductors decreased
from $223 billion in 2000 to $178
billion in 2003, then increased to $220 billion in 2004 and $235 billion in 2005.
Over the past decade, the increased use of semiconductors has driven demand for
additional semiconductor manufacturing capacity. In turn, the addition of
semiconductor manufacturing capacity, whether through new construction or
refurbishment of existing manufacturing facilities, has been a driver of demand
for metrology systems such as those we produce.

The
increased use of semiconductors has been accompanied by in increase in their
complexity. Due to the creation of new applications and markets for
semiconductors, suppliers and manufacturers are faced with an increasing demand
for new products that provide greater functionality and higher performance at
lower prices. As a result, many new complex materials, structures and processes
are being introduced to semiconductor manufacturing. New materials include
copper, low- and high-k dielectrics, silicon-on-insulator, silicon-germanium,
strained silicon and raised source/drain. Manufacturers are also increasingly
moving toward 300 mm silicon wafers from 200 mm silicon wafers. While 300 mm
wafers can yield up to twice as many integrated circuits as 200 mm wafers,
larger wafers increase manufacturing challenges. For example, because 300 mm
wafers can bend or bow more than twice as much as 200 mm wafers, they are more
susceptible to damage. The larger area of 300 mm wafers also makes it more
difficult to maintain film uniformity across the entire wafer. Semiconductors
also continue to move toward smaller feature sizes and more complex multi-level
circuitry. The increase in complexity of semiconductors and the resulting
increase in the complexity and cost of the semiconductor manufacturing process
has also been a driver of demand for metrology systems.

- 13 -

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The
ever-increasing level of complexity and the decrease in feature sizes has also
significantly increased the cost and performance requirements of semiconductor
fabrication equipment. The cost of wafer fabrication equipment has also
increased due to the higher levels of automation being utilized by
manufacturers. Thus, semiconductor manufacturers must increase their investment
in capital equipment in order to sustain technological leadership, to expand
manufacturing capacity and maintain profitability. According to published
reports by an industry market research firm, the cost of building a
state-of-the-art semiconductor manufacturing facility has grown from
approximately $200 million in 1983 to over $3 billion for facilities capable of
manufacturing 300 mm wafers. We believe that the process control equipment
market, which includes the metrology segment, in the future will grow at a rate
greater than the overall process equipment market since process control
equipment is in the future expected to consume a larger portion of the overall
costs of semiconductor manufacturing equipment.

While
we expect that the demand for semiconductors will increase and the market for
semiconductor process control equipment will expand, we cannot assure you that
either will occur, that we will benefit from any increase in demand or
expansion of the process control market, or that our products will be accepted
in the market place. Our industry is intensively competitive and if we fail to
compete effectively our revenues and market share will decline. In addition,
the semiconductor industry, and the semiconductor capital equipment market in
particular, are highly cyclical. Therefore, while we anticipate demand for
semiconductors will increase and the market for semiconductors capital
equipment will expand, it is likely that there will be periodic downturns which
may be severe and protracted.

The
Semiconductor Manufacturing Process

Semiconductors
typically consist of transistors or other components connected by an intricate
system of circuitry on flat silicon discs known as wafers. Integrated circuit
manufacturing involves hundreds of individual steps, some of which are repeated
several times, through which numerous copies of an integrated circuit are
formed on a single silicon wafer. Typically, up to 30 very thin patterned
layers are created on each wafer during the manufacturing process. At the end
of the manufacturing process, the wafer is cut into individual chips or die.
Because semiconductor specifications are extremely exacting, and integrated
circuits are becoming more complex, requiring ever more sophisticated
manufacturing processes, the process steps are constantly monitored, and
critical parameters are measured at each step using metrology equipment.

Many
of the manufacturing steps involve the controlled application or removal of
layers of materials to or from the wafer. The application of materials to the
wafer, known as deposition, involves the layering of extremely thin films of
electrically insulating, conducting or semi-conducting materials. These layers
can range from one-thousandth to less than one-hundred-thousandth of a
millimeter in thickness and create electrically active regions on the wafer and
its surface. A wide range of materials and deposition processes are used to
build up thin film layers on wafers to achieve specific performance
characteristics. One of the principal methods of thin film layer deposition is
chemical vapor deposition (CVD). In CVD, a chemical is introduced into the
chamber where the wafer is being processed and is deposited using heat and a
chemical reaction to form a layer of solid material on the surface of the
silicon wafer. Metrology systems monitor the thickness and uniformity of thin
film layers during the deposition process.

Once
the thin film has been deposited on the wafer to form a solid material, circuit
patterns are created using a process known as photolithography. During this
process, a light-sensitive coating called photoresist is applied to the wafer,
which is then exposed to intense light through a patterned, opaque piece of
glass. For the photolithography process to work properly, the thickness of the
photoresist must be precise and uniform. In addition, to control the
photolithography process, the film thickness, reflectivity, overlay
registration and critical dimensions are all measured and verified. The exposed
photoresist is developed when it is subjected to a chemical solution. The
developed wafer is then exposed
to another chemical solution, or plasma, that etches away any areas not covered
by the photoresist to create the structure of the integrated circuit.
Semiconductor manufacturers use metrology systems to verify the removal of
material through the etch process and the critical dimensions of the structures
created.

- 14 -

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To meet the processing challenges posed by
ever smaller feature sizes and because of the use of new materials such as
copper in the manufacture of integrated circuits, manufacturers are
increasingly using a process technology known as chemical mechanical polishing.
Chemical mechanical polishing, or CMP, removes uneven film material deposited
on the surface of the wafer from processes such as CVD and photolithography by
carefully sanding the wafer with abrasives and chemicals, creating an
extremely flat and even surface for the patterning of subsequent film layers.
Metrology systems are used to control and verify the results of the CMP process
by measuring the thin film layer to determine when the correct thickness has been
achieved.

The
processes described above are repeated in sequence until the last layer of
structures on the wafer has been completed. Each integrated circuit on the
wafer is then inspected and its functionality tested before shipment.
Measurements taken by metrology systems during the manufacturing process help
insure process uniformity and help semiconductor manufacturers avoid costly
rework and mis-processing, thereby increasing efficiency and profitability.

The
Need for Greater Overall Equipment Efficiency

We
believe that one of the major challenges to achieving improvements in
semiconductor manufacturing cost productivity is continuously improving
equipment productivity. Overall equipment efficiency, that is, the percentage
of time that processing equipment is utilized to produce wafers, is used as a
metric to quantify the productivity of a processing tool. The major factors
affecting productivity are equipment downtime, qualification time,
mis-processing and operator skills. We believe that in order to improve cost
productivity, earn an acceptable return on their investment in capital
equipment and to meet the demand for improved semiconductor device performance,
semiconductor manufacturers must find ways to improve overall equipment
efficiency.

Process
Control. The steps used to create semiconductors are an exacting processes
that require strict control of equipment performance and process sequences for
the resulting semiconductors to function properly. Tight control is achieved
through monitoring of the in-process wafers and by measuring relevant
parameters after each process step. These procedures are usually carried out on
a small sample of the wafers. The monitoring may include measurement of several
parameters, such as the thickness of the layers of thin film deposited, the
sizes of the features that are patterned through the photolithography process,
as well as the registration or alignment between two consecutive layers, known
as overlay. Monitoring also includes inspection of the wafer for
irregularities, defects or scratches. If parameters are out of specification or
if defects or contamination are present, the manufacturer adjusts the process
and measures another sample of wafers thereby allowing manufacturers to reduce
costs and improve device performance.

Traditional
Stand-Alone Process Control and Its Limitations. In the standard approach
to semiconductor manufacturing, process control is a stand-alone operation.
Stand-alone process control systems, however, impose a number of limitations on
the semiconductor manufacturer. The semiconductor manufacturer must interrupt
the process sequence and add extra steps in order to remove sample wafers from
the fabrication process equipment and put them on a stand-alone measuring or
inspection tool. The conventional stand-alone approach necessitates redundant
robotic wafer handling hardware and software in both the process equipment and
the stand-alone process monitoring tools, as well as additional wafer transferring
automation systems between the two pieces of equipment, resulting in decreased
factory efficiency and reduced productivity. In addition, removing the wafer
samples from the process equipment to the metrology tool increases the risk of
contamination or damage. As this removal significantly detracts from useable
process time, it is not practical to make a large number of measurements,
thereby compromising the accuracy of the measurement of process deviations and
trends. If a measurement indicates that the process has been out of
specification, the wafers made since the sample wafers were removed for
inspection may have to be discarded or re-worked, actions that are increasingly
costly for the manufacturer.

The
Need for More Effective Process Control Tools. In addition to the inherent
limitations of stand-alone process control systems, a number of technical and
operational trends within the semiconductor manufacturing industry are
strengthening the need for more effective process control solutions. These
trends include:

| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Development of smaller semiconductor features.The
  development of smaller features, now as small as 90 nm in production, enables
  semiconductor manufacturers to produce larger numbers of circuits per wafer
  and to achieve higher circuit performance. As feature geometries decrease,
  manufacturing yields become increasingly sensitive to processing deviations
  and defects, as more integrated circuits are lost with every discarded wafer.
  In addition, the increased complexity and number of layers of the integrated
  circuits increase the chance of error during the manufacture of the wafer.

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| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Shortening of technology life cycles.The
  technology life cycle of integrated circuits continues to shorten as
  semiconductor manufacturers strive to adopt new processes that allow a faster
  transition to smaller, faster and more complex devices. In the past, the
  technology life cycle was approximately three years; it is now only two
  years. The accelerating rate of obsolescence of technology makes early
  achievement of enhanced productivity and high manufacturing yields an even
  more critical component of a semiconductor manufacturers profitability.                                                                                                                                                                                                                                                      
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |  | Transition to copper and other new materials.Copper
  metal layers and other new materials such as low and high k-dielectrics and
  silicon on insulator are increasingly replacing aluminum for advanced
  integrated circuits in order to increase performance and reduce the cost of
  integrated circuits. Copper and low-K materials make it possible to build
  higher speed devices using fewer layers. The use of copper and other new
  materials, requires new processing and metrology equipment and thus
  represents challenging developments for the semiconductor manufacturing
  industry.                                                                                                                                                                                                                                 
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |  | Change to 300-millimeter wafers.The
  transition in wafer size from 200-millimeter diameter to 300-millimeter
  diameter that began in 1999more
  than doubles the number of integrated circuits per wafer. Maintaining process
  uniformity across these larger wafers is more difficult. Processing larger
  wafers also increases the cost of mistakes caused by both the larger number
  of integrated circuits per wafer and the greater complexity (and, therefore,
  cost) of processing larger wafers. Thus, with 300 mm wafers, the need for
  effective metrology to quickly detect and correct errors in the manufacturing
  process has increased. In addition, new metrology equipment is needed to
  accommodate the larger wafer size. It is forecasted that in 2006 80% of
  equipment sales will towards 300mm processing.
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |  | Increase in foundry manufacturing.As a result of the rising investment for
  semiconductor production and the proliferation of different types of
  semiconductors, semiconductor manufacturing is increasingly being outsourced
  to large semiconductor contract manufacturers, or foundries. A foundry
  typically runs several different processes and makes hundreds to thousands of
  different semiconductor product types in one facility, making the maintenance
  of a constant high production yield and overall equipment efficiency more
  difficult to achieve.                                                                                                                                                                                                                                                              
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |  | Increase in Automation. In an effort to
  achieve greater operating efficiencies, semiconductor manufacturers are
  increasingly relying upon automation. Automation represents the fastest
  growing segment of the semiconductor manufacturing industry.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 

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In
order to address the increasing costs associated with these trends, we believe
semiconductor manufacturers must enhance manufacturing productivity. One way to
enhance productivity is through improvements in process control, with a greater
emphasis on metrology as part of process control. As part of this emphasis on
metrology, manufacturers are taking more measurements to characterize each step
of the semiconductor manufacturing process, new and enhanced measurement
techniques are being used to provide meaningful data and the data provided is
being used in new ways to enhance the manufacturing process. We believe that
the demand for advanced process control systems that address the evolving needs
of semiconductor manufacturers will continue to drive the growth in the market
for process control systems, and integrated process control systems in
particular.

We
believe integrated metrology systems provide semiconductor manufacturers with
the greatest opportunity to increase the productivity and yields of their
equipment, thereby increasing their profitability. Therefore, we plan to
continue to maintain a major focus on the integrated metrology market. However,
recognizing that a significant number of semiconductor manufacturers will
continue to rely upon stand-alone equipment, we intend to leverage our market
leading position in the integrated metrology market and our metrology expertise
to deepen our penetration of the stand-alone metrology market. Furthermore, the
technological and operational trends within the semiconductor manufacturing
industry that are strengthening the need for more effective process control
solutions can sometimes be addressed through the use of stand-alone metrology
equipment, although, we believe, that greater efficiency can be achieved
through the use of integrated metrology systems.

The Nova Approach

Integrated
Metrology

Our
integrated metrology systems provide semiconductor manufacturers with more
effective and efficient process control by measuring wafers and their
properties without removing the wafer from the process equipment. All our
products use our patented measuring methods that enable us to produce optical
measuring systems that are small enough to be incorporated directly inside many
types of equipment used in semiconductor processing. Integrated systems measure
the wafer within the actual process environment, reducing labor and wafer
handling as well as the risk of contamination of or damage to the wafer. In
addition, we believe that our systems deliver significant increases in overall
equipment efficiency through advanced process control, along with improving
wafer-to-wafer uniformity, all with minimal operator intervention.

We
provide our customers with flexible integrated process control solutions by
offering systems that meet thin film measurement needs in critical applications
in the fabrication process. Our integrated process control platform can be
deployed to multiple processes and applications of semiconductor manufacturing.

Our
systems can be installed directly in new equipment or used to upgrade existing
equipment with minimal integration costs, extending the useful life of existing
process equipment and saving significant capital costs. To our knowledge, only
our metrology systems can be used to retrofit older 200 mm semiconductor
manufacturing equipment, giving us a unique opportunity as manufacturers seek
to increase production quickly to meet the increasing demand for
semiconductors. Our pioneering approach, centered around our NovaReady
integration package, later adopted by the process equipment manufacturers,
allows process equipment manufacturers to prepare their equipment to accept our
measurement and inspection systems, which can then be integrated with a simple
plug-and-play installation.

We
believe our integrated process control systems and solutions provide several
important advantages to semiconductor manufacturers, enabling manufacturers to:

| |   |                                                                                                                                                                                                                                         
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | utilize the
  process equipment wafer handling system to allow measurement of the sample
  wafers while processing other wafers and avoid the need for the costly
  additional wafer handling required by stand-alone metrology systems;

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| |   |                                                                                                                                                                         
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | perform the
  measurements without removing the wafer from the process equipment,
  increasing the efficiency of the process and decreasing the risk of
  contamination;
| |   |                                                                                                                                                                         
| |  | reduce
  capital costs of the fabrication facility by increasing overall equipment
  efficiency and reducing labor costs and necessary clean room area;                 
| |   |                                                                                                                                                                         
| |  | reduce the
  amount of time required to qualify process equipment that is usually idle
  during qualification steps, thus, minimizing costly equipment down-time;       
| |   |                                                                                                                                                                         
| |  | reduce the
  number of test wafers; and                                                                                                                                 
| |   |                                                                                                                                                                         
| |  | detect
  processing errors as early as possible.                                                                                                                        

We
believe that as semiconductor manufacturers demand greater efficiency from
their manufacturing equipment, process equipment manufacturers will increasingly
seek to offer their customers integrated metrology in their tools to lower
costs and increase overall efficiency. We believe the drive toward more
efficient manufacturing operations in the face of increasing complexity will
continue the trend of adopting integrated metrology solutions such as those we
offer to multiple processes.

Stand-alone
Metrology

We
believe that our integrated metrology systems offer significant advantages over
traditional stand-alone systems. We do, however, believe that a significant
number of semiconductor manufacturers will continue to primarily use
stand-alone metrology equipment for most of their manufacturing processes. In
order to be able to serve all the metrology needs of our customers, whether
integrated or stand-alone, we plan to leverage our position in integrated
metrology to increase our offerings and market penetration for stand-alone
systems.

As
a result of the ever changing semiconductor manufacturing process and
accompanying process control needs, we have begun to develop a new process
control equipment concept. Under this concept, the same basic metrology will be
used in different configurations, depending upon customer demands. For example,
the same metrology module could be used as an integrated system inside the
process equipment, as stand-alone systems or in metrology cluster tools. This
would allow for easy customization of metrology solutions for any given process
and would allow multiple metrology solutions to be combined in a single
platform to answer all process needs. As we envision it, this new concept will
allow semiconductor manufacturers unparalleled flexibility, upgradeability and
affordability in both stand-alone and integrated forms. As technology life
cycles continue to decrease, flexibility and upgradeability will become even
more important. While we have not yet fully developed our new process equipment
concept, we anticipate that we will begin offering new products based on the
concept within the next 12 months. We cannot assure you, however, that we will
be able to meet this anticipated schedule or that, if introduced, these
products will be accepted by the market and purchased by customers in amounts
sufficient to generate significant revenues or any profits.

Our Technology

We
believe that our technological and engineering expertise and research and
development capabilities allow us to develop and offer new products and
technologies to meet the ever-changing demands of the semiconductor industry.
We have applied our technological and engineering expertise to develop a wide
range of integrated and stand-alone products for the CMP, copper CMP, etch and
lithography processes. Because of our open architecture policy, our integrated
metrology solutions can work with most models of CMP and etch tools made by the
major process equipment manufacturers, for both 200 mm and 300 mm applications.
In addition, to our knowledge, only our integrated metrology systems can be
used to retrofit existing 200 mm process equipment, giving us a significant
advantage over our competitors.

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Our
suite of technological capabilities includes:

| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Ellipsometry.Ellipsometry is a non-contact,
  non-destructive optical measuring technique used to measure very accurately the
  thickness and other properties of transparent thin films. When a surface is
  exposed to a polarized light laser, Ellipsometers measure the change in the
  reflected lights polarization. By using multiple light angles and multiple
  wavelengths, Ellipsometry can provide accurate and reliable measurement of a
  wide range of film thicknesses, film materials and film stacks.                                                                   
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |  | Broadband Spectrophotometry. Our broadband
  Spectrophotometry capabilities range from deep ultraviolet to near infrared.
  This technology enables fast, accurate and small spot size film thickness
  measurement in large range of applications on a very cost effective basis,
  both as an integrated system and as a stand-alone system.                                                                                                                                                                                                                                             
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |  | Scatterometry. Our Scatterometry systems are
  based on our broadband Spectrophotometry. These systems use fully polarized
  deep ultraviolet to near-infrared spectral light source. This technology
  enables fast and cost effective system development. Scatterometry provides
  two and three dimensional characterization of very fine geometries on
  patterned product wafers. These profiling and critical dimension capabilities
  are key enablers of advanced process control, allowing almost real time
  metrology of the most advanced design rule, down to 65 nm and below.
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |  | Imaging and image processing. This
  technology has three different applications: 1) navigating on product wafers
  to perform measurement on selected very small sites; 2) detecting defects on
  product wafers after critical process steps, such as lithography and etch;
  and 3) measurement of the accuracy of registration between two layers
  (overlay measurement), mostly used in lithography.                                                                                                                                                                                 

The
measurement channels that we use in our metrology products are unique and
protected by patented intellectual property. Our measurement channels include:
polarized normal incidence spectral reflectometer/ellipsometer; multi-angle
oblique incidence spectral ellipsometer; and multi-focal image overlay
microscope. In addition, we are developing additional measurement channels
including: multi-angle, multi-wavelength, null ellipsometer; eddy current
micro-probe and phase imaging profilometer. In addition to these proprietary
measurement channels, we are also seeking to acquire new measurement channels
from third parties.

Throughout
our history, we have been a technological leader in the integrated metrology
field. We were the first to offer integrated metrology solutions for
semiconductor manufacturers and are the only provider of integrated metrology
solutions that can measure wafers in water, which allows for more efficient and
accurate metrology. Furthermore, because our systems are small enough to fit
inside wafer fabrication equipment, to our knowledge, only our metrology
solutions can be used to retrofit older 200 mm systems. Our systems have also
been recognized by the industry. In 2004, we received the prestigious Editors
Choice Best Product Award from Semiconductor International magazine for our
NovaScan 2020Cu, 3030Cu Copper CMP process monitoring.

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Products

Our
products include metrology systems for thin film measurement in chemical
mechanical polishing and chemical vapor deposition applications; optical
topography systems for use in post-copper chemical mechanical polishing
applications; and optical critical dimension systems for lithography and etch
applications. Our integrated  thickness
monitoring system for chemical mechanical polishing processing control enables
wafer-to-wafer closed loop control. We offer several models of this integrated
thickness monitoring systems, depending on polisher type and end-user
requirements. These metrology systems address a broad range of metrology
requirements of our end-user and process equipment manufacturer customers. Both
our integrated and stand-alone systems incorporate patented optical scanning,
dynamic auto-focus, unique pattern recognition for arbitrarily oriented wafers
and proprietary algorithms for in-water measuring of two layers simultaneously.
We offer several different product models that are tailored to both
conventional chemical mechanical polishing equipment as well as to newer, high
throughput polishers. Following is a summary of our products.

Thin Film Process Control

| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | The NovaScan
  840 combines high-speed measurement and effective handling, enabling
  measurement of wafers both before and after polishing. While we no longer
  market this system, this system and prior generations were our main revenue
  source in 2001 and prior years.                                                                                                                                                                                                                                                                                                                                                  
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| |  | The NovaScan
  2020 and 2040 are the second generation of integrated thickness monitoring
  systems with enhanced spectral range, responding to the needs of the industry
  for emerging chemical mechanical polishing high-end applications of thin
  films and complex layer stacks. The 2020 model was introduced to the market
  in the end of 2000, and since then has replaced the NovaScan 840 and
  accounted for the majority of our sales for 200 mm production lines. The
  NovaScan 2040 was introduced in 2002 and is the fastest integrated film
  thickness 200 mm measurement system in the market today.        
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| |  | The NovaScan
  3030 and 3060 are the second generation of the 300mm measuring system, with
  improved optics and motion system enabling high speed measurement, and with
  broad spectral rage (ultraviolet to infrared) allowing accurate measurements
  on complex structures and thin film layers. The 3030 model was introduced to
  the market in 2001 and since then has replaced the NovaScan 3000 and accounts
  for the major portion of our sales for 300 mm production lines. The NovaScan
  3060 was introduced in 2002 and is the fastest integrated film thickness 300
  mm measurement system in the market today.
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| |  | The NovaScan
  2020Cu has the same basic platform as the NovaScan 2040, with additional
  hardware and software improvements, enabling the system to answer the unique
  requirements of copper chemical mechanical polishing monitoring. The system
  went through several beta tests during 2001 and 2002 and was released for
  sale in the beginning of 2003. This product did not generate significant
  revenues in 2004 or 2005, and we do not expect it to generate significant
  revenues in the following years.                                                                                                       
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| |  | The NovaScan
  3030Cu has same basic platform as the NovaScan 3030, with additional hardware
  and software improvements, enabling the system to answer the unique
  requirements of 300 mm copper CMP monitoring. The system went through
  field-testing during 2002 and was released for sale in the beginning of 2003.
  This product generated approximately 10% of our revenues in 2005 and we
  currently do not expect it to generate a significantly higher portion of our
  revenues in the coming years.                                                                                                              
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| |  | The NovaScan
  840CVD system is a 200 mm integrated metrology vacuum chemical vapor
  deposition measurement system, measuring different layers in the chemical
  vapor deposition process. Data can be fed forward to the chemical mechanical
  polishing process tool. Integration solutions were developed for different
  process equipment. The system was introduced to the market in the end of 2000
  and several units have been sold. However, we do not expect to sell a
  significant number of these systems in the future.                                                                                         
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| |  | The NovaScan
  3090 CMP system is a scatterometry-based system for the chemical mechanical
  polishing metrology needs measuring thin films thicknesses in one, two or
  three dimensions. The system went through field-testing and was released for
  sale in 2005. We expect this system to account for a significant portion of
  our revenues in 2006.                                                                                                                                                                                                                                                                      
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| |  | The NovaScan
  3090 CD system is a scatterometry-based system for measuring the critical
  dimensions (CD) and profiling lines and trenches on 200 mm and 300 mm wafers.
  The system went through field-testing during 2003 and was released for sale
  in 2004. The systems are sold as integrated metrology systems and as stand-alone
  systems with third-party automation modules.                                                                                                                                                                                                                                         

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| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | The NovaScan
  3090 SA is similar in performance to the NovaScan 3090 CD, providing full two
  and three dimension profiling capabilities in a stand-alone configuration.
  The systems are utilized in lithography, etch, thin film deposition and
  chemical mechanical polishing process. The system was released for sale in
  2005.                                                                                                                           
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| |  | A closed
  loop control option for the NovaScan systems delivers reliable, highly
  automated wafer-to-wafer uniformity over chemical mechanical polishing
  manufacturing processes. The thickness data of every processed wafer is
  obtained and process parameters are fed back to adjust the next wafer polish.                                                                                                                                               
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| |  | NovaNet is a
  highly sophisticated computer network, connecting all NovaScan systems on a
  factory floor. The network is managed by a dedicated server, running with
  proprietary software developed by Nova, and insuring safe recipe distribution
  and recipe integrity across the factory. The NovaNet also includes a report
  generator (NSA) that allows the creation of reports from all the systems
  connected and allows programmable cross sections.

While
we continue to emphasize our integrated metrology solutions, we offer our
products as stand-alone equipment as well, thereby significantly expanding our
potential customer base. Revenues from stand-alone systems, however, were not a
significant portion of our revenues in 2005. Furthermore, our revenues remain substantially dependent on sales of our
CMP product line.

Research and Development

We
have assembled a core team of experienced scientists and engineers who are
highly skilled in their particular field or discipline. Our research and
development core competencies, technologies and disciplines are in thin
film metrology, and include measurement instruments, optical
modeling, image acquisition, pattern recognition, equipment integration
and fab automation. Our research and development staff consists of about
90 highly skilled members, including independent contractors. Our staff
includes 25 scientists holding Ph.D. degrees and about
30 persons holding M.S. degrees. Since June 2003, our research and
development operations have been certified as ISO9001/2000 quality
standard.

The
process control market is characterized by continuous technological development
and product innovations. We believe that the rapid and ongoing development of
new products and enhancements to our existing product line is critical to our
success. Accordingly, we devote a significant portion of our technical,
management and financial resources to developing new applications and emerging
technologies. In 2003, 2004 and 2005, our research and development expenses,
net of participation by the Office of the Chief Scientist, were $8.6 million,
$8.7 million and $9.3 million, respectively, representing 32%, 24%, and 31% of
our respective total revenues for those years. We anticipate that our research
and development expenses, net, will be approximately $9 million in 2006.

Our
research and development policy is based on a structured process of initiating
new projects and on-going review of existing development projects. Our vision
is to continue to be a market leader in the semiconductor process control
market and our research and development policies and activities are designed to
support this vision. Our launch of new development projects is based on market
requirement specifications, generated through our marketing activities and
research on customer needs, followed by a proposed detailed business plan, a
detailed development plan with milestones, risk analysis, profit and loss model
goals and required budget. Each development project is monitored through a
structured process, including design reviews and project management reviews.

Intellectual Property

Our
success depends in part upon our ability to protect our intellectual property.
We, therefore, have an extensive program devoted to seeking patent protection
for our inventions and discoveries that we believe will provide us with
competitive advantages. We have been granted 49 U.S. patents and 29 non-U.S.
patents and hold an exclusive license to one U. S. patent. The U.S. patents we
hold have expiration dates ranging from 2014 to 2023. We also have 25 U.S.
patent applications pending and more than 60 applications pending in other
countries. Our patents and applications principally cover various aspects of
optical measurement systems and methods, integrated process control
implementation concepts, and optical, opto-mechanical and mechanical design. We
have also registered four trademarks in the United States and two trademarks in
countries other than the United States.

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To
protect our proprietary rights, we also rely on a combination of copyrights,
trademarks, trade secret laws, contractual provisions and licenses. Our
copyrights include software copyrights. We also enter into confidentiality
agreements with our employees and some of our consultants and customers, and
seek to control access to and distribution of our proprietary information, such
as our proprietary algorithms.

While
we attempt to protect our intellectual property through patents, copyrights and
non-disclosure and confidentiality agreements, we may not be able to adequately
protect our technology. Competitors may be able to develop similar technology
independently or design around our patents and, despite our efforts, our trade
secrets may be disclosed to others. Furthermore, the laws of countries other
than the U.S. may not protect our intellectual property to the same extent as
the laws in the U.S. We also cannot assure that: (i) our pending patent
applications will be approved; (ii) any patents granted will be broad enough to
protect our technology or provide us with competitive advantages or will not be
successfully challenged or invalidated by third parties; or (iii) that the
patents of others will not have an adverse effect on our ability to do
business. We may also have to commence legal proceedings against third parties
to protect our intellectual property, as we have done recently.

In
March 2005, we filed a civil action in the United States District Court for the
Northern District of California against Nanometrics Inc. seeking to enforce our
United States Patent No. 6,752,689. This patent relates to
an integrated optical measuring system. In the civil action, we seek
an injunction against Nanometrics from infringing patent No. 6,752,689,
monetary damages for willful infringement, attorneys fees and costs and expenses.
Nanometrics has filed a counterclaim seeking judgment declaring the patent
invalid, that Nanometrics does not infringe the patent and awarding Nanometrics
costs and fees.

While
we believe our patent is valid and enforceable, if the patent is invalidated,
our competitors will likely be able to freely use the technology subject to the
patent and our competitive position could be harmed. We cannot predict the
outcome of the litigation or the extent of any harm we may suffer if our patent
is declared invalid. Furthermore, we have incurred and it is likely that we
will continue to incur, substantial costs which may be material. In addition,
the litigation may divert managements time and attention from other matters.

In
April 2006 Nanometrics filed a civil action in the United States District Court
for the Northern District of California against us and our wholly-owned
subsidiary, Nova Inc. alleging infringement of its United States Patent No.
Re:34,783. This patent relates to measurements reflectance of materials.
In the civil action, Nanometrics seeks an injunction monetary damages for
willful infringement, attorneys fees, and costs and expenses. We filed our
answer and counterclaim in May 2006, seeking a declaration that Nanometrics
patent is invalid and unenforceable, and that neither us nor Nova Inc. infringe
the patent. While we believe that Nanometrics claims are without merit and
intend to aggressively defend against them, we cannot predict the outcome of
the litigation. If the outcome of the litigation is adverse to us, we may
become subject to significant liabilities, including treble damages; be
required to seek licenses from Nanometrics or third parties, which licenses may
not be available on reasonable terms or at all, or be prevented from selling
our products. Any adverse outcome could be material. Furthermore, we have
incurred and it is likely that we will continue to incur, substantial costs in
connection with this litigation which may be material. In addition, the litigation
may divert managements time and attention from other matters.

From
time to time, we receive communications from others asserting that our products
infringe or may infringe their intellectual property rights. Typically, our
in-house patent counsel investigates these matters and, where appropriate,
retains outside counsel to provide assistance. Other than the litigation with
Nanometrics described above we are not presently involved in any material legal
proceeds in which a third party has asserted that we have violated their
intellectual property rights.If, however, we become involved in any
such litigation and its outcome is adverse to us, it may result in a loss of
proprietary rights, subject us to significant liabilities, including treble
damages in some instances, require us to seek licenses from third parties which
may not be available on reasonable terms or at all, or prevent us from selling
our products. Furthermore, any litigation relating to intellectual property,
even if we are ultimately successful, could result in substantial costs and
diversion of time and effort by our management. This in and of itself could
have an negative impact on us.

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While, other than the litigation with
Nanometrics described above, we are not
currently involved in any material legal proceedings in which a third party has
asserted that we have violated their intellectual property rights, we have
become aware of a United States patent held by a competitor, which may be
interpreted to cover some aspects of the products we sell in the United States.
Nonetheless, we have not received any indications of intention to enforce this
patent or any notice from the competitor with respect to this patent. In
addition, the patent is being reexamined by the United States Patent and
Trademark Office (USPTO), is unenforceable at this time, and may or may not
survive the reexamination. If the USPTO decides to allow the patent to stand in
some reexamined form, it is possible that the competitor could seek to enforce
the patent rights against certain of our products sold in the United States,
seeking damages, an injunction, or requiring us to pay royalties for a license.
While we believe that we would be successful in any litigation seeking to
enforce those patent rights, the ultimate outcome of any litigation or other
legal proceedings cannot be predicted.

For
additional information regarding our intellectual property, seeOur
Technology starting on page 18.

Our Customers, Sales
and Marketing

Our
two pronged, integrated sales and marketing strategy involves marketing our
products directly to semiconductor manufacturers in addition to process
equipment manufacturers in order to create demand for our products. We believe
that the pricing structure of our NovaReady integration package enables process
equipment manufacturers to increase their margins, and that the features and
benefits of our systems can improve equipment yields, overall equipment
efficiency and increase productivity, creating an incentive for process
equipment manufacturers to promote our products to semiconductor manufacturers.
At the same time, we believe that semiconductor manufacturers, eager to improve
their own margins through increased factory throughput and yield improvements,
will demand that the equipment they employ incorporate or use metrology systems
such as those we manufacture. We believe that by marketing directly to end
users as well as to process equipment manufacturers, we are able to ensure that
both parties are aware of the wide range of benefits that our products can
deliver, and that we are able to continuously enhance our products with
functionality demanded by these two distinct types of customers.

To
further enhance our marketing efforts, we have established a system of
integrated sales and support activities with key process equipment
manufacturers. This allows us to provide comprehensive and long-term
application support directly to semiconductor manufacturers. We expect to
continue to add new process equipment manufacturers as partners as we introduce
new integrated process control systems that can be integrated with different
types of equipment.

We
also seek to establish and maintain close and mutually beneficial relationships
with our customers by consistently providing them with a high level of service,
support and new capabilities. We have established a global network of direct
sales and marketing, customer service and applications support offices. We
maintain sales, service or applications offices in Europe, Israel, Japan,
Korea, Singapore, Taiwan, and the U.S., with a total staff of 70 people. These
offices provide highly qualified application support specialists, training to
process equipment manufacturer customers and end users, marketing,
demonstrations and evaluations, spare parts hubs and sales and support
engineers.

We
serve all sectors of the integrated circuit manufacturing industry including
logic, ASIC, foundries and memory manufactures. Our end user and process
equipment manufacturer customers are located in different countries, including
Japan, Korea, Singapore, Taiwan, the U.S. and various European countries.

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The
table below describes the distribution of our total revenues, from systems and
services, according to the geographic location of the actual installation of
our systems in end-user sites:

| |              |                         |   |        |  |      |        |  |   |        | 
| | ------------ | ----------------------- | - | ------ |  | ---- | ------ |  | - | ------ | 
| |              | Year ended December 31, |  
| |              |                         |  
| |              | 2003                    |   | 2004   |  | 2005 |       
| |              |                         |   |        |  |      |       
| |              |                         |   |        |  |      |       
| |              | (in thousands)          |  
| |              |                         |   |        |  |      |        |  |   |        | 
| | U.S.         |                         | $ | 9,422  |  | $    | 15,943 |  | $ | 9,945  | 
| | Europe       |                         |   | 5,360  |  |      | 4,905  |  |   | 1,990  | 
| | Japan        |                         |   | 5,953  |  |      | 6,132  |  |   | 6,666  | 
| | Asia-Pacific |                         |   | 5,953  |  |      | 9,826  |  |   | 11,541 | 
| |              |                         |   |        |  |      |        |  |   |        | 
| | Total        |                         | $ | 26,688 |  | $    | 36,806 |  | $ | 30,142 | 
| |              |                         |   |        |  |      |        |  |   |        | 

The
semiconductor industry is dominated by a small number of large companies. As a
result, while our overall customer base is diverse, our sales are highly
concentrated among a relatively small number of customers. The following table
indicates the percentage of our total revenues derived from sales to our five
largest customers and the range of these revenues from these customers for the
periods indicated.

| |                                                 |  |                           |        |      |  |        |  |      |        |  |  |        | 
| | ----------------------------------------------- |  | ------------------------- | ------ | ---- |  | ------ |  | ---- | ------ |  |  | ------ | 
| |                                                 |  | Year ended
  December 31, |       
| |                                                 |  |                           |       
| |                                                 |  | 2002                      |        | 2003 |  | 2004   |  | 2005 |       
| |                                                 |  |                           |        |      |  |        |  |      |       
| | Total
  revenues from five largest customers    |  |                           | 86%    |      |  | 87%    |  |      | 82%    |  |  | 83%    | 
| |                                                 |  |                           |        |      |  |        |  |      |        |  |  |        | 
| | Range of
  revenues from five largest customers |  |                           | 4%-30% |      |  | 3%-36% |  |      | 3%-45% |  |  | 2%-48% | 

We
anticipate that our revenues will continue to depend on a limited number of
major customers, although the companies considered to be our major customers
and the percentage of our revenue represented by each major customer may vary
from year to year. As our customer base is highly concentrated, if any of our
customers becomes insolvent or has difficulties meeting its financial
obligations to us, we may suffer losses that may be material in amount. A loss
of any of our major customers may likewise cause us to suffer a material
decrease in sales and revenue.

The
highly competitive nature of the market for semiconductor capital equipment
affects our ability to successfully implement our marketing and sale efforts.
Competitive factors in the market for integrated process control systems
include technological leadership, system performance, ease of use, reliability,
cost of ownership, technical support and customer relationships. For integrated
process control, an adequate business model, internal organization and unique
process equipment manufacturer agreements and partnerships are also significant
factors. We believe we compete favorably on the basis of these factors in the
markets we serve.

Our
current integrated products primarily compete with products manufactured by
Nanometrics Inc. While we believe that in 2006 the successful launch of our
NovaScan 3090 family of products will allow us to compete effectively, we
expect our integrated products to face intense competition in 2006 and in the
coming years. In the scatterometry field, which is a new application field in
the semiconductor industry, used in CMP and etch processes, we face intense
competition in both integrated and stand-alone metrology, from several
companies.

Manufacturing

In
order to leverage the relatively high volume of integrated systems we
manufacture and to decrease production costs, we continue to focus our internal
manufacturing activities on processes that add significant value or require
unique technology or specialized knowledge and outsource others. Our
manufacturing operations received the ISO 9002 quality mark by an international
certification institute in October 1999. Since then, we have upgraded our
quality systems to conform to ISO 9001/2000 requirements.

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Our
principal manufacturing activities include assembly, integration, final testing
and calibration. Our production activities are conducted in our manufacturing
and service facility in Israel. We rely and expect to continue to rely on
subcontractors and turnkey suppliers to fabricate components, build assemblies
and perform other non-core activities in a cost-effective manner. While we use
standard components and subassemblies wherever possible, most mechanical parts,
metal fabrications and critical components used in our products are engineered
and manufactured to our specifications. A small portion of these components and
subassemblies are obtained from a limited group of suppliers, and occasionally
from a single source supplier.

We
have the capacity to produce up to 80 systems per quarter in our current
facilities. Currently, we are operating at approximately 70% of that capacity.

We
have only one manufacturing facility, which is located in Ness-Ziona, Israel.
Any event affecting this facility, including natural disaster, labor stoppages
or armed conflict, may disrupt or indefinitely discontinue our manufacturing
capabilities and could significantly impair our ability to fulfill orders and
generate revenues.

Our Subsidiaries

Our
subsidiaries and the countries of their incorporation are as follows:

|                                              |  |                           
|--------------------------------------------- |  | --------------------------
|Name of
  subsidiary                          |  | Country of
  incorporation
|                                              |  |                           
|                                              |  |                           
|Nova Measuring Instruments
  Inc.             |  | Delaware, USA             
|Nova Measuring Instruments
  K.K.             |  | Japan                     
|Nova Measuring Instruments
  Taiwan Ltd.      |  | Taiwan                    
|Nova Measuring Instruments
  Netherlands B.V. |  | Netherlands               

Capital Expenditures

Our
capital expenditures are primarily for network infrastructure, computer
hardware and software, leasehold improvements of our facilities and system
demonstration tools. None of these assets are held as collateral or guarantee
other obligations. For additional information on our capital expenditures, see
Liquidity and Capital Resources starting on page 34.

Properties and
Equipment

Our
main facilities, located in Ness-Ziona, Israel, occupy approximately 5,500
square meters, including: approximately 1,300 square meters of production
facilities, approximately 3,000 square meters of research and development
offices (including approximately 300 square meters of laboratories) and
approximately 1,200 square meters of headquarters, sales and marketing, service
and support and administration facilities. Our current lease commitment
relating to our facilities in Israel expires at the end of 2007.

Our
U.S. subsidiary leases approximately 400 square meters in Arizona and 300
square meters in Santa Clara for use as a pre-sale and support facility. Our
Japanese and Taiwan subsidiaries lease approximately 200 and 300 square meters
for use as a service and pre-sale facility, respectively. At the end of 2005
our Netherlands subsidiary closed its offices which occupied approximately 100
square meters.

We
believe that our facilities and equipment are in good operating condition and
adequate for their present usage.

Government Regulation

For
information relating to the impact of certain government regulations on our
business, seeConditional Grants from the Office of the Chief Scientist starting
on page 35.

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Item 5. Operating and Financial Review and
Prospects

Information
in this Operating Review and Financial Prospects Section should be read in
conjunction with our Consolidated Financial Statements and notes thereto which
are included elsewhere in this report.

Executive Overview

We
are a worldwide leading designer, developer and producer of integrated
metrology systems for the semiconductor manufacturing industry and a leading
designer, developer and producer of stand-alone metrology systems for the
semiconductor industry. Our metrology systems are used to take precise
measurements of semiconductors during the manufacturing process to control the
manufacturing process and increase the productivity of the manufacturing
equipment. We market and sell our metrology systems to semiconductor process
equipment manufacturers and directly to semiconductor manufacturers.

Our
business is greatly affected by the level of spending on capital equipment by
semiconductor manufacturers. Capital expenditures by semiconductor
manufacturers tend to be cyclical in nature and depend on numerous factors,
many of which are beyond our control. Factors affecting the semiconductor
industry, which are beyond our control, include general economic conditions
throughout the world and the demand and perceived demand for semiconductors. In
addition, demand for our products and services is affected by the timing of new
product announcements and releases by us and our competitors, market acceptance
of our new or enhanced products and changes or advances in semiconductor design
or manufacturing processes.

In
2003, demand for semiconductors started to increase and, as a result, demand
for capital equipment by semiconductor manufacturers also increased. This
increased demand continued in 2004. Accordingly, our financial results for 2003
and 2004 improved. In 2005, however, demand for capital equipment decreased and
the decrease is reflected in our financial results for 2005, in which we
suffered steeper losses than in 2003 and 2004. As the industry began an upcycle
toward the end of 2005 and current market research forecasts a growth of about
10% in the semiconductor capital equipment market for 2006, we are hopeful that
we will be able to increase revenues in 2006. However, we cannot predict with
certainty how long the industry upturn will last and whether we will be able to
increase our sales and revenues.

We
derive our revenues principally from sales of our metrology systems and
services relating to our systems. In 2005, product sales produced 72.9% of our
total revenues and services produced 27.1%. Presently, we have no long-term
debt and continue to finance our operations mainly from the proceeds of our
initial public offering in 2000. As of the end of 2005, we had working capital
of $14.8 million, including cash and cash equivalents, short-term deposits and
held to maturity securities of $22.8 million, and no long-term debt.

From
quarter to quarter and from year to year, our revenues can vary significantly
for a number of reasons. Importantly, we do not have long-term or multi-unit
purchase contracts with our customers. Therefore, while most of our customers
have purchased multiple systems from us and we anticipate that our customers
will continue to do so, our customers can determine at any time to stop doing
business with us. In addition, primarily because the semiconductor industry is
dominated by a small number of large companies, our customer base is
concentrated among a limited number of customers. A loss of any single customer
could cause our revenues to decrease by a material amount. Furthermore, because
our systems range in price from $100,000 to over $600,000, the loss of
relatively few sales could also cause our revenue to decrease by a material
amount. Our service revenues, which tend to be more predictable and less
subject to wide fluctuations, tend to help decrease volatility in our earnings.

Our
service organization is operated on a profit and loss basis and is measured as a
cost center in each territory and on a global basis. The objectives of our
service organization are defined and measured by: customer satisfaction;
quality parameters, such as time to repair and mean time between failures; and
by profit and loss criteria. The service organization provides support to all
products we sell, during both the warranty period and the post warranty period.

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When
evaluating the performance of the Company, our management tends to focus on
several financial metrics and several qualitative areas such as: warranty cost
per system and warranty costs as a percentage of sale price; costs of
production and costs of production as a percentage of sales; inventory as a
percentage of yearly sales; days sales outstanding; and the mixture of our
sales and geographical distribution of installations of our systems at end
users sites compared to industry capital equipment trends. In 2005 and 2004,
warranty costs amounted to approximately 10% of sale price. Factors that affect
warranty costs include the number of systems installed in a specific site or
territory and the maturity of the products. Costs of production include
materials, labor, and write-off per product during product life time, and
ranged from 34% to 44%
of the sale price in 2005, depending on the product. Factors that affect cost
of production include sales volume, product configuration, product maturity,
and actual sale price. Our average inventory levels in 2005 and 2004 were approximately 21%
and 16% of yearly
sales, respectively. In 2005, average days sales outstanding for total revenues
were 65, and ranged between 57 and 71 days over the four quarters of 2005.
Geographical distribution analysis of installation at end users sites of our
products reveals an increase in the installation of our products in Japan from
15% of sales in 2004 to 22% in 2005 and in Asia-Pacific (excluding Japan) from
32% of sales in 2004 to 38% in 2005. This trend is in line with the industry
capital equipment trend of higher investments in Japan and in the Asia-Pacific
region in 2004 and 2005. In 2006, the Company intends to continue to focus on
these regions and seek to increase its market share in strategic accounts
sites.

Significant Events in 2005 and Outlook for
2006

For
Nova, the most significant event in 2005 was the release of the new NovaScan
3090 product family following a delay of about six months. As a result of the
delayed introduction of the new NovaScan 3090, we lost some of our market share
to a competitor and suffered a decrease in our revenue. In addition, in 2004
and 2005, our relationship and integration with a major equipment manufacturer
for the etch process led to several joint evaluation processes in strategic
accounts creating the potential for multiple systems sales in the etch segment
in future years.

In
the first half of 2005, we saw a mild slowdown in the semiconductor equipment
industry. This trend, together with the loss of three strategic end user
accounts to our competition, were the main reasons for our 50% revenues decline
in the first quarter of 2005 compared to the fourth quarter of 2004. Recent
semiconductor and industry projections, however, indicate the industry is
expected to return to growth in 2006. If the industry returns to growth, we
believe semiconductor manufacturers will seek to add capacity and accelerate
production, resulting in increased demand for capital equipment, including
metrology systems such as those we sell. We are also selling our NovaScan 3090
products in several strategic accounts and we expect to regain market share in
2006.

Other
trends in the industry include the move toward more complex semiconductor
devices and the adoption of more sophisticated manufacturing techniques. We
believe these trends are positive developments for the semiconductor metrology
market because, as semiconductors and their manufacture become more complex and
sophisticated, manufacturers will increasingly look to make their operations
more efficient. Metrology systems can help deliver that efficiency. For
additional information on industry trends, see Item 4 Information on the
Company starting on page 12.

Nova
will focus in 2006 on continuing development of its current chemical mechanical
polishing (CMP), copper CMP and optical critical dimension systems as well as
investing in the products and technologies included in its long-term strategy.
Over the next three years, Nova anticipates introducing future generations of
its current products and new product to address the advancing technology trends
toward feature sizes of 45 nm and below and new processes and materials. We
believe that in 2006 our opportunities will most likely come from the increased
need for monitoring and control resulting from decreasing feature sizes, and
the accelerating move to 300 mm equipment and new materials. The main
challenges and risks we see are to be on time with the right process control
solutions to meet the needs of our existing customers and new customers. In
order to address these risk and challenges, we are working closely with leading
customers development process groups and with the leading process equipment
manufacturers. The purpose of working closely with customers and process
equipment manufacturers is to receive from them as early as possible
information and feedback on the metrology and process needs of the upcoming new
manufacturing processes and materials. We believe receiving this information as
early as possible will assist us in developing metrology solutions to meet the new
needs of the semiconductor industry. In tandem with this type of long term
development, our ongoing marketing activity supports our current products with
short term improvements to answer the customers ongoing needs and to make
required changes.

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Currently,
our main revenue generator is our oxide CMP product line and sales of our oxide
CMP product line are affected by the total number of process tools sold in this
segment. In years prior to 2003, the oxide CMP represented more than 50% of the
entire CMP equipment market. In 2004, this percentage decreased and we expect
it to continue to decrease as copper CMP equipment is expected to dominate the
CMP equipment market. We can not foresee what will ultimately be the process
control needs for copper CMP, and whether the products and solutions we will
bring to market for the copper CMP market will be accepted in the market.

Critical Accounting Policies

Our
discussion and analysis of our financial condition and results of operations
are based upon our Consolidated Financial Statements, which have been prepared
in accordance with accounting principals generally accepted in the United
States of America. We believe the following critical accounting policies, among
others, affect our more significant judgments and estimates used the
preparation of our Consolidated Financial Statements.

Use of estimates - General

The
preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.

Revenue recognition

We
recognize revenues upon the shipment of our products to the customer or
provision of support service, provided that persuasive evidence of an
arrangement exists, title has transferred, the price is fixed, collection of
resulting receivables is probable and there are no remaining significant
obligations.In
cases of arrangements with multiple deliverables, revenue is typically
recognized upon shipment, if collection of the resulting receivable is
probable, the fee is fixed or determinable, and vendor-specific objective
evidence exists to allocate a portion of the total fee to any undelivered
elements of the arrangement. Such undelivered elements in these arrangements
typically consist of services and/or upgrades. If vendor-specific objective
evidence does not exist for the undelivered elements of the arrangement, all
revenue is deferred until such evidence does exist, or until all elements are
delivered, whichever is earlier. When transactions involve newly introduced
products or when customers specify acceptance criteria that cannot be
demonstrated prior to the shipment, we defer the relevant revenues.

Service
contracts (which sometimes include application support) generally specify fixed
payment amounts for periods longer than one month, and are recognized on a
straight line basis over the term of the contract. Revenue from sale of spare
parts is usually recognized upon shipment of the parts.

Allowances for doubtful accounts

We
review on an on-going basis the need for allowances for doubtful accounts for
estimated losses resulting from the inability of our customers to make required
payments. When determining what allowance, if any, to make for doubtful
accounts, we review many factors, including our history of relatively few
write-offs, customer relationships and customers creditworthiness. Based on
this review, we estimate the amount of accounts receivable, if any, we may be
unable to collect and allowances for doubtful accounts may be required. To
date, based upon managements review, no allowance for doubtful accounts was
deemed necessary. If the financial condition of our customers were to
deteriorate, their ability to make payments could be impaired and our estimates
could prove to be inaccurate. If significant, allowances for doubtful accounts
could have a material adverse effect on our financial results.

Warranty provisions

We
provide for the estimated cost of product warranties at the time revenue is
recognized. While we are engaged in extensive product quality programs and
processes, including actively monitoring and evaluating the quality of our
component suppliers, our warranty obligations are affected by product failure
rates, material usage and service delivery costs incurred in correcting product
failures at our locations or at customer sites. Should actual product failure
rates, material usage or service delivery costs differ from our estimates,
revisions to the estimated warranty liability may be required.

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Inventories write-off

We
value our inventory at the lower of the actual cost or the current estimated
market value of the inventory. We regularly review inventory quantities on hand
and record a provision for excess and obsolete inventory based primarily on our
estimated forecast of product demand and production requirements for the next
twelve months. As demonstrated during 2001, demand for our products can
fluctuate significantly. A significant increase in the demand for our products
could result in a short-term increase in inventory purchases while a
significant decrease in demand could result in an increase in the amount of
excess inventory quantities on hand, which could lead to losses. In addition, our
industry is characterized by rapid technological change, frequent new product
developments, and rapid product obsolescence that could result in an increase
in the amount of obsolete inventory quantities on hand. Additionally, our
estimates of future product demand may prove to be inaccurate, in which case we
may have understated or overstated the provision required for excess and
obsolete inventory. In the future, if our inventory is determined to be
overvalued, we would be required to recognize such costs in our cost of goods
sold at the time of such determination. Likewise, if our inventory is
determined to be undervalued, we may have over-reported our costs of goods sold
in previous periods and would be required to recognize such additional
operating income at the time of sale. Therefore, although we make every effort
to ensure the accuracy of our forecasts of future product demand, any
significant unanticipated changes in demand or technological developments could
have a significant impact on the value of our inventory and our reported
operating results.

For
a discussion of other significant accounting policies used in the preparation
of our financial statements and recent accounting pronouncements, see Note 2 to
our Consolidated Financial Statements contained elsewhere in this report.

Operating results

Overview

A
significant portion of our revenues historically has been derived from
customers in the United States of America, and we expect that this trend will
continue, although we expect that U.S. sales as a percentage of total sales may
decrease as our total sales and sales to other geographic areas, particularly
Asia, increase. In 2003, 62% of our revenues were derived from U.S. customers,
10% were from European customers, 21% were from Japanese customers, and 7% were
from Asian (other than Japanese) customers. In 2004, 67% of our revenues were
derived from U.S. customers, 11% were from European customers, 18% were from
Japanese customers, and 4% were from Asian (other than Japanese) customers. In
2005, 66% of our revenues were derived from U.S. customers, 11% were from
European customers, 18% were from Japanese customers, and 5% were from Asian
(other than Japanese) customers.

The
table below describes the distribution of our total revenues, from systems and
services, by geographic areas of our product installations at semiconductor
manufacturing facilities. As our customers include both semiconductor
manufacturers and process equipment manufactures, this distribution is different
from the distribution of our revenues by customer location discussed in the
immediately preceding paragraph.

|             |  |      |     |      |  |      |     |   |  |  |     |   | 
|------------ |  | ---- | --- | ---- |  | ---- | --- | - |  |  | --- | - | 
|             |  | 2003 |     | 2004 |  | 2005 |    
|             |  |      |     |      |  |      |    
|USA          |  |      | 36  | %    |  |      | 41  | % |  |  | 33  | % | 
|Europe       |  |      | 20  | %    |  |      | 12  | % |  |  | 7   | % | 
|Japan        |  |      | 22  | %    |  |      | 15  | % |  |  | 22  | % | 
|Asia-Pacific |  |      | 22  | %    |  |      | 32  | % |  |  | 38  | % | 
|             |  |      |     |      |  |      |     |   |  |  |     |   | 
|Total        |  |      | 100 | %    |  |      | 100 | % |  |  | 100 | % | 

Historically,
a substantial portion of our revenues has come from a small number of
customers. In 2003, 2004 and 2005, our five largest customers accounted for
87%, 82 % and 83% of our revenues, respectively. In 2003, 2004 and 2005, our
single largest customer accounted for 36%, 45% and 48% of our revenues,
respectively. We anticipate that our revenues will continue to depend on a
limited number of major customers, although the companies considered being
major customers and the percentage of our revenue represented by each major
customer may vary from period to period. Therefore, the loss of any one of our
major customers could materially and adversely affect us.

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The
sales cycle for our systems typically ranges from three to 24 months and
depends upon the status of our systems integration with a particular
manufacture and model of process equipment, the evaluation criteria of our
customers, and the technology or application of the process. Additionally, the
rate and timing of customer orders may vary significantly from month to month
as a function of the introduction of a new type of system to a production line.
We have a relatively low backlog. Accordingly, if sales of our products do not
occur when we expect or we are unable to adjust our estimates on a timely
basis, our expenses and inventory levels may fluctuate relative to revenues and
total assets. In 2005, our inventory levels at the end of each quarter ranged
from $5.8 million to $6.9 million. We planned our 2005 inventories for sales of
200 mm systems and 300 mm systems according to our expectation that
approximately 70% of equipment sales would be for 300 mm equipment and that the
NovaScan 3060 would account for most of our sales of 300 mm systems. Actual
sales in 2005 were similar to this plan. In 2006, we anticipate proliferation
of the new NovaScan 3090 product series for the 300 mm market, and expect that
50% of our 300 mm sales will derive from NovaScan 3090 products and 50% from
NovaScan 3060 products. If our actual sales are significantly different from
our expectations, we may have to write-off some of our inventory.

We
schedule production of our systems based upon order backlog and customer
forecasts. We include in backlog only those orders to which the customer has
assigned a purchase order number and for which delivery has been specified
within 12 months. As of December 31, 2005 we had an insignificant backlog. In
general, because shipment dates may be changed and customers may cancel or
delay orders with little or no penalty, our backlog as of any particular date
may not be a reliable indicator of actual sales for any succeeding period. We
do not maintain any reserves for cancellations or variations in our customers
orders because historically cancellations and variations have been
insignificant. In addition, if a cancellation occurs, we may be able to sell
the equipment to other customers.

Our
revenues decreased 18% in 2005 following 38% increase in 2004 and 31% increase
in 2003.

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The
following table shows the relationship, expressed as a percentage, of the
listed items from our consolidated statements of operations to our total
revenues for the periods indicated:

| |                                          |  |                                                        |       |      |  |       |    |  |       |   
| | ---------------------------------------- |  | ------------------------------------------------------ | ----- | ---- |  | ----- | -- |  | ----- | --
| |                                          |  | Percentage of Total Revenues
  Year ended December 31, |      
| |                                          |  |                                                        |      
| |                                          |  | 2003                                                   |       | 2004 |  | 2005  |   
| |                                          |  |                                                        |       |      |  |       |   
| |                                          |  |                                                        |       |      |  |       |   
| | Revenues from products sale              |  |                                                        | 79.3  | %    |  | 79.5  | %  |  | 72.9  | % 
| | Revenues from services                   |  |                                                        | 20.7  | %    |  | 20.5  | %  |  | 27.1  | % 
| |                                          |  |                                                        |       |      |  |       |    |  |       |   
| | Total revenues                           |  |                                                        | 100.0 | %    |  | 100.0 | %  |  | 100.0 | % 
| |                                          |  |                                                        |       |      |  |       |    |  |       |   
| | Cost of products sale                    |  |                                                        | 38.5  | %    |  | 39.1  | %  |  | 37.9  | % 
| | Cost of services                         |  |                                                        | 23.5  | %    |  | 18.3  | %  |  | 26.2  | % 
| |                                          |  |                                                        |       |      |  |       |    |  |       |   
| | Total cost of revenues                   |  |                                                        | 62.0  | %    |  | 57.4  | %  |  | 64.1  | % 
| |                                          |  |                                                        |       |      |  |       |    |  |       |   
| | Gross profit                             |  |                                                        | 38.0  | %    |  | 42.6  | %  |  | 35.9  | % 
| |                                          |  |                                                        |       |      |  |       |    |  |       |   
| | Operating expenses:                      |  |                                                        |       |      |  |       |    |  |       |   
| | Research and development
  expenses, net |  |                                                        | 32.1  | %    |  | 23.5  | %  |  | 30.8  | % 
| | Sales and marketing
  expenses           |  |                                                        | 24.5  | %    |  | 18.1  | %  |  | 23.1  | % 
| | General and administrative
  expenses    |  |                                                        | 7.1   | %    |  | 6.3   | %  |  | 12.0  | % 
| | Other operating income                   |  |                                                        | (8.3  | )%   |  |      |    |  |      |   
| |                                          |  |                                                        |       |      |  |       |    |  |       |   
| | Total operating expenses                 |  |                                                        | 55.4  | %    |  | 47.9  | %  |  | 65.9  | % 
| |                                          |  |                                                        |       |      |  |       |    |  |       |   
| | Operating
  loss                         |  |                                                        | (17.4 | )%   |  | (5.3  | )% |  | (30.0 | )%
| |                                          |  |                                                        |       |      |  |       |    |  |       |   
| | Financing income, net                    |  |                                                        | 1.6   | %    |  | 1.4   | %  |  | 2.1   | % 
| |                                          |  |                                                        |       |      |  |       |    |  |       |   
| |                                          |  |                                                        |       |      |  |       |    |  |       |   
| | Net Loss                                 |  |                                                        | (15.8 | )%   |  | (3.9  | )% |  | (27.9 | )%

Comparison of Years Ended December 31, 2005
and 2004

Revenues.Our revenues in 2005 decreased by $6.7 million, or
18.1%, compared to 2004, with revenues attributable to product sales accounting
for $22.0 million, a decrease of $7.3 million, or 24.9%, compared to 2004, and
services accounting for $8.2 million, an increase of $0.6 million, or 8.3%,
compared to 2004. The decrease in product sales revenue in 2005 was attributed
to the competition in the 300 mm integrated metrology market, including the
delay in introduction of our NovaScan 3090 product series during 2004, and also
to the general slowdown in the semiconductor industry in the first half of
2005. Revenues from services accounted for 27.1% of total revenues in 2005, as
compared to 20.4% of total revenues in 2004. The increase in the percentage of
our revenues from services is attributed mainly to an increase in service
contracts revenues and a decrease in revenues from product sales.

We
expect that sales from our main integrated process control product line
targeting the CMP market, including dielectric and copper, will continue to
account for a substantial portion of our revenues for at least the next year,
and that the new product lines sales (integrated and stand-alone process
control systems for etch) will gradually become more significant following
wider market adoption of integrated metrology for etch. As our revenues are
largely dependent upon the sale of systems for CMP processing, any decrease in
demand for our CMP products would have a material adverse affect on us. In
2006, we expect service revenue to increase relative to 2005 as the warranty
periods for additional systems will expire and we expect customers to buy
service contracts for these systems.

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Cost
of Revenues and Gross Profit.Cost of revenues
consists of the labor, material and overhead costs of manufacturing our
systems, and the costs associated with our worldwide service and support
infrastructure. It also consists of inventory write-offs and provision for
estimated future warranty costs for systems we have sold. Our cost of revenues
attributable to product sales in 2005 was $11.4 million, a decrease of $3.0
million, or 20.8%, compared to 2004. This decrease is attributable mainly to
the decreased volume of systems sold. As a percentage of total revenues, our
cost of revenues attributable to product sales in 2005 decreased to 37.9% from
39.1% in 2004. This decrease is attributable to the mixture of products sold.
Inventory write-down did not have significant affect on our cost of goods sold
in 2005 or in 2004. Our cost of revenues attributable to services in 2005 was
$7.9 million, an increase of $1.2 million, or 17.5%, compared to 2004. This
increase is attributable to an increase in labor and material costs relating to
service contracts and installations at new customer sites.

Our
gross profit decreased by 31.2% to $10.8 million in 2005 from $15.7 million in
2004. Our gross profit represented 35.9% and 42.6% of our total revenues in
2005 and 2004, respectively. Our gross profits decrease from 2004 to 2005 is
attributable mainly to the lower volume of systems sold.

Research
and Development expenses, Net.Research and
development expenses, net, consist primarily of salaries and related expenses
and also include consulting fees, subcontracting costs, related materials and
overhead expenses, after offsetting conditional grants received or receivable
from the Office of the Chief Scientist. Our research and development expenses,
net, increased 7.3% from $8.7 million in 2004 to $9.3 million in 2005, after
offsetting conditional grants received or receivable from the Office of the
Chief Scientist of $1.9 million in 2005 and 2004, each. In 2005 research and
development expenses, net, represented 30.9% of our revenues compared to 23.5%
of our revenues in 2004, due to the significant decrease in our revenues in
2005.

Approximately
$5 million of our research and development expenses, net, in 2005, resulted
from our research and development efforts relating to the introduction of new
NovaScan 3090 models for the next manufacturing technology nodes and creating a
new technology infrastructure for scatterometry based metrology solutions. We
believe that meeting the needs of semiconductor manufacturers with respect to
the manufacture of semiconductors with features ranging from 90 nm to below 45
nm will allow us to maintain our position as a market leader in integrated
process control equipment. The balance of the research and development
expenses, net, was related to current products activities, such as engineering
improvements, new versions of software and application support and
developments, as well as to new software products for scatterometry based
metrology and also to developing a technology infrastructure for next
generation metrology tools, both for stand-alone and for integrated metrology
market segments.

Sales
and Marketing.Sales and marketing expenses are
comprised of salaries and related costs for sales and marketing personnel,
related travel expenses, and overhead. They also include commissions to our
representatives and sales personnel and royalties. Our sales and marketing
expenses increased by 6% from $6.6 million in 2004 to $7.0 million in 2005.
Sales and marketing expenses represented 23.1% and 18.1%, respectively, of our
revenues in 2005 and 2004. This increase as a percentage of revenue is related
to lower volume of revenues in 2005.

General
and Administrative. General and administrative
expenses are comprised of salaries and related expenses and other non-personnel
related expenses. Our general and administrative expenses increased 55.6% from
$2.3 million in 2004 to $3.6 million in 2005. This increase is attributed
mainly to increase of legal expenses of about $0.6 million mainly due to
Nanometrics IP infringement law suit and executives retirement payments of
about $0.3 million. General and administrative expenses represented 6.3% and
12.0% of our revenues in 2004 and 2005, respectively. The increase in general
and administrative expenses as a percentage of revenues from 2004 to 2005 is a
result of a decrease in our revenues in 2005 and the increase of our general
and administration expenses as described above.

Comparison of Years Ended December 31, 2004
and 2003

Revenues.Our revenues in 2004 increased by $10.1 million, or
37.9%, compared to 2003, with revenues attributable to product sales accounting
for $29.3 million, an increase of $8.1 million, or 38.4%, compared to 2003, and
services accounting for $7.5 million, an increase of $2.0 million, or 36.1%,
compared to 2003. The increase in product sales revenue in 2004 was attributed
mainly to the general growth in the semiconductor industry and also to a
moderate increase in revenues from our new product for copper CMP. Revenues
from services accounted for 20.5% of total revenues in 2004, as compared to
20.7% of total revenues in 2003.

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Cost
of Revenues and Gross Profit.Cost of revenues
consists of the labor, material and overhead costs of manufacturing our
systems, and the costs associated with our worldwide service and support
infrastructure. It also consists of inventory write-offs and provision for
estimated future warranty costs for systems we have sold. Our cost of revenues
attributable to product sales in 2004 was $14.4 million, an increase of $4.1
million, or 40.2%, compared to 2003. This increase is attributable mainly to
the increased volume of systems sold. As a percentage of total revenues, our
cost of revenues attributable to product sales in 2004 increased to 39.1% from
38.5% in 2003. Inventory write-down did not have significant affect on our cost
of goods sold in 2003 and in 2004. Our cost of revenues attributable to services
in 2004 was $6.7 million, an increase of $0.4 million, or 7.2%, compared to
2003.

Our
gross profit increased by 54.6% to $15.7 million in 2004 from $10.2 million in
2003. Our gross profit represented 42.6% and 38.0% of our total revenues in
2004 and 2003, respectively. Our gross profits increase from 2003 to 2004 is
attributable to the higher volume of systems sold and higher average sales
price.

Research
and Development expenses, Net.Research and
development expenses, net, consist primarily of salaries and related expenses
and also include consulting fees, subcontracting costs, related materials and
overhead expenses, after offsetting conditional grants received or receivable
from the Office of the Chief Scientist. Our research and development expenses,
net, increased 1.2% from $8.6 million in 2003 to $8.7 million in 2004, after
offsetting conditional grants received or receivable from the Office of the
Chief Scientist of $2.3 million and $1.9 million in 2003 and 2004, respectively.
The grants increased from 2003 to 2004 due to additional development programs
initiated in 2004 which were approved by the Office of the Chief Scientist.
While our 2004 research and development expenses, net, were at levels similar
to 2003, they represented 23.6% and 32.1% of our revenues in 2004 and 2003,
respectively, due to the significant increase in our revenues in 2004.

Approximately
$5.5 million of our research and development expenses, net, in 2004, resulted
from our research and development efforts relating to the introduction of new
products and new models of the NovaScan systems for the next manufacturing
technology nodes. We believe that meeting the needs of semiconductor
manufacturers with respect to the manufacture of semiconductors with features
ranging from 90 nm to below 45 nm will allow us to maintain our position as a
market leader in integrated process control equipment (According to the
International Technology Roadmap for Semiconductors, ITRS, semiconductor
manufacturers began high volume manufacturing of semiconductors with 90 nm
features in 2004, and 90 nm manufacturing is expected to be adopted widely in
2005 and 2006. ITRS also indicates that high volume manufacturing of
semiconductors with 65 nm features is expected to begin in 2006). The balance
of the research and development expenses, net, were related to current products
activities, such as engineering improvements, new versions of software and
application support and developments.

Sales
and Marketing.Sales and marketing expenses are
comprised of salaries and related costs for sales and marketing personnel,
related travel expenses, and overhead. They also include commissions to our
representatives and sales personnel and royalties. Our sales and marketing
expenses increased 1.7% from $6.5 million in 2003 to $6.7 million in 2004.
Sales and marketing expenses represented 18.1% and 24.5%, respectively, of our
revenues in 2004 and 2003. This decrease as a percentage of revenue is related
to higher volume of revenues in 2004.

General
and Administrative. General and administrative
expenses are comprised of salaries and related expenses and other non-personnel
related expenses. Our general and administrative expenses increased 22.8% from
$1.9 million in 2003 to $2.3 million in 2004. This increase is attributed
mainly to increase of legal expenses and increased operation levels of the
company. General and administrative expenses represented 7.1% and 6.3% of our
revenues in 2003 and 2004, respectively. The decrease in general and
administrative expenses as a percentage of revenues from 2003 to 2004 is a
result of an increase in our revenues in 2004.

Other
Operating Income. During the fourth quarter of 2003,
the Office of the Chief Scientist approved the Companys request to allocate
$2.2 million from the grants provided by the Office of the Chief Scientist to a
specific lithography project, to be repaid as royalties only from sales of
specific lithography products. As a result, the Company canceled in 2003 a
royalty provision, made mainly in prior years, in the total amount of $2.2
million. The other income in the year 2003 represents this cancellation.

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Liquidity and Capital Resources

As
of December 31, 2005 we had working capital of $14.8 million compared to
working capital of $25.7 million as of December 31, 2004. This decrease is
attributed primarily to decrease in cash and cash equivalents during 2005 and
to the increase in trade account payables and other liabilities during 2005.
Cash and cash equivalents, short-term and long-term deposits and securities
held to maturity as of December 31, 2005 were $22.8 million compared to $30.8
million as of December 31, 2004.

Trade
accounts receivable decreased slightly from $6.85 million as of December 31,
2004 to $6.84 million as of December 31, 2005. Inventories increased from $6.4
million as of December 31, 2004 to $6.6 million as of December 31, 2005.

Operating
activities in 2005 used cash of $7.4 million compared to $1.8 million in 2004.
Operating activities in 2005 used more cash relative to 2004 mainly due to the
increased operational losses in 2005. Financing activities generated $0.5
million of cash in 2004, compared to $0.3 million in 2003.

The
following table describes our investments in capital expenditures during the
last three years:

| |                                |  |          |       |        |  |          |  |                       |       |          |  |        |  |  |     |  |  |    | 
| | ------------------------------ |  | -------- | ----- | ------ |  | -------- |  | --------------------- | ----- | -------- |  | ------ |  |  | --- |  |  | -- | 
| |                                |  | 2005     |       | 2004   |  | 2003     | 
| |                                |  |          |       |        |  |          | 
| |                                |  | Domestic |       | Abroad |  | Domestic |  | Abroad                |       | Domestic |  | Abroad | 
| |                                |  |          |       |        |  |          |  |                       |       |          |  |        | 
| |                                |  |          |       |        |  |          |  | (in dollar thousands) |       |          |  |        |  |  |    
| | Electronic equipment           |  |          | 1,176 |        |  | 41       |  |                       | 844   |          |  | 78     |  |  | 310 |  |  | 22 | 
| | Office furniture and equipment |  |          | 13    |        |  | 2        |  |                       | 230   |          |  | 3      |  |  | 6   |  |  | 9  | 
| |                                |  |          |       |        |  |          |  |                       |       |          |  |        |  |  |     |  |  |    | 
| | Leasehold improvements         |  |          | 48    |        |  | 2        |  |                       | 79    |          |  | 8      |  |  | 6   |  |  | 11 | 
| |                                |  |          |       |        |  |          |  |                       |       |          |  |        | 
| |                                |  |          |       |        |  |          |  |                       |       |          |  |        |  |  |     |  |  |    | 
| | Total                          |  |          | 1,237 |        |  | 45       |  |                       | 1,153 |          |  | 89     |  |  | 322 |  |  | 42 | 

The
investment in capital expenditures was financed mainly from the cash reserves
of the Company. The increase in capital expenditures for electronic equipment
in 2004 and 2005 was due to our investments in information systems improvements
(software and hardware), electronic equipment used in our research and
development labs and systems for our demonstration centers and application
development. Although we currently have no significant capital commitments, we
expect to spend approximately $1.5 million on capital expenditures in the next
12 months, mainly for information systems improvements (software and hardware),
electronic equipment used in our research and development labs and
manufacturing clean room facilities in Israel.

Our
principal liquidity requirements are expected to be for working capital,
research and development, capital expenditures and lease payments for our
worldwide facilities. We believe that our current cash reserves and expected
cash flow will be adequate to fund our activities for at least the next 12
months.

Our
long-term capital requirements will be affected by many factors, including the
success of our current products, our ability to enhance our current products
and our ability to develop and introduce new products that will be accepted by
the semiconductor industry. We plan to finance our long-term capital needs with
the remaining net proceeds of our initial public offering, together with cash
flow from operations, if any. If these funds are insufficient to finance our
activities, we will have to raise additional funds through the issuance of
additional equity or debt securities, through borrowing or through other means.
We cannot assure you that additional financing will be available on acceptable
terms.

Presently,
we have no long-term debt, nor any readily available source of long-term debt
financing such as a line of credit.

With
regard to usage of hedging financial instruments and the impact of inflation
and currency fluctuations, see Quantitative and Qualitative Disclosures About
Market Risk starting on page 65.

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Off-balance
sheet arrangements

We
do not have and are not party to any off-balance sheet arrangements.

Contractual Obligation

As
of December 31, 2005 we had contractual obligations as described in the
following table:

|                              |  |                       |  |                  |       |           |  |           |  |                         |   |  |  |   |  | 
|----------------------------- |  | --------------------- |  | ---------------- | ----- | --------- |  | --------- |  | ----------------------- | - |  |  | - |  | 
|                              |  | Total                 |  | Less than 1 year |       | 1-3 years |  | 3-5 years |  | More 
  than 5 
  years |  
|                              |  | (in dollar thousands) | 
|Operating Lease
  Obligations |  | 2,808                 |  |                  | 1,607 |           |  | 1,201     |  |                         |  |  |  |  |  | 
|Purchase
  Obligations        |  | 4,507                 |  |                  | 4,507 |           |  |          |  |                         |  |  |  |  |  | 
|Other Long Term
  Liabilities |  | 195                   |  |                  | 95    |           |  | 100       |  |                         |  |  |  |  |  | 
|                              |  |                       |  |                  |       |           |  |           |  |                         |   |  |  |   |  | 
|Total                         |  | 7,510                 |  |                  | 6,209 |           |  | 1,301     |  |                         |  |  |  |  |  | 

Research
and Development

For
information regarding our research and development activities, see Research
and Development starting on page 21.

Conditional
Grants from the Office of the Chief Scientist

Under
the Law for the Encouragement of Industrial Research and Development, 1984, a
qualifying research and development program is eligible for conditional grants
of up to 50% of the programs expenses. The program must be approved by a
committee of the Office of the Chief Scientist of the Israeli Ministry of
Industry, Trade and Labor. The recipient of the conditional grants is required
to return the grants by the payment of royalties on the revenues derived from
using the grants. Current regulations promulgated under the law provide for the
payment of royalties to the Office of the Chief Scientist ranging from 3% to 6%
on the revenues derived from using the conditional grants until 100% of the
grants are repaid. Conditional grants received under programs approved after
January 1, 1999 will accrue interest at an annual rate of the 12-month LIBOR
applicable to dollar deposits. Royalties are paid in NIS linked to the dollar
at the exchange rate in effect at the time of payment. Following the full
payment of such royalties and interest, there is generally no further liability
for payment.

The
terms of the conditional grants under the law require that we manufacture in
Israel the products developed with these grants. These restrictions apply even
after grants are fully repaid. Under the regulations promulgated under the law,
the products may be manufactured outside Israel by us or by another entity and
know-how may be transferred outside of Israel, if prior approval is received
from the Office of the Chief Scientist which may be given only if we abide by
all the provisions of the law and related regulations. Ordinarily, as a
condition to obtaining approval to manufacture outside Israel, we would be
required to pay increased royalties and as a condition to obtaining approval to
transfer know-how outside Israel, ordinarily we would be required to pay a lump
sum, all as defined under the relevant law. If we perform the manufacturing,
the increased royalties would ordinarily be one percentage point above the
otherwise applicable royalty rate. If the manufacturing is performed by an
entity other than us, the rate would depend on the amount of manufacturing
performed outside of Israel and the size of the conditional grants in relation
to the investments made by us in the project. The total amount to be repaid to
the Office of the Chief Scientist would also be adjusted to between 120% and
300% of the conditional grants, depending on the manufacturing volume that is performed
outside Israel. If we wish to transfer know-how, the terms for approval shall
be determined according to the character of the transaction and the
consideration paid to us for such transfer. Approval of the transfer of
technology may be granted only if the recipient abides by all the provisions of
the law and related regulations, including the restrictions on the transfer of
know-how outside of Israel and the obligation to pay royalties in an amount
that may be increased. Approval to manufacture products outside of Israel or
consent to the transfer of technology, if requested, might not be granted.

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As
of December 31, 2005 we received conditional grants from the Office of the
Chief Scientist totaling $8.9 million. Because the implementation of
regulations raising royalty rates to between 3% and 6% has been deferred, we
are obligated to pay royalties of 3% of revenues derived from sales of products
funded with these grants. As of December 31, 2005, our contingent liability to
the Office of the Chief Scientist for conditional grants received was
approximately $5.7 million. See also Note 7A to our consolidated financial
statements contained elsewhere in this report.

The
funds available for Office of the Chief Scientist conditional grants were
reduced for 2004 and 2005, and the Israeli authorities have indicated that the
government may further reduce or abolish Office of the Chief Scientist grants
in the future. Even if these conditional grants are maintained, we might not
receive Office of the Chief Scientist grants in the future and cannot presently
predict the amount of any grants we might receive.

In
addition to royalty-bearing grants from the Office of Chief Scientist, in 2005,
we participated in two programs sponsored by the Office of Chief Scientist. In
one program, we are a member of a research consortium comprised of several
Israeli high technology companies, which are engaged in the development of
multimedia on-line technology. In the other program, we are cooperating with a
research institute in Israel for the development of advanced measurement
techniques. In both programs, the Office of Chief Scientist contributes 66% of
the approved research and development budget for the research consortium and
the members of the research consortium contribute the remaining 34%. No
royalties from this funding are payable to the Israeli government. Expenses in
excess of the approved budget are borne by the consortium members. In general,
any consortium member that develops technology as part of the consortium
retains the intellectual property rights to the technology developed by this
member, and all the members of the consortium have the right to utilize and
implement such technology without having to pay royalties to the developing
consortium member. As of December 31, 2005, we had received approximately $2.3
million in grants from the Office of Chief Scientist in connection with these
programs.

Political
and economic conditions in Israel

The
Company is incorporated under the laws of Israel, and has its principal offices
and manufacturing facilities in Israel. The Company is, therefore, directly
influenced by the political, economic and military conditions affecting Israel.
Any major hostilities involving Israel, the interruption or curtailment of
trade between Israel and its trading partners or a significant downturn in the
economic or financial condition of Israel could have a material adverse effect
on the Companys business, financial condition and results of operations.

Political
Conditions. Since the establishment of the state of Israel in
1948, a number of armed conflicts have taken place between Israel and its Arab
neighbors and a state of hostility, varying from time-to-time in intensity and
degree, has led to security and economic problems for Israel. However, a peace
agreement between Israel and Egypt was signed in 1979, a peace agreement
between Israel and Jordan was signed in 1994 and, since 1993, several
agreements between Israel and the Palestinian Authority representatives have
been signed. As of the date hereof, Israel has not entered into any agreement
with Syria or Lebanon. Currently there is stagnation in the peace process in
the Middle East and ongoing hostilities between Palestinian militant groups and
Israel. The resumption of hostilities in the region, which have occurred after
the failure of Camp David peace talks, as well as the events of September 11,
2001, and the ongoing tension in the region, has a negative effect on the
stability of the region. There can be no assurance as to whether or how the
peace process will develop or what affect it or these ongoing hostilities may
have upon the Company.

Beginning
in 1948, nearly all Arab countries have formally adhered to a boycott of Israel
and Israeli companies and, since the early 1950s, of non-Israeli companies
doing business in Israel or with Israeli companies. Attempts to ensure that
Arab countries are complying with this boycott have intensified due to recent
hostilities between the State of Israel and the Palestinians. Despite measures
to counteract the boycott, including anti-boycott legislation in the US, the
boycott has had an indeterminate negative effect upon trade with and foreign
investments in Israel. Although in the past such attempts did not materially
affect us, there can be no assurance that restrictive laws, policies, or
practices directed toward Israel or Israeli businesses will not have an adverse
impact on the operation or expansion of the Companys businesses.

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Due
to recent presence of the Israeli military in the territories previously
transferred to the control of the Palestinian authority, there were certain
initiatives within the institutions of the European Union to suspend the trade
agreements entered into between the State of Israel and members of the European
Union. These initiatives culminated in a resolution of the European Parliament
recommending that the European Union members suspend those trade agreements. It
is uncertain whether such agreements will in fact be suspended, but if such
agreements are suspended, it may affect the Company ability to trade with
European companies.

Military
Service. Generally, all male adult citizens and permanent
residents of Israel under the age of 45, (doctors  under the age of 49) are, unless exempt,
obligated to perform up to approximately 36 days of military reserve duty annually. Generally, male adult citizens and permanent
residents of Israel over the age of 45 and under the age of 54 are, unless exempt, obligated
to perform up to approximately 13 days of military reserve duty
annually, (doctors up to approximately 21 days). Additionally, all such residents are subject to being called to active duty at any
time
under emergency circumstances. Some of the Companys officers
and employees are currently obligated to perform annual
reserve duty. While the Company has operated
effectively under these requirements since it began operations, no assessment can be made as to the full impact of such requirements
on the Companys workforce or business if conditions should change, and no
prediction can be made as to the effect on Company of any expansion
or reduction of such obligations.

Economic
Conditions.Israels economy has been subject to numerous
destabilizing factors, including a period of rampant inflation in the early to
mid-1980s that reached an annual peak of 445%, low foreign exchange reserves,
fluctuations in world commodity prices, military conflicts and civil unrest. In
the past, the Israeli economy has been in a recession, and the Israeli
government has, for these and other reasons, intervened in the economy by
utilizing, among other means, fiscal and monetary policies, import duties,
foreign currency restrictions and control of wages, prices and exchange rates.
The Israeli government periodically changes its policies in all these areas.

Item 6. Directors, Senior Management and Employees

The
following is the list of senior management and directors:

|                     |  |    |     |                                                               |          | 
|-------------------- |  | -- | --- | ------------------------------------------------------------- | -------- | 
|Name                 |  |    | Age |                                                               | Position | 
|                     |  |    |     |                                                               |          | 
|                     |  |    |     |                                                              
|Giora Dishon         |  | 61 |     | President, Chief Executive Officer, Director and
  Co-Founder
|Moshe Finarov        |  | 54 |     | Chief Technology Officer, Director and Co-Founder            
|Micha Brunstein*     |  | 62 |     | Chairman of the board                                        
|Avi Kerbs *          |  | 59 |     | Director                                                     
|Joseph Ciechanover * |  | 72 |     | Director                                                     
|Alon Dumanis *       |  | 56 |     | Director                                                     
|Lauri Hanover */**   |  | 46 |     | External Director                                            
|Dan Falk *           |  | 61 |     | External Director                                            
|Dror David *         |  | 37 |     | Chief Financial Officer, Vice President of Resources         
|Gabi Seligsohn *     |  | 40 |     | Executive Vice President, Sales and Marketing                

|   |                                                                                                      
|-- | -----------------------------------------------------------------------------------------------------
|*  | Each one of these persons beneficially owns less
  than one percent of the Companys ordinary shares.
|   |                                                                                                      
|** | External Director with financial expertise.                                                          

Our directors (other than the external directors)
serve as such until the Companys next annual general meeting of shareholders.
Our external directors, in accordance with Israeli law, serve for a three-year
term, which may be renewed for only one additional three-year term. Ms. Lauri
Hanover was elected in 2000 and was reelected in 2003. Mr. Dan Falk was elected
in 2005.

Effective
as of April 28, 2006, Mr. Barry L. Coxresigned
from his position as Chairman and member of the Board of Directors of the
Company.

Effective
as of September 29, 2005, Dr. Karey Holland resigned from her
position as a member of the Board of Directors of the Company.

- 37 -

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Effective
of June 19, 2006, Dr. Micha Brunstein was named as the chairman of the Board of
Directors.

Dr.
Giora Dishonis a co-founder of Nova and has served as
President and Chief Executive Officer since Novas formation in 1993. From 1989
to 1993 he served as Thin Film and Flat Panel Display Product Line Manager at
Orbot Systems and Orbotech Ltd., a manufacturer of automated optical inspection
equipment. From 1986 to 1988 he was a Visiting Scientist at the
Microelectronics Center of North Carolina, and from 1982 to 1986 he served as
the Managing Director at AVX Israel Ltd., a manufacturer of electronic devices.
Dr. Dishon holds a B.Sc. in Chemistry, a MSc. and a Ph.D. in Materials Science
from the Hebrew University in Jerusalem.

Dr.
Moshe Finarovis a co-founder of Nova Measuring Instruments
and a member of the Board of Directors. He has served as Chief Technology
Officer and VP Technology since Novas formation in 1993. From 1989 to 1993 he
served as Senior Physicist at Orbotech Ltd. and from 1974 to 1988 he was
employed at PULSAR and ENIMS Scientific Research Institutes in Moscow. Dr.
Finarov holds a Ph.D in Semiconductor Physics and M.Sc in Microelectronics from
Moscow Steel & Alloys Institute. He is named on approximately 30 US patents
and published approximately 40 papers.

Dr.
Micha Brunstein was elected as director of Nova during
November 2003 by the other members of the board of directors, and thereafter by
annual shareholders meetings. As described above, effective of June 19, 2006,
Dr. Micha Brunstein was named as the chairman of the Board of Directors of
Nova. During the years 1990 to 1999, Dr. Brunstein served as a Managing
Director of Applied Materials Israel Ltd. Prior to that, Dr, Brunstein served
as President of Opal Inc. and as a Director of New Business development in
Optrotech Ltd. At present, Dr. Brunstein serves as the chairman and board
member of Ham-let Ltd., a company whose stock is traded in the Tel Aviv Stock
Exchange, and Valor Computerized Systems Ltd., whose stock is traded in the
Frankfurt Stock Exchange. Dr. Brunstein holds B.Sc. in Mathematics and Physics
from the Hebrew University, Jerusalem, and M.Sc. and Ph.D. degrees in Physics
from the Tel Aviv University.

Mr.
Avi Kerbs has served as a director of Nova since 1993. He
serves as the president and chief executive officer of Teuza Management &
Development Ltd., the management company of Teuza-A Fairchild Technology
Venture Ltd., a venture capital Company and has served in this capacity since
1991. Teuza-A Fairchild Technology Venture Ltd. is a major shareholder of Nova.
He serves as a director of most of the companies comprising the investment
portfolio of the Teuza Fund. Mr. Kerbs holds a B.Sc. in Industrial Engineering
and Management and an M.Sc. in Management, both from the Technion, Israels
Institute of Technology. Mr. Kerbs serves as a member of the Technions Board
of Governors, is a Governor of the Haifa University Board of Governors and the
Chairman of the Scientific Academic Club of the Haifa University. Mr. Kerbs was
originally appointed to our board of directors by Teuza.

Mr.
Joseph Ciechanover has served as a director of Nova from
October 1996 until December 1998 and again from February 2000 until the
present. He is the founder and president of the Challenge Fund-Etgar L.P., a
venture capital firm holding approximately 2% of Novas outstanding shares, and
served as chairman of the board of El-Al Israel Airlines from 1995 until
2001. He served as a chairman of Israel Discount Bank from
1986-1993 and the president and a member of the board of directors of PEC
Israel Economic Corporation, a diversified investment company which merged
later into Discount Investment Corp. Since 1995, Mr. Ciechanover has been a
member of the board of directors of United Retail Group, Inc. and serves on the
audit compensation committees. United Retail Group, Inc.s stock is publicly
traded in the United States. Mr. Ciechanover holds a law degree from the Hebrew
University in Jerusalem, an L.L.M. from the University of California at
Berkeley and a Ph.D. in philosophy from Boston University.

Dr.
Alon Dumanis, is the Chief Executive Officer of Docor
International Management, a Dutch venture capital, subsidiary of The Van-Leer
Group Foundation. Dr. Dumanis serves either as Chairman or as a member of the
Board of Directors of various companies. Dr. Dumanis is a member of the Board
of Directors of Tadiran Communications and formerly, a member of the Board of
Directors at El Al Israel Airlines (TASE-LY) and Board of Directors of
Inventech Investments Co. Ltd. (TASE-IVTC), a major shareholder. Previously,
Dr. Dumanis was the Head of the Material Command in the Israel Air Force with
the rank of Brigadier General. Dr. Dumanis currently serves as chairperson and
member of several national steering committees and is the author of many papers
published locally and internationally in a number of subject areas, including
technology and management. Dr. Dumanis holds a Ph.D. in Aerospace Engineering
from Purdue University in the United States.

- 38 -

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Ms.
Lauri Hanover has been a Director of the Company since 2000
and was appointed as the Companys external director in accordance with the
provisions of Israeli law. Ms. Hanover was nominated by the Board of Directors
to serve as the board member who has accounting and financial expertise. Ms.
Hanover has served as Senior Vice President and Chief Financial Officer of
Lumenis Ltd., a company publicly traded in the United States, since 2004. She
previously served as Corporate Vice President and Chief Financial Officer of
NICE Systems Ltd. from 2000 to 2004 and as Executive Vice
President and Chief Financial Officer of Sapiens International Corporation N.V.
from March 1997 until 2000. From 1984 to 1997, Ms. Hanover served in a variety
of financial management positions, including Corporate Controller, at Scitex
Corporation Ltd. Ms. Hanover holds a bachelors degree in finance from the
Wharton School of Business and a Bachelor of Arts degree from the College of
Arts and Sciences, both of the University of Pennsylvania. Ms. Hanover
also holds a masters degree in business administration from New York University.
Ms. Hanover has served as an external director on the Board of Directors of Nur
Macroprinter Ltd. since 2003. Nur Macroprinter is publicly traded in the United
States.

Mr.
Dan Falk was appointed as the Companys external director in
accordance with the provisions of the Israeli law in 2005. Mr. Falk is a
business consultant to public and private companies. During 1999 to 2000 Mr.
Falk served as Chief Executive Officer and Chief Operating Officer of Sapiens
International NV. Before that, Mr. Falk served as Executive Vice President and
CFO of Orbotech Ltd. Mr. Falk serves as a member of various companies
boards of directors such as Orbotech Ltd., Nice Systems Ltd., Ormat
Technologies, Inc., Attunity Ltd., ClickSoftware Technologies, Ltd., Orad Hi-tech
Systems Ltd., Jacada Ltd., Dmatek Ltd., Poalim Ventures1,
Plastopil Ltd. (all of which are companies publicly traded in the
United States or other countries) and Netafim Ltd.

Mr.
Dror David has served as Chief Financial Officer and Vice President
of Resources of Nova since August 2005. From 1998 to 2005, he served in various
managerial positions in Nova including Vice President of Finance, Operations
Manager, and Global Controller. From 1994 to 1998 Mr. David served as an Audit
and Tax Consultant with Brightman, Almagor & Co.. Mr. David holds a B.A. in
Accounting & Economics from the Bar-Ilan University and M.B.A from the
Derby University of Britain.

Mr.
Gabi Seligsohn was appointed Executive Vice President, Global
Business Management Group, in August 2005. Having joined Nova in 1998, Mr.
Seligsohn has served in several key positions in the company. From August 2002
until August 2005 he was President of Novas US Subsidiary, Nova Inc. Previous
to that he was Vice President Strategic Business Development at Nova Inc. where
he established Novas OEM group managing the Applied Materials and Lam Research
accounts between the year 2000 to 2002. From 1998 to 2000 he served as global
strategic account manager for the Companys five leading customers. Mr.
Seligsohn joined Nova after two years service as Sales Manager for key
financial accounts at Digital Equipment Corporation. Mr. Seligsohn holds an LLB
from the University of Reading in England.

Voting
agreement

We
are not aware of any voting agreement currently valid.

Compensation

The
aggregate direct remuneration paid or payable to all 13 persons partial who
served in the capacity of director or executive officer during 2005 (including
persons who served partial term) was approximately
$1,000,000 including approximately
$224,000, which was set aside for pension and retirement benefits and including
amounts expended by us for automobiles made available to our executive officers
and $100,000 for executives retirement payments.

External
directors of the Company receive remuneration comprised of: an annual payment
in the amount of NIS 30,708 (approximately $6,840) and an additional payment
per meeting of NIS 1,143 (approximately $255).

The
total amount paid or payable to the directors, including external directors,
for 2005 was $114,000. In 2004, this amount was $105,000 and in 2003 -
$122,000.

- 39 -

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As
of May 15, 2003, we entered into an agreement with Mr. Barry L. Cox according
to which Mr. Cox served as chairperson of our board of directors. Under the
agreement, Mr. Cox was entitled to gross annual compensation of $50,000 as well
as a one-time grant of an option to purchase up to 50,000 ordinary shares of
the Company, at the fair market value of the shares at the time of grant. The
option vests during a three-year period so that a third of the entire amount
granted to Mr. Cox shall be exercisable upon each anniversary of the grant. Mr. Cox has resigned from the Board effective
April 28, 2006. On June 19, 2006 (following the recommendations of the
Compensation Committee and the Audit Committee), the Board of directors
approved the severance arrangements with Mr. Barry Cox continuing payment of
his compensation through the end of 2006 in a total amount of $25,000.
These payments have not yet been approved by our shareholders.

On
May 15, 2003, the Companys Board of Directors and Audit Committee resolved (i)
that the monthly gross salary of Dr. Dishon shall be increased to 44,000 NIS
(approximately $9,800) for the period February 1, 2003 through July 31, 2003
and increased to 50,000 NIS (approximately $11,120) starting on August 1, 2003
and (ii) that the monthly gross salary of Dr. Finarov shall be increased to
40,000 NIS (approximately $8,900) for the period February 1, 2003 through July
31, 2003 and increased to 44,000 NIS (approximately $9,800) starting on August
1, 2003. These changes in the terms of compensation for Drs. Dishon and Finarov
were approved by our shareholders on September 1, 2003.

On
November 1, 2005, the Companys Audit Committee and on November 2, 2005 the
Companys Board of Directors resolved (i) that the monthly gross salary of Dr.
Dishon shall be increased to 57,000 NIS (approximately $12,000) starting on
July 1, 2005 and (ii) that the monthly gross salary of Dr. Finarov shall be
increased to 53,000 NIS (approximately $11,500) starting on July 1, 2005. In
June, 2006, the Companys Audit Committee and the Companys Board of Directors
approved further increases in the salaries of Drs. Dishon and Finarov as well
as the allocation of additional options. These changes in the terms of
compensation for Dr. Dishon and Dr. Finarov have not yet been approved by our
shareholders.

During
June, 2006, Dr. Micha Brunstein was named as the chairman of the Board of
Directors of the Company. Following the recommendations of the Compensation Committee and the Audit Committee,
the Board of Directors resolved that Dr. Brunstein will be entitled to
gross annual compensation of $110,000 and to the grant of an option to acquire
100,000 of the Companys ordinary shares pursuant to the Companys Option Plan
8. Dr. Brunsteins salary and the option grant have not yet been approved by
our shareholders.

On
November 10, 2004, the Companys Board of Directors and the Companys Audit
Committee, in each case after all of directors and external directors gave
notification of their personal interest in such resolutions, approved the
issuance of options to directors as set forth below.

Name of directors

Position

# of optionsGiora Dishon

Director, CEO &
  President

70,000Moshe Finarov

Director & CTO

60,000Barry Cox

Former Chairman of the board

10,000Micha Brunstein

Director

10,000Avi Kerbs

Director

10,000Joseph Ciechanover

Director

10,000Alon Dumanis

Director

10,000Lauri Hanover

External Director

10,000Karey Holland

Former External Director

10,000


- 40 -

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The
options were granted in December 2004 subject to shareholder approval, which
was given on September 29, 2005. The options are subject to the terms and
conditions of the Companys Option Plan 7B. Subject to any permitted
acceleration of vesting, the options vest over a period of between one and four
years and their term may not exceed seven years from the date of grant. The
exercise price of these options is $3.40 per share.

On
July 30, 2005, the Companys Audit Committee (in which all directors, including
both external directors, notified the Company of their personal interest in the
approval of said resolution) and the Companys Board of Directors (in which all
directors, including both external directors, have notified the Company of
their personal interest in the approval of said resolution), approved the grant
of options to directors as set forth below:

Name of directors

Position

# of optionsGiora Dishon

Director, CEO &
  President

63,000Moshe Finarov

Director & CTO

54,000Barry Cox

Former Chairman of the board

9,000Micha Brunstein

Director

9,000Avi Kerbs

Director

9,000Joseph Ciechanover

Director

9,000Alon Dumanis

Director

9,000Lauri Hanover

External Director

9,000Karey Holland

Former External Director

9,000


These
grants were approved by the shareholders on September 29, 2005. The grant
of the above options is subject to the terms and conditions of the Companys
Option Plan 7C. Subject to any permitted acceleration of vesting, the options
vest over a period of between one and four years and their term may not exceed
seven years from the date of grant. The exercise price of these options will be
the fair market value of the Companys shares on the date of grant, unless
otherwise determined by the Board of Directors. The grant of the above options
is subject to receipt of a letter of consent from the Israeli Securities
Committee, receipt of a letter of consent from the Tel-Aviv Stock Exchange and
the effectiveness of a Registration Statement on Form S-8 with respect to the
ordinary shares underlying the options.

- 41 -

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On
July 31, 2005, the Companys Board of Directors (in which all directors,
including both external directors, notified the Company of their personal
interest in the approval of said resolution) and the Companys Audit Committee
(in which all directors, including both external directors, notified the
Company of their personal interest in the approval of said resolution),
approved the recommendation of the Companys Compensation Committee to approve
a plan to accelerate the vesting of certain options outstanding as of December
29, 2005 as described below:

|            |  |              |  |               |  |                    |  |         |  |          |  |                        | 
|----------- |  | ------------ |  | ------------- |  | ------------------ |  | ------- |  | -------- |  | ---------------------- | 
|Last Name   |  | First
  Name |  | Grant Date    |  | Exercise
  Price $ |  | Granted |  | Unvested |  | Vested &
  Exercisable | 
|            |  |              |  |               |  |                    |  |         |  |          |  |                        | 
|Domanis     |  | Alon         |  | Mar-04-Dec-04 |  | 3.4-5.15           |  | 20,000  |  | 16,864   |  | 3,136                  | 
|Brunsten    |  | Micha        |  | Mar-04-Dec-04 |  | 3.4-5.15           |  | 20,000  |  | 16,864   |  | 3,136                  | 
|Ciechanover |  | Joseph       |  | Feb-03-Dec-04 |  | 2.06-5.15          |  | 30,000  |  | 21,864   |  | 8,136                  | 
|Hanover     |  | Lauri        |  | Feb-03-Dec-04 |  | 2.06-5.15          |  | 30,000  |  | 21,864   |  | 8,136                  | 
|Kerbs       |  | Avi          |  | Feb-03-Dec-04 |  | 2.06-5.15          |  | 30,000  |  | 21,864   |  | 8,136                  | 
|Holland     |  | Karey        |  | Feb-03-Dec-04 |  | 2.06-5.15          |  | 30,000  |  | 21,864   |  | 8,136                  | 
|Cox         |  | Barry        |  | May-03-Dec-04 |  | 2.68-3.4           |  | 60,000  |  | 26,667   |  | 33,333                 | 
|Dishon      |  | Giora        |  | Feb-03-Dec-04 |  | 2.06-5.15          |  | 195,000 |  | 144,682  |  | 50,318                 | 
|Finarov     |  | Moshe        |  | Feb-03-Dec-04 |  | 2.06-5.15          |  | 165,000 |  | 122,818  |  | 42,182                 | 

The acceleration of the options under Plans 6, 7A and
7B was approved by the shareholders on September 29, 2005. As a result, the
options identified above vested and became fully exercisable on December 29,
2005.

On September 29, 2005, the Shareholders of the Company
approved the extension of the period in which Dr. Holland may exercise her
options, to a period of 180 days from the date of termination of Dr. Hollands
tenure as a director and external director.

Board of
Directors Committees

The
Companys Board of Directors has appointed the following committees:

The Audit Committee is comprised of four
members, but currently has only three members. The members are Lauri Hanover,
Dan Falk and Joseph Ciechanover. The functions of the audit committee according
to Israeli Law are to locate deficiencies in the business management of the
Company, among other things, in consultation with the Companys auditors and
internal auditors and to suggest to the Board of Directors the measures to be
taken regarding such deficiencies. The Audit Committee is also responsible for
approving related party transactions. In addition, as described under Item 16,
the audit committee is responsible for the approval of all audit and non-audit
services provided to the Company by Deloitte & Touche. The Audit Committee
operates under a charter adopted by the Board of Directors.

The Compensation Committeeis comprised of
Joseph Ciechanover, Lauri Hanover and Dan Falk. The function of the
compensation committee is described in the approved charter of the committee,
and includes determining the compensation of directors, senior management and
employees (subject to provisions regarding related party transactions).

The Investment Committeeis comprised of
Lauri Hanover, Avi Kerbs, Dan Falk and Joseph Ciechanover. The function of the
investment committee is described in the approved charter of the committee, and
includes reviewing and determining the cash investment policy of the cash
reserves of the Company.

The Nominating Committeeis comprised of Alon
Dumanis, Dan Falk and Joseph Ciechanover. The function of the nomination
committee is described in the approved charter of the committee, and includes
reviewing the board structure and recommend nomination of new board members.

The
Strategic Committeeis comprised
of Micha Brunstein, Avi Kerbs, Alon Dumanis, Dan Falk and Giora Dishon. The
function of the strategic committee is described in the approved charter of the
committee, and includes advising and recommending strategic and long term plans
and goals for the Company.

All
committees are acting according to charters that were approved by the Company
Board of directors.

- 42 -

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Employees

Set
forth below is a chart showing the number of people we employed at the times
indicated.

|                                |  |                      |  |      |     |      |  |     |  | 
|------------------------------- |  | -------------------- |  | ---- | --- | ---- |  | --- |  | 
|                                |  | as of
  December 31, | 
|                                |  |                      | 
|                                |  | 2003                 |  | 2004 |     | 2005 | 
|                                |  |                      |  |      |     |      | 
|                                |  |                      |  |      |     |      |  |     |  | 
|Total Personnel                 |  | 212                  |  |      | 239 |      |  | 239 |  | 
|                                |  |                      |  |      |     |      |  |     |  | 
|Located in
  Israel             |  | 150                  |  |      | 159 |      |  | 156 |  | 
|Located abroad
  (mainly U.S.)  |  | 62                   |  |      | 80  |      |  | 83  |  | 
|                                |  |                      |  |      |     |      |  |     |  | 
|In operations                   |  | 37                   |  |      | 40  |      |  | 33  |  | 
|In research and
  development   |  | 72                   |  |      | 82  |      |  | 84  |  | 
|In sales and
  marketing        |  | 24                   |  |      | 29  |      |  | 29  |  | 
|In service and
  support        |  | 62                   |  |      | 66  |      |  | 69  |  | 
|In general and
  administration |  | 17                   |  |      | 22  |      |  | 24  |  | 

As
of December 31, 2005, we employed a total of 239 persons worldwide, not
including 30 independent contractors and temporary employees, of which 84 were
in research and development, 33 were in operations, 69 were in
service and support, and testing, 29 were in sales and marketing and 24 were in
general and administration. As of December 2005, 156 of our employees were
based in Israel and 83 were located abroad.

We
are a member of the Industrialists Association in Israel, an employers union.
As a result of this membership, a number of collective bargaining agreements
apply to us. These agreements principally concern cost of living wage
increases, paid vacation and holidays, length of the workday, wage tariffs,
termination and severance payments. We provide our employees with benefits and
working conditions that are at least as favorable as those found in the
collective bargaining agreements.

Israeli
labor laws and regulations apply to all our employees employed by Nova
Measuring Instruments Ltd. The laws principally concern matters such as paid
vacation, paid sick days, length of the workday, payment for overtime and
severance payments upon the retirement or death of an employee or termination
of employment.

Share ownership

Giora
Dishon, President, Chief Executive Officer and Co-Founder, and Moshe Finarov,
Vice President, Director of Technology, Director and Co-Founder, beneficially
owned 754,442 (including 107,500 shares held by a trustee pursuant to Israeli
tax laws) and 724,541 (including 107,600 shares held by a trustee pursuant to
Israeli tax laws) ordinary shares of the Company, respectively, as of April 1,
2006. All other directors, external directors and senior management each hold
less than 1% of the Companys shares. The following table sets forth
information regarding options held by our directors and officers as of April 1,
2006.

- 43 -

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|                                         |  |                                         |  |                    |           |                             |  |           |  | 
|---------------------------------------- |  | --------------------------------------- |  | ------------------ | --------- | --------------------------- |  | --------- |  | 
|Name                                     |  | Ordinary
  Shares 
  Underlying Options |  | Expiration
  Dates |           | Exercise
  Prices ($/share) | 
|                                         |  |                                         |  |                    |           |                             | 
|                                        
|Giora Dishon (1)                         |  | 255,000                                 |  |                    | 2007-2011 |                             |  | 2.06-7.37 |  | 
|                                        
|Moshe Finarov (1)                        |  | 225,000                                 |  |                    | 2007-2011 |                             |  | 2.06-7.37 |  | 
|                                        
|13 directors and officers as a group (1) |  | 909,592                                 |  |                    | 2006-2011 |                             |  | 2.06-7.37 |  | 

(1) All such options are currently exercisable.

(2)  The vesting period of each
option is between one and four years from the date of grant according to the
applicable option plan.

As
of December 31, 2005, options to acquire 5,730,822 ordinary shares had been
issued under our options plans, of which options to acquire 1,728,567 shares
have been exercised, 823,251 have been terminated and forfeited and 3,170,885
were exercisable.

As
of December 31, 2005, we had eight employee share option plans that provided
for the grant of options to our employees, including senior management, to
purchase an aggregate of 5,080,822 ordinary shares. The existing share option
plans are described below (excluding the first share option plan that was
comprised of options to acquire 827,700 ordinary shares, which have been fully
exercised).

| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Option Plan 2 - Options to purchase 650,000 shares
  at an exercise price per share of NIS 0.01 (approximately $.0025); as of
  December 31, 2005, all options under this plan were granted, 620,544 options
  were exercised, 4,000 options were exercisable and 25,456 options had been
  forfeited;                                                                                                                                                                                                                                                                                      
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| |  | Option Plan 3 - Options to purchase 387,000 shares
  at an exercise price per share of $3.17; as of December 31, 2005, all options
  under this plan were granted, 67,277 options were exercised, 250,000 options
  were exercisable and 69,723 options had been forfeited;                                                                                                                                                                                                                                                                                                                 
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| |  | Option Plan 4 - Options to purchase 668,350 shares
  at exercise price of $6.27 or $7.37 per share; originally, this plan included
  1,000,000 shares, and was reduced to 668,350 shares by a decision of the
  Board of Directors of the Company. As of December 31, 2005, all options under
  this plan were granted, 5,594 options were exercised, 418,115 options were
  exercisable and 244,641 options had been forfeited;                                                                                                                                                            
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| |  | Option Plan 5 - Options to purchase 746,500 shares
  at an exercise price of $1.13, $2.17 or $2.46, the fair market value of Novas
  stock on the date of grant; as of December 31, 2005, all options under this
  plan were granted, 124,200 options were exercised, 464,115 options were
  exercisable and 150,066 options had been forfeited;                                                                                                                                                                                                                                           
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| |  | Option Plan 6 - Options to purchase 960,000 shares
  at an exercise prices of $2.06, the fair market value of Novas stock on the
  date of grant; as of December 31, 2005, all options under this plan were
  granted, 49,252 options were exercised, 720,829 options were exercisable and
  189,919 options had been forfeited. On September 29, 2005, our shareholders
  have approved amendments to the plan allowing our Board to accelerate the
  vesting dates and to determine an exercise price which is different from the
  fair market value of our shares at the date of grant;
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| |  | Options to purchase 116,272 ordinary shares at an
  exercise price of $5.16 per share; granted in March 1999 to Mendy Erad, the
  Chairman of the Board at that time; as of December 31, 2005, 14,000 options
  were exercised and 102,272 options had been forfeited;                                                                                                                                                                                                                                                                                                                      

- 44 -

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| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Options to purchase an aggregate of 75,000 ordinary
  shares at an exercise price of $3.69 per share granted to the members of our
  Board of Directors, other than our external directors; as of December 31,
  2005, 20,000 options were exercised, 35,000 options were exercisable and
  20,000 options had been forfeited;                                                                                                                                                                                                                                 
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| |  | Options to purchase 50,000 ordinary shares at an
  exercise price of $2.68 per share; granted in May 2003 to Barry Cox, the
  Chairman of the Board; as of December 31, 2005, 50,000 options were
  exercisable;                                                                                                                                                                                                                                                                                                                                               
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| |  | Option Plan 7A - Options to purchase 600,000 shares
  at an exercise prices of $4.01 and $5.15, the fair market value of Novas
  stock on the date of grant; as of December 31, 2005, all options under this
  plan were granted, 536,054 were exercisable and 63,946 options had been
  forfeited. On September 29, 2005, our shareholders have approved amendments
  to the plan allowing our Board to accelerate the vesting dates and to
  determine an exercise price which is different from the fair market value of
  our shares at the date of grant;
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| |  | Option Plan 7B - Options to purchase 650,000 shares
  at an exercise price of $3.40, the fair market value of Novas stock on the
  date of grant; as of December 31, 2005, all options under this plan were
  granted, 590,500 were exercisable and 59,500 had been forfeited. On September
  29, 2005, our shareholders have approved amendments to the plan allowing our
  Board to accelerate the vesting dates and to determine an exercise price
  which is different from the fair market value of our shares at the date of
  grant;                   
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| |  | Option Plan 7C - Options to purchase 250,000
  ordinary shares at an exercise price equal to the fair market value of Novas
  stock on the date of grant; 180,000 options were approved to be granted to
  directors under this plan. These options have not yet been granted; and                                                                                                                                                                                                                                                                            
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| |  | Option Plan 8 - Options to purchase 2,500,000
  ordinary shares at an exercise price equal to the fair market value of Novas
  stock on the date of grant; 465,300 options were approved to be granted to
  employees and managers under this plan. These options have not yet been
  granted.                                                                                                                                                                                                                                                                

In addition
to the option plans described above, in 2003, we implemented an Employee Stock
Purchase Plan pursuant to which eligible employees of the Company may purchase
up to 150,000 ordinary shares, subject to certain adjustments, at a discounted
price. The Company issued a total of 138,505 shares under this plan.

- 45 -

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The
following table summarizes information about share options outstanding as of
December 31, 2005:

|                                   |  |                                       |           |                                                  |  |                                       |  |                      |        |                                     |  |           |  |  |        | 
|---------------------------------- |  | ------------------------------------- | --------- | ------------------------------------------------ |  | ------------------------------------- |  | -------------------- | ------ | ----------------------------------- |  | --------- |  |  | ------ | 
|Outstanding as ofDecember 31, 2005 |  | Exercisable as of
  December 31, 2005 |          
|                                   |  |                                       |          
|Range of
  exercise
  prices       |  | Number
  outstanding                  |           | Weighted
  average
  remainingcontractual
  life |  | Weighted
  average
  exercise
  price |  | Number
  exercisable |        | Weighted
  average
  exercise price | 
|                                   |  |                                       |           |                                                  |  |                                       |  |                      |        |                                     | 
|(US dollars)                       |  |                                       |           | (in years)                                       |  | (US dollars)                          |  |                      |        | (US dollars)                        | 
|                                   |  |                                       |           |                                                  |  |                                       |  |                      |        |                                     | 
|0.0025                             |  |                                       | 4,000     |                                                  |  | 0.5                                   |  |                      | 0.0025 |                                     |  | 4,000     |  |  | 0.0025 | 
|2.06                               |  |                                       | 720,829   |                                                  |  | 4.2                                   |  |                      | 2.06   |                                     |  | 720,829   |  |  | 2.06   | 
|2.17-3.69                          |  |                                       | 807,234   |                                                  |  | 2.4                                   |  |                      | 2.69   |                                     |  | 799,115   |  |  | 2.69   | 
|3.4                                |  |                                       | 590,500   |                                                  |  | 5.9                                   |  |                      | 3.4    |                                     |  | 590,500   |  |  | 3.4    | 
|4.01                               |  |                                       | 476,054   |                                                  |  | 5.4                                   |  |                      | 4.01   |                                     |  | 476,054   |  |  | 4.01   | 
|5.15                               |  |                                       | 60,000    |                                                  |  | 5.2                                   |  |                      | 5.15   |                                     |  | 60,000    |  |  | 5.15   | 
|5.16                               |  |                                       | 102,272   |                                                  |  | 1.0                                   |  |                      | 5.16   |                                     |  | 102,272   |  |  | 5.16   | 
|6.27-7.37                          |  |                                       | 418,115   |                                                  |  | 1.5                                   |  |                      | 6.97   |                                     |  | 418,115   |  |  | 6.97   | 
|                                   |  |                                       |           |                                                  |  |                                       |  |                      |        |                                     |  |           |  |  |        | 
|                                   |  |                                       | 3,179,004 |                                                  |  |                                       |  |                      |        |                                     |  | 3,170,885 |  |  |        | 
|                                   |  |                                       |           |                                                  |  |                                       |  |                      |        |                                     |  |           |  |  |        | 

Item 7.
Major Shareholder and Related Party Transactions

Major
shareholders

The
following table shows the number of ordinary shares beneficially owned by
persons known by us to own beneficially more than five percent of the Companys
ordinary shares, as of April 30, 2006.

|                                                |  |                                                   |           |                                                      |  |       |  
|----------------------------------------------- |  | ------------------------------------------------- | --------- | ---------------------------------------------------- |  | ----- | -
|Name                                            |  | Number of Ordinary
  Shares Beneficially
  Owned* |           | Percentage of Ordinary
  Shares Beneficially
  Owned | 
|                                                |  |                                                   |           |                                                      | 
|Clal Electronics Industries Ltd. (1)            |  |                                                   | 2,823,584 |                                                      |  | 18.23 | %
|Inventech Investments Co. Ltd.                  |  |                                                   | 833,974   |                                                      |  | 5.4   | %
|Teuza - A Fairchild Technology Venture Ltd. (2) |  |                                                   | 1,603,407 |                                                      |  | 10.4  | %
|Teuza Management & Development (1991) Ltd. (2)  |  |                                                   | 1,603,407 |                                                      |  | 10.4  | %
|Austin W. Marxe & David Greenhouse (3)          |  |                                                   | 2,367,837 |                                                      |  | 15.4  | %
|Tamir Fishman Ventures II, L.L.C. (4)           |  |                                                   | 1,175,600 |                                                      |  | 7.6   | %
|Shai Saul (4)                                   |  |                                                   | 1,175,600 |                                                      |  | 7.6   | %
|Michael Elias (4)                               |  |                                                   | 1,182,850 |                                                      |  | 7.6   | %
|Tamir Fishman & Co. Ltd. (4)                    |  |                                                   | 1,180,700 |                                                      |  | 7.6   | %
|Eldad Tamir (4)                                 |  |                                                   | 1,180,700 |                                                      |  | 7.6   | %
|Danny Fishman (4)                               |  |                                                   | 1,180,700 |                                                      |  | 7.6   | %
|Giora Dishon (5)                                |  |                                                   | 963,042   |                                                      |  | 6.1   | %
|Moshe Finarov(6)                                |  |                                                   | 871,941   |                                                      |  | 5.6   | %

* Unless specifically stated otherwise, the
information provided hereinabove is based upon information contained in filings
made by the named person with the U.S. Securities and Exchange Commission
(SEC) pursuant to Regulation 13D-G.

- 46 -

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|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | The following information is contained in Schedule
  13D (Amendment No. 2) filed on December 18, 2003 by, among others, Clal
  Electronics Ltd.: each of Clal Electronics Industries Ltd., Clal Industries
  and Investments Ltd., IDB Development Corporation Ltd., IDB Holding
  Corporation Ltd., Nochi Dankner (Chairman of Clal Industries), Shelly
  Dankner-Bergman (Director of Clal Industries), Avraham Livnat and Ruth Manor
  reported having shared voting and dispositive control over 2,823,584 shares.                                                                                                                                                                                                                                                                                                                                                                                                                                                
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|(2) | The information was provided by Avi Kerbs, President
  and Chief Executive Officer of Teuza Management & Development Ltd., the
  management company of Teuza-A Fairchild Technology Venture Ltd.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|(3) | As reported on the Schedule 13G (Amendment 4) filed
  by Messrs. Marxe and Greenhouse on February 15, 2006, the amount indicated
  includes 536,778 shares held by Special Situations Cayman Fund, L.P., 77,631
  shares held by Special Situations Technology Fund, L.P., 397,869 shares held
  by Special Situations Technology Fund II, L.P., 109,246 shares held by
  Special Situations Fund III, L.P. and 1,246,313 shares held by Special
  Situations Fund III, QP, L.P.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|(4) | The following information is contained in a Schedule
  13G (Amendment No. 2) filed by, among others, Tamir Fishman Ventures II, LLC
  (TFV), on March 30, 2005: (a) Five limited partnerships and a corporation
  directly beneficially own, in the aggregate, 1,175,600 shares; (b) TFV
  beneficially owns 1,175,600 shares as the sole general partner of the five
  limited partnerships and by virtue of its management rights with respect to a
  corporation ; (c) Shai Saul, is a managing member of TFV; (d) Michael Elias
  is a managing member of TFV and reports having sole voting and dispositive
  power over an additional 7,250 shares; (d) Tamir Fishman & Co. Ltd is a
  managing member of TFV and reports directly owning 5,100 additional shares;
  (e) Eldad Tamir and Danny Fishman are each Co-President and Co-CEO of Tamir
  Fishman & Co. Ltd. The total number of shares beneficially owned collectively
  in this group is 1,182,850.
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|(5) | Includes 107,500 shares held in trust under Israeli
  tax law for the benefit of the named shareholder and options to purchase
  255,000 ordinary shares, which are currently exercisable.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|(6) | Includes 107,600 shares held in trust under Israel
  tax law for the benefit of the named person and options to purchase 225,000
  shares which are currently exercisable.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            

All the shareholders of the company have the same
voting rights.

The Company believes that, as of December
31, 2005, approximately 30% of its ordinary shares were held by United States
holders, and there were approximately 30 record holders in U.S.

Control
of Registrant

To
the Companys knowledge, it is not owned or controlled by a foreign government.
Except for the shareholders identified above owning more than ten percent of
the Companys ordinary shares, the Company has no knowledge of any corporation
or other natural or legal person owning a controlling interest in the Company.

Related
Party Transactions

In 2002, the Company obtained directors
and officers liability insurance for its officers and directors with coverage
in an aggregate amount of $5,000,000. This coverage was renewed in 2003, 2004
and 2005. In addition, the Company undertook to indemnify the Companys
officers and directors up to an aggregate amount of $15,000,000 pursuant to the
terms set forth in an Indemnification and Exculpation Letter. On September 29,
2005, the General Meeting of Shareholders of the Company approved the
continuation of the terms of Indemnification and Exculpation for the directors
and officers of the Company, to the extent such terms concern the directors of
the Company, until the adoption of new terms to be prepared and approved by the
Audit Committee and the Board of Directors in conformity with the 2005
amendment to the Companies Law, which terms shall be presented for the approval
of the shareholders at the earliest opportunity.

- 47 -

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The
Indemnification and Exculpation Letter also exculpates the officers and
directors from certain liabilities relating to their positions and directors
and officers with in the framework allowed under the Israeli Companys Law. The
shareholders further approved our undertaking to indemnify our officers and directors
within the framework allowed under Israeli Companys Law up to an aggregate
amount of $15,000,000. Under the Companies Law, a company is prohibited from
undertaking to indemnify, to insure or to exempt its officers or directors
against: (i)   breaches of fiduciary duty to the Company (other than
with respect to actions taken in good faith and upon reasonable grounds that
such actions shall not adversely affect the Company); (ii) breaches of the duty
of care which were made either intentionally or recklessly, unless if they were
made negligently; (iii) an action intended to produce unlawful personal profit;
or (iv) a fine imposed upon the Officer. The directors and officers insurance
and Indemnification and Exculpation Letter, to the extent applicable to
directors, were approved by the Companys shareholders on October 31, 2002,
covering acts and omissions made in their status as officers; worldwide
(including the US and Canada). Companys undertakings under the Indemnification
and Exculpation Letter are subject to its undertaking made under its F-1
according to which it shall not be bound to indemnify and exculpate its
directors and officers if such undertaking shall be held contradictory to
public policy under the ruling of a competent court.

For
information relating to options granted to officers and directors, see Share
Ownership starting on page 43.

Item 8. Financial Information

Consolidated
Financial Statements

See
Financial Statements on page 68 of this report and pages F-1 through F-24.

Significant
Changes

None.

Legal
Proceedings

From
time to time, we are a party to legal proceedings and claims in the ordinary
course of business. We are not currently a party to any material legal
proceedings, apart from the below.

In
1998, Intel Corporation (Intel), a major customer and former shareholder,
notified us by letter that a lawsuit had been filed against a number of
semiconductor manufacturers, including Intel, by the Lemelson Medical,
Education & Research Foundation. The suit alleged that these semiconductor
manufacturers infringed upon U.S. patents owned by Lemelson. In its 1998
letter, Intel requested that we defend, indemnify and hold it harmless against
the Lemelson claims to the extent the claims resulted from the use of the
products we sold to Intel. We did not undertake the defense or agree to hold
Intel harmless as it requested. Subsequently, in January 2004, in a suit filed
against Lemelson by Cognex Corporation,but not involving Intel or Nova, the
United States District Court for the District of Nevada found that various
Lemelson patents, including those upon which Lemelson based its claims against
Intel, were invalid and not enforceable. We, therefore, believe that we will
not have any liability to Intel in connection with the Lemelson suit against
Intel and other semiconductor manufacturers. We have, however, not received any
formal communication from Intel withdrawing its request for defense and
indemnification.

In
March 2005, we filed a civil action in the United States District Court for the
Northern District of California against Nanometrics Inc. seeking to enforce our
United States Patent No. 6,752,689 and in April 2006 Nanometrics filed a civil
action in the United States District Court for the Northern District of
California against us and our wholly-owned subsidiary, Nova Inc. seeking to
enforce their United States Patent No. Re:34,783. For additional information
regarding this litigation, see Intellectual Property starting on page 21. In
addition, as described below under Material Contracts starting on page 54, in
connection with our pending acquisition of HyperNex, Inc., we commenced
litigation against one of HyperNexs key suppliers as a result of the
suppliers refusal to consent to the assignment to Nova of the suppliers
contract with HyperNex.

Dividend
Policies

We
anticipate that, for the foreseeable future, we will retain any earnings to
support operations and to finance the growth and development of our business.
Therefore, we do not expect to pay cash dividends for at least the next several
years.

- 48 -

---

---



We
obtained the status of approved enterprise under the Law for the
Encouragement of Capital Investments, 1959, under which we may take advantage
of certain tax exemptions. We may further obtain such status in the future. If
we distribute a cash dividend from income which is tax exempt, we would have to
pay corporate tax at a rate of up to 25% on the amount equal to the amount
distributed and on the amount of corporate tax which would have been due in the
absence of the tax exemption, in addition to withholding tax on such dividends
paid. For further description of the conditions limiting our ability to declare
and pay dividends see Taxation starting on page 56.

The
distribution of dividends may also be limited by the Israeli Companies Law,
which permits the distribution of dividends only out of retained earnings or
earnings derived over the two most recent fiscal years, whichever is higher,
provided that there is no reasonable concern that payment of a dividend will
prevent a company from satisfying its existing and foreseeable obligations as
they become due. Our Articles provide that dividends will be paid at the
discretion of, and upon resolution by, our Board of Directors however, the
Board of Directors at its discretion, may transfer the decision in this matter
to the general meeting.

Export
Sales

Substantially
all of our products are sold to customers located outside Israel.

Item 9. The Offer and Listing

Offer
and listing details

The
information presented in the table below presents, for the periods indicated,
the reported high and low closing sales prices on the Nasdaq National Market of
our ordinary shares. The shares began trading on the Nasdaq National Market on
April 11, 2000 at a price of $18 per share. Our ordinary shares were registered
for trading on the Tel Aviv Stock Exchange in 2002 and the table below
presents, for the periods indicated, the reported high and low sales prices on
the Tel Aviv Stock Exchange.

- 49 -

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|                         |  |                       |       |     |  |      | 
|------------------------ |  | --------------------- | ----- | --- |  | ---- | 
|Nasdaq
  National Market
|                         |  | Price per share (US$) |      
|                         |  |                       |      
|                         |  | High                  |       | Low | 
|                         |  |                       |       |     | 
|Yearly highs and lows    |  |                       |       |     |  |      | 
|2001                     |  |                       | 10.97 |     |  | 2.46 | 
|2002                     |  |                       | 4.54  |     |  | 0.86 | 
|2003                     |  |                       | 7.19  |     |  | 1.42 | 
|2004                     |  |                       | 8.21  |     |  | 3.00 | 
|2005                     |  |                       | 3.84  |     |  | 2.00 | 
|                         |  |                       |       |     |  |      | 
|Quarterly highs and lows |  |                       |       |     |  |      | 
|2004                     |  |                       |       |     |  |      | 
|First quarter            |  |                       | 8.21  |     |  | 5.15 | 
|Second quarter           |  |                       | 7.32  |     |  | 3.80 | 
|Third quarter            |  |                       | 4.25  |     |  | 3.00 | 
|Fourth quarter           |  |                       | 4.63  |     |  | 3.19 | 
|2005                     |  |                       |       |     |  |      | 
|First quarter            |  |                       | 3.84  |     |  | 2.77 | 
|Second quarter           |  |                       | 3.00  |     |  | 2.22 | 
|Third quarter            |  |                       | 2.98  |     |  | 2.20 | 
|Fourth quarter           |  |                       | 2.47  |     |  | 2.00 | 
|2006                     |  |                       |       |     |  |      | 
|First quarter            |  |                       | 2.64  |     |  | 1.90 | 
|                         |  |                       |       |     |  |      | 
|Monthly highs and lows   |  |                       |       |     |  |      | 
|2005                     |  |                       |       |     |  |      | 
|December                 |  |                       | 2.42  |     |  | 2.14 | 
|2006                     |  |                       |       |     |  |      | 
|January                  |  |                       | 2.64  |     |  | 2.36 | 
|February                 |  |                       | 2.55  |     |  | 2.08 | 
|March                    |  |                       | 2.24  |     |  | 1.90 | 
|April                    |  |                       | 1.96  |     |  | 1.72 | 
|May                      |  |                       |       |     |  |      | 

|                          |  |                       |       |     |  |       | 
|------------------------- |  | --------------------- | ----- | --- |  | ----- | 
|Tel Aviv Stock Exchange * | 
|                          |  | Price per share (NIS) |      
|                          |  |                       |      
|                          |  | High                  |       | Low | 
|                          |  |                       |       |     | 
|Yearly highs and lows     |  |                       |       |     |  |       | 
|2002                      |  |                       | 11.58 |     |  | 10.80 | 
|2005                      |  |                       | 14.08 |     |  | 9.56  | 

*During the years 2003 and 2004 there has been no
market activity at the TASE

Item 10. Additional Information

Set
forth below is a summary of certain provisions of the Companys memorandum and
articles of association, as amended to date, and Israeli law affecting
shareholders of the Company. This summary does not purport to be complete and
is qualified in its entirety by reference to our memorandum and articles of
association and such law.

Registration.
The Company was incepted and registered in the Israeli Registrar of Companys
on May 17, 1993, under registration number 51-181-246-3.

- 50 -

---

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Purpose
of the Company. The purposes of the Company, as provided by
Article B(3) of our memorandum and articles of association, are (a) to invent,
design, plan, develop, manufacture, market and trade in the field of measuring
instruments in electronics, micro-electronics, medicine, chemistry, metallurgy,
ceramics and any other field, (b) to initiate, participate, manage, execute,
import and export any kind of project within the borders of the State of Israel
and/or outside Israel, (c) to register patents, trademarks, trade names
intellectual property rights marketing rights and any other right of any kind
whatsoever, both in Israel and abroad and (d) to engage in any legal activity,
both in Israel and abroad.

Approval
of Related Party Transaction; Corporate Borrowings.The
Israeli Companies Law, to which the company is subject, requires that an office
holder of a company, including directors and executive officers, promptly
disclose to the board of directors of that company any personal interest that
the office holder may have and all related material information known about any
existing or proposed transaction with the company. The approval of the board of
directors is required, as long as the transaction is in the best of the
company, for a transaction that it not an extraordinary transaction, between
the company and its office holder or between the company and another person in
which the office holder has a personal interest, unless the articles of
association provide otherwise. If the transaction is an extraordinary
transaction, it also requires the approval of the audit committee prior to its
being approved by the board of directors. In the event that the transaction is
between the company and a director regarding the directors terms of engagement
with the company, including with regard to other positions in the company
filled by the director and including with respect to indemnification, insurance
and exemptions, the transaction requires the approval of the audit committee,
the board of directors and the shareholders.

The
Companies Law applies the same disclosure requirements 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. Approving an extraordinary transaction with a controlling
shareholder requires the approval of the companys audit committee, the board
of directors and the companys shareholders. Approval by the companys
shareholder must be by the affirmative vote of a majority of the shares
attending in person or by proxy and, in addition, at least one third of the
holders of shares who do not have personal interest in approving the
transaction attending in person or represented by proxy must vote in favor of
the proposal, or the aggregate number of shares voted against the proposal must
not exceed one per cent (1%) of the Companys voting rights.

Under
our articles of association, a transaction by the Company with an officer or
director of the Company, in which transaction such officer or director has a
personal interest, other than an extraordinary transaction, does not require
any board or shareholder approval. Interested board members may not vote on
extraordinary transactions. Arrangements regarding the compensation of
directors are considered extraordinary transactions and require approval by
the board of directors, audit committee and shareholders. Arrangements as to
compensation of officers employment terms require approval only by the board of
directors and audit committee.

Under
regulations promulgated under the Companies Law regarding payment of
compensation to external directors, compensation of external directors shall be
comprised of annual compensation and a per meeting payment ranging as stated in
the regulations. These amounts are adjusted twice a year in accordance with the
Israeli consumer price index. However, with regard to a company, which shares
are traded in an exchange outside of Israel, and is subject to laws which
impose upon the external directors demands which exceed the demands imposed
upon them under Israeli law, the maximum amount payable to the external
directors is 100,000 NIS per annum and NIS 3,000 per meeting. The approval of
the shareholders of the Company is required for such compensation, unless it is
at a fixed amount set forth in these regulations, or if the external director
is in its three years tenure and the compensation does not change.
Additionally, external directors may entitled to compensation in stock
(including by way of granting options to purchase the Companys stock),
provided that such compensation is granted within the framework of a stock
incentive plan applicable to all other directors and further provided the
amount of stock granted or purchasable shall not fall below the lowest amount
granted to any other director and shall not exceed the average amount of stock
granted to all other directors.

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Our
articles of association grant broad powers to the board of directors to
authorize the Company to borrow funds, repay borrowings, make guarantees, and
grant security interests in borrowings. There is no mandatory retirement age
for the Companys directors and a director need not be a shareholder of the
Company.

Share
Capital. The Company currently has one class of ordinary
stock, 0.01 NIS par value per share. Our articles of association provide that
the board of directors may declare dividends out of funds legally available
therefor. Under the Israeli Companies Law, dividends may be paid out of net
earnings, as calculated under that law, for the two years preceding the
distribution of the dividend and retained earnings, provided that there is no
reasonable concern that the dividend will prevent the company from satisfying
its existing and foreseeable obligations as they become due. For more
information, see the Companys balance sheet and the statement of shareholders
equity in the financial statements. Each ordinary share is entitled to one vote
of all meetings of shareholders.

Changes
of Rights of Holders of the Ordinary Shares.The rights
attached to the ordinary shares may be changed, converted, expanded or altered
in any other way by the shareholders with the vote of the holders of at least
75% of the ordinary shares.

Shareholders
Meetings.An annual meeting shall be convened at least once
every calendar year, and no later than 15 months after the preceding annual
meeting, to deliberate on the financial reports, appointment of directors, appointment
of an auditing accountant, and any other matter which the board of directors
places on the agenda of the annual meeting, at a time and place that the board
of directors shall determine. An extraordinary meeting may be called by the
board of directors and at the demand of any of the following: two directors or
one-quarter of the directors then serving; one or more shareholders who hold at
least five per cent of the issued and outstanding capital stock and at least
one percent of the voting rights in the Company; or one or more shareholders
who hold at least five percent of the voting rights in the Company.

According
to our articles of association, the quorum required for an ordinary meeting of
shareholders is at least two shareholders present in person or by proxy who
together hold or represent in the aggregate more than one third (33.33%) of the
voting power. A meeting adjourned for lack of a quorum is adjourned to the same
day in the following week at the same time and place or to a later date if said
date is indicated in the prior written notice or if the Company has sent to the
shareholders a prior notice of no less than 72 hours before the date set for
the postponed meeting. At the reconvened meeting, the required quorum consists
of any number of members present in person or by proxy, regardless of the
number of shares represented. Israeli Companies Law and regulations determine
that prior notice of no less than 21 days should be given the companys
shareholders, prior to convening a meeting. In the event that the issue to be
resolved is an issue listed in Article 87 to the Israeli Companies Law and is
to be voted upon pursuant to a proxy solicitation, a notice of no less than 35
days should be given to the companys shareholders.

There
are no limitations on the rights of non-resident or foreign owners to hold or
vote ordinary shares imposed under Israeli law or under the Companys
memorandum or articles of association.

Board
of Directors. Our articles of association provide that
directors may be elected either at our annual general meeting or an
extraordinary meeting of shareholders by a vote of the holders of at least 50%
of the total number of votes represented at such meeting. In addition, our
board of directors is authorized to appoint directors, at its discretion,
provided that the total number of directors shall not exceed the maximum number
of directors permitted by our articles of association. Each of our directors
holds office until the next annual general meeting of shareholders. However, in
accordance with the Israeli Companies Law, our external directors serve for
three years, which may be renewed for only one additional three year term. The
Companies Law requires that the offices of the Chief Executive Officer and the
Chairman of the board of directors be held by different persons. However, the
Companies Law further provide that those positions may be held by the same
person for a period not exceeding three years if approved by a majority of the
companys shareholder, including at least two thirds of the voting present
shareholders (shares held by abstaining shareholders are not considered) which
are not controlling shareholders or the aggregate number of shares voting
against the proposal shall not exceed 1% of company voting shareholders.

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The
Companies Law provides that Israeli public companies must have at least two
external directors. External directors may be elected at our annual general
meeting or an extraordinary meeting of our shareholders in a number and manner
stipulated by law, namely, for a term of three years which may be renewed for
only one additional three year term and requires the affirmative vote of a
majority of the shares and in addition either that (i) at least one third
(33.33%) of the holders of shares who are not controlling shareholders
attending in person or represented by proxy have voted in favor of the proposal
(shares held by abstaining shareholders shall not be considered) or (ii) the
aggregate number of shares voting against the proposal has not exceeded 1% of
the companys voting shareholders. External directors may be removed from
office only under the following circumstances: (i) an external director ceases
to meet the legal requirements for appointment as an external director or
breaches his or her fiduciary duty to the company and a resolution to remove
such external director is made by the shareholders at a meeting at which such
external director is granted a reasonable opportunity to express his position such
a resolution requires the same majority of votes that elected the external
director) (ii) an external director ceases to meet the legal requirements for
appointment as an external director or breaches his or her fiduciary duty to
the Company and a court orders that such director be removed; or (iii) an
external director is unable to perform his or her duties or is convicted of
certain felonies and a court orders that such director be removed.

According
to a recent amendment made to the Companies Law, an external director is
qualified for nomination as an external director, only if he/she has either
professional qualifications or accounting and financial expertise. The
amendment also provides that at least one of the external directors must have
accounting and financial expertise. Since the Company is not anticipated to
nominate an external director before August 2006, this amendment does not apply
to the Company until such nomination. At the time of nomination, the Company
shall be required to nominate an external director who has professional
qualifications or accounting and financial expertise provided that at least one
of the external directors to serve the Company has accounting and financial
expertise.

Regulations
adopted pursuant to that recent legislation provide that a director with
accounting and financial expertise is a director that due to his education,
experience and skills has high expertise and understanding in
business-accounting matters and financial statements in a way that enables him
to deeply understand the financial statements of the company and to facilitate
discussion with respect to the way the financial data should be presented. The
assessment of the accounting and financial expertise of a director shall be made
by the board of directors, who shall take into consideration, inter alia, the education, experience and
knowledge of the director in the following subjects:

| |     |                                                                                                                                                                                      
| | --- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | (1) | Accounting matters and audit accounting matters,
  which are typical to the sector in which the company works and of companies
  with the same size and complexity as of the company;
| |     |                                                                                                                                                                                      
| | (2) | The duties and obligations of the auditing
  accountant; and                                                                                                                         
| |     |                                                                                                                                                                                      
| | (3) | Preparing of financial statements and their approval
  according to applicable law, including securities law.                                                                        

The
regulations also provide that a director with professional qualifications is a
director who meets one of the following conditions:

| |     |                                                                                                                                                                                     |     |                                                                                                              
| | --- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | --- | -------------------------------------------------------------------------------------------------------------
| | (1) | A holder of an academic degree in one of the
  following: economics, business administration, accounting, law, or public
  administration;                                         
| |     |                                                                                                                                                                                     |     |                                                                                                              
| | (2) | A holder of another academic degree or is otherwise
  a graduate of higher education in a major field of business of the company or
  in other filed which is relevant to the role;
| |     |                                                                                                                                                                                     |     |                                                                                                              
| | (3) | He has experience of at least five years in one of
  the following, or that he has cumulative experience of at least five years in
  two or more of the following:                 
| |     |                                                                                                                                                                                     |     |                                                                                                              
| |     |                                                                                                                                                                                     | (a) | In a senior position in the business management of a
  corporation which has a significant scope of business;
| |     |                                                                                                                                                                                     |     |                                                                                                              
| |     |                                                                                                                                                                                     | (b) | In a senior public position or in a senior role in
  the public service; or                                  
| |     |                                                                                                                                                                                     |     |                                                                                                              
| |     |                                                                                                                                                                                     | (c) | In a senior position in the major fields of business
  of the company.                                       

According
to the Companies Law, the Board of directors of a public company must establish
the minimum number of board members that are to have accounting and financial
expertise while considering, inter alia,
the nature of the company, its size, the scope and complexity of its operations
and the number of directors stated in the Articles of Association of the
company. When adopting such a resolution (that sets the minimum number of board
members that are to have accounting and financial expertise) the company must
also appoint such directors.

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On
April 2006, the Board of Directors resolved that the minimum number of board
members that need to have accounting and financial expertise, including the
external director with accounting and financial expertise is one (1).

The
board stated that the member that has accounting and financial expertise is Ms.
Lauri Hanover.

Our
board of directors has the authority to issue preferred stock in one or more
classes or series and to fix the voting powers, preferences and relative
participating, optional or other special rights of such preferred stock,
without any further vote or action by the shareholders, subject to specific
events as detailed in our Articles of Association and relevant rules.

Changes
in Capital. Our share capital may be increased or decreased
by a vote of the holders of at least 75% of the shares present at the
shareholders meeting.

Acquisition
of a Controlling Stake.According to the Companys Law, an acquisition pursuant to which a
purchaser shall hold a controlling stake, that is defined as 25% or more of
the voting rights if no other shareholder holds a controlling stake, or an
acquisition pursuant to which such purchaser shall hold 45% or more of the
voting rights of the company if no other shareholder owns more than 45% of the
voting rights, may not be performed by way of market accumulation, but only by
way of a tender offer made to all of the companys shareholders on a pro rata
basis. Such offer needs to be approved by the companys shareholders. A
shareholder may be free to object to such offer without such objection being
deemed as waiver of his right to sell its respective shares if the transaction
is approved by a majority of the companys shareholders despite his objection.
Shares purchased not in accordance with those provisions shall become dormant
shares and shall not grant the purchaser any rights so long as held by the
purchaser.

Merger.
The Companies Law requires an acquirer of a public companys shares who wishes
to acquire all of the companys shares without the approval of its minority
shareholders to acquire at least 95% of all outstanding shares. Even if the
acquirer acquires 95% of the outstanding shares, the remaining minority
shareholders may seek to block the acquisition in court.

The
Companies Law provides that corporate mergers require the approval of both
companies boards of directors and shareholders. In the event, however that
shares of the target company are held by the acquiring company or by a person
holding 25% or more of any type of controlling means of the acquiring company,
the merger will not be approved if a majority of the shareholders of the target
company attending and voting at the meeting at which the merger is considered
(without taking into account, for that purpose, the shares held by the acquiring
company or by a person holding 25% or more of any type of controlling means of
the acquiring company) object to and do not vote in favor of the merger. If a
person holds 25% or more of any type of controlling means of more than one
merging company, the same provisions shall apply with regard to the
shareholders vote with respect to each such company. Upon the request of a
creditor of either party to the proposed merger, the Israeli courts may delay
or prevent the merger if the courts conclude that there exists a reasonable
concern that as a result of the merger the surviving company will be unable to
satisfy the target companys obligations. Furthermore, a merger may not close
unless at least 30 days have passed from the time that the general meeting of each
of the merging companies was held
and at least 50 days have passed from the date on which the merger proposal was
sent to the Israeli Registrar of Companies.

In
addition, the Companies Law preserves provisions of its predecessor, the
Companies Ordinance, dealing with arrangements between a company and its
shareholders. These arrangements may be used to effect squeeze out transactions
in which the target company becomes a wholly owned subsidiary of the acquirer.
These provisions generally require that the merger be approved by at least 75%
of the shares of participating shareholders and a majority of the shareholders
voting at a shareholders meeting. In addition to shareholder approval, court
approval of the transaction is required, which entails further delay.

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A
merger, the acquisition of a controlling stake or any transaction in which all
or substantially all the assets of a company are de facto transferred to
another company, may require the approval of the Israeli Commissioner of
Restrictive Trade Practices, in the event that the aggregate annual sales
volume in Israel of all the companies which are parties to such transaction,
exceeds 150,000,000 NIS (approximately $33,000,000, an amount which is adjusted
on an annual basis), and also if after the consummation of such transactions,
the joint market, in Israel, or at any identified geographic part of Israel
will be in excess of 50% with respect to such products and services.

Material
Contracts

On
April 24, 2006, we entered into an Asset Purchase Agreement with HyperNex, Inc.
(HyperNex), Delaware corporation located at State College, Pennsylvania and
its shareholders providing for the acquisition by us of substantially all the
assets of HyperNex and our assumption of certain specified liabilities, including
liabilities accruing after the closing relating to contracts assumed by Nova. A
copy of the agreement is filed with this report as Exhibit 4.19.

Under
the terms of the Asset Purchase Agreement, we will issue up to 1.8 million
ordinary shares as follows: at the closing of the acquisition transaction, we
will issue 883,350 ordinary shares to HyperNex and 286,650 ordinary shares to
HyperNex employees; and 15 months after closing, subject to certain
contingencies, including potential indemnity claims that may be made by us, we
will issue up to an additional 475,650 ordinary shares to HyperNex and an
additional 154,350 ordinary shares to the employees. The total number of shares
issuable 15 months after the closing is also subject to downward adjustment in the
event that HyperNexs net worth is less than the target net worth set forth in
the Asset Purchase Agreement. The Asset Purchase Agreement also provides the
recipients of our ordinary shares with certain limited piggy-back registration
rights with respect to our ordinary shares they receive. These piggy-back
registration rights are subject to certain customary carve-outs and limitations
as well as other limitations set forth in the Asset Purchase Agreement.

The
Asset Purchase Agreement also provides that in connection with the closing,
each HyperNex employee receiving shares will enter into a restricted stock
agreement with respect to our ordinary shares received and to be received by
the employee, an employment agreement and a non-compete agreement. In addition,
so long as either HyperNex or its shareholders own at least 8% of our
outstanding capital stock, they will be entitled to appoint an observer to our
Board of Directors.

The
Asset Purchase Agreement contains customary representations, warranties and
covenants and generally provides that the parties respective liabilities for
breaches of the representations and warranties will not exceed 35% of the stock
issued under the Asset Purchase Agreement or its monetary value at closing, or
100% of the stock or its monetary value at closing in the case of breaches of
certain representations and warranties and certain knowing breaches. Under
certain circumstances, a partys liability for a knowing breach of a
representation or a warranty may also be unlimited. The transaction is also
subject to certain closing conditions, including the completion of legal due
diligence by us to its satisfaction and the negotiation and execution of
amendments to certain agreements with third parties. Under certain specified circumstances,
the Asset Purchase Agreement may be terminated by us or HyperNex prior to the
consummation of the transactions described in the agreement.

The
forgoing summary does not purport to be complete and is qualified in its
entirety by reference to the full text of the Asset Purchase Agreement, a copy
of which is filed with this report as Exhibit 4.19.

The
closing of the HyperNex acquisition is being delayed because of the refusal of
a key supplier of HyperNex to consent to the assignment of its contract with
HyperNex to us. The terms of the agreement between HyperNex and the supplier
provide, among other things, that the suppliers consent to the assignment of
its agreement with us may not be unreasonably withheld or delayed. We believe
that HyperNexs supplier is being unreasonable in withholding its consent.
Accordingly, on June 6, 2006, we filed a civil action in the United States
District Court for the Middle District of Pennsylvania, seeking to enjoin the
supplier from interfering with the closing of the Asset Purchase Agreement. As
this litigation is in its initial stages, we cannot predict its outcome. If the
outcome of the litigation is adverse to us, we may not be able to consummate
our proposed acquisition of HyperNex Inc. which may have a material adverse
effect on us. In addition, we have incurred, and it is likely that we will
continue to incur, substantial costs as a result of this litigation which, in
the future, may be material.

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Costs
related to this agreement have accumulated to approximately $1 million as of
June 2006. These costs include legal, accounting and consulting fees, travels
and bridge funding to support Hypernex on-going activity until closing. There
is no assurance that we will be able to recover the bridge funding in case we
are not able to consummate the acquisition. The above described costs will be
presented in our 2006 second quarter financial results and forward.

Exchange
Controls

Non-residents
of Israel who purchase our ordinary shares outside of Israel with U.S. dollars
or other foreign currency will be able to convert dividends (if any) thereon,
and any amounts payable upon the dissolution, liquidation or winding up of the
affairs of the Company, as well as the proceeds of any sale in Israel of the
ordinary shares to an Israeli resident, into freely repatriable dollars, at a
rate of exchange prevailing at the time of conversion, pursuant to regulations
issued under the Currency Control Law, 1978, provided that Israeli income tax
has been withheld by the Company with respect to such amounts. Israeli
residents are eligible to purchase securities of certain companies, including
our ordinary shares, if they are listed on a foreign exchange in a designated
country, which is defined to include the Nasdaq.

Taxation

The
following summary describes the current tax structure applicable to companies
in Israel, with special reference to its effect on us. It also discusses
Israeli tax consequences material to persons holding our ordinary shares.
Because some parts of the summary are based on new tax legislation yet to be
judicially or administratively interpreted, we cannot be sure that the views
expressed will accord with any future interpretation. The summary is not
intended, and should not be construed, as legal or professional tax advice and
does not exhaust all possible tax considerations. Accordingly, you should
consult your own tax advisor as to the particular tax consequences of an
investment in our ordinary shares.

Tax
Reform

During
the year 2002, tax reform legislation was enacted with effect from January 1,
2003, which significantly changed the taxation basis of corporate and
individual taxpayers from a territorial basis to a worldwide basis. From such
date, an Israel resident taxpayer will be taxed on income produced and derived
both in and out of Israel. The main provisions of the tax reform that may
affect the Company are as follows:

Transfer
pricing of international transactions with related parties.The
Income Tax Ordinance was amended to include provisions concerning transfer
pricing between related parties, where one of the parties is situated abroad.
Detailed provisions are to be included in Income Tax Regulations that have yet
to be issued. Although the Company considers that the transfer pricing policy
adopted with foreign affiliates is economically fair, an adjustment may be
required following the issue of the said Regulations.

Employee
stock incentive plans.The tax reform codified past practice
and determined three alternative tracks for taxing employee stock option plans.
Where a trustee arrangement is in place, the employer can either claim an
expense for tax purposes while the employee will be fully taxed up to the
maximum marginal tax rate of 50% or the Company can waive the tax expense and
the employee will pay a reduced tax rate of 25%. Where there is no trustee
arrangement, the employee is fully taxable and no expense is allowed to the
Company. There are detailed provisions for implementing these tracks. For
Option Plans 6 and 7, which were allocated after the implementation of the tax
reform, the Company has used the trustee arrangement, with waiver of the tax
expense for the company and employee payment of reduced tax rate of 25%. As a
result of the reform, the income tax authorities allowed the Company a change
of tracks with regard to unvested options issued under option plans prior to
the tax reform taking effect, subject to the optionees agreeing to certain
restrictions.

Controlled
foreign company (CFC).The amendment to the law introduced
Controlled Foreign Company (CFC) provisions, which, in certain circumstances,
will lead to the Israeli company being charged tax on passive income of foreign
affiliates as if it had received a dividend from such companies. This change is
not expected to have material affect on the companys financial results and tax
payments.

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Capital
gains tax.Capital gains tax is reduced to 25% from 36%,
except with respect to capital gains from marketable securities, with
transitional provisions for assets acquired prior to January 1, 2003. For
further discussion see below Capital Gains Tax.

Carrying
forward of capital losses.The seven year limit for carrying forward
of capital losses has been removed with respect to capital losses arising from
1996 and thereafter. This change is not expected to have material affect on the
companys financial results and tax payments.

General
Corporate Tax Structure

In
2005, the Israeli Knesset approved a law for the amendment of the Income Tax
Ordinance, according to which the regular corporate tax rate is to be reduced
gradually and annually from 35% in 2004 tax year to 34% in
2005 tax year, ending at 25% for the 2010 tax year.

Following
this amendment of law, Israeli companies are taxed at a rate of 34% of taxable
income in 2005. This rate is currently scheduled to decrease as follows: in
2006-31%, 2007-29%, 2008-27%, 2009-26% and 2010 and onward-25%. However, the
effective tax rate payable by a company that derives income from an approved
enterprise may be considerably less, as further discussed below.

Tax
Benefits under the Law for the Encouragement of Capital Investments, 1959

The
Law for the Encouragement of Capital Investments, 1959, provides that upon
application to the Investment Center of the Ministry of Industry Trade and Labor,
a proposed capital investment in eligible facilities may be designated as an
approved enterprise. Each certificate of approval for an approved enterprise
relates to a specific investment program delineated both by its financial
scope, including its capital sources, and by its physical characteristics, such
as the equipment to be purchased and utilized under the program. The tax
benefits derived from this certificate of approval relate only to taxable
income derived from growth in operations as determined generally by the growth
in manufacturing revenues 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. The tax benefits under the law are not available for
income derived from products manufactured outside of Israel.

Taxable
income of a company derived from an approved enterprise is taxed at the maximum
rate of 25%, rather than the usual rate of 35% (or less as described above),
for the benefit period. This period is ordinarily seven years commencing with
the year in which the approved enterprise first generates taxable income, and
is limited to 12 years from the year of commencement of operations, as
determined by the Investment Center, or 14 years from the year of approval,
whichever is earlier.

A
company owning an approved enterprise may elect to receive an alternative
package of benefits. Under the alternative package, the companys undistributed
income derived from an approved enterprise will be exempt from tax for a period
of between two and ten years from the first year of taxable income, depending
on the geographic location of the approved enterprise within Israel, subject to
the 12- and 14-year limitations, and the company will be eligible for the tax
benefits under the law for the remainder of the benefits period.

A
company that has an approved enterprise program is eligible for further tax
benefits if it qualifies as a foreign investors company. A foreign investors
company is a company more than 25% of whose share capital and combined share
and loan capital is owned by non-Israeli residents. A company, which qualifies
as a foreign investors company and has an approved enterprise program is
eligible for tax benefits for a ten-year benefit period instead of the ordinary
seven-year period. Income derived from the approved enterprise program will be
exempt from tax for a specified period and will be taxed at a reduced rate for
the rest of the period. The tax rate for the additional eight years is 25%,
unless the level of foreign investment exceeds 49%, in which case the tax rate
is 20% if the foreign investment is more than 49% and less than 74%, 15% if
more than 74% and less than 90%, and 10% if 90% or more.

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The
Investment Center bases its decision of whether to approve or reject a
companys application for designation as an approved enterprise on criteria set
forth in the law and related regulations, the then prevailing policy of the
Investment Center and the specific objectives and financial criteria of the
applicant. Accordingly, a company cannot be certain in advance whether its
application will be approved. In addition, the benefits available to an
approved enterprise are conditional upon compliance with the conditions
stipulated in the law and related regulations and the criteria set forth in the
specific certificate of approval. In the event that a company violates these
conditions, in whole or in part, it would be required to refund the amount of
tax benefits plus an amount linked to the Israeli consumer price index and
interest.

A
major portion of our production facilities has been granted the status of
approved enterprises. Income arising from our approved enterprise facilities is
tax-free under the alternative package of benefits described above and entitled
to reduced tax rates of up to 25%, based on the level of foreign ownership for
specified periods. We have derived, and expect to continue to derive, a substantial
portion of our income from our approved enterprise facilities. In general, the
benefits for most of our current production facilities in Israel will continue
until termination in 2006. Our current investments in facilities are made under
new approvals, the benefits of which will continue no longer than 2012.

An
approved enterprise may elect to distribute dividends from taxable or
tax-exempt income. Dividends distributed from taxable income are considered to
be attributable to the entire taxable income of the enterprise and their
effective tax rate is the result of a weighted combination of the applicable
tax rates. We currently intend to reinvest the amount of our income and not to
distribute such income as a dividend. In the event that we do pay a cash
dividend from income that is derived from our approved enterprises under the
alternative package of benefits, which income would normally be tax-exempt, we
would be required to pay tax on the amount intended to be distributed as
dividends at the rate which would have been applicable had we not elected the
alternative package of benefits, generally 10% to 25%, depending on the
percentage of our shares held by foreign shareholders. The dividend recipient
is taxed at the reduced rate of 15% applicable to dividends from approved
enterprises if the dividend is distributed during the tax-exemption period or
within 12 years thereafter. We would be required to withhold this tax at
source, as final tax in Israel. See U.S. Taxation - Distributions on the
Ordinary Shares and Note 11 to our Consolidated Financial Statements.

The
law also provides that an approved enterprise is entitled to accelerated
depreciation on property and equipment included in an approved investment
program, generally ranging from 200% for equipment, to 400% for buildings, of
ordinary depreciation rates during the first five tax years of the operation of
these assets with a ceiling of 20% per year for depreciation on buildings.

In
March 2005, the government of Israel approved an amendment to the Investment
Law, in which it revised the criteria for investments qualified to receive tax
benefits as an Approved Enterprise. Among other things, company that met the
criteria of alternate package of tax benefits will receive those benefits
without a prior approval.

Tax
Benefits for Research and Development

Israeli
tax law allows a tax deduction in the year incurred for expenditures, including
capital expenditures, in scientific research and development projects, if the
projects are approved by the relevant Israeli government ministry and the
research and development is for the promotion of the enterprise. Expenditures
from projects not so approved are deductible over a three-year period. However,
expenses made out of proceeds made available to us through government grants
are not deductible according to Israeli law.

Tax
Benefits under the Law for the Encouragement of Industry (Taxes), 1969

According
to the Law for the Encouragement of Industry (Taxes), 1969, an industrial
company is a company located in Israel, of which at least 90% of the income,
exclusive of income from defense 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 believe that we currently qualify as
an industrial company within the definition of the Law for the Encouragement of
Industry (Taxes), 1969.

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Under
the 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;                                                                                                                                                                                        
| |   |                                                                                                                                                                                                                                                                                     
| |  | deduction of specified expenses incurred in
  connection with a public issuance of securities over a three-year period for
  tax purposes, although Israeli tax authorities have indicated that they do
  not allow these deductions in connection with offerings outside of Israel;
| |   |                                                                                                                                                                                                                                                                                     
| |  | an election to file a consolidated tax return with
  related Israeli industrial companies that satisfy conditions set forth in the
  law; and                                                                                                                                       

Additionally,
certain tax laws and regulation allow accelerated depreciation rates on
equipment and buildings for industrial companies while referring to the
definition of industrial company set out by the Law for the Encouragement of
Industry (Taxes), 1969.

Eligibility
for the benefits under the law does not require receipt of prior approval from
any governmental authority. However, the Israeli tax authorities may determine
that we do not qualify as an industrial company. In addition, we might not
continue to qualify as an industrial Company in the future. As a result of
either of the foregoing, the benefits described above might not be available in
the future.

Special
Provisions Relating to Taxation Under Inflationary Conditions

The
Income Tax Law (Inflationary Adjustments) (the Inflationary Adjustments Law),
1985 represents an attempt to overcome the problems presented to a traditional
tax system by an economy undergoing inflation. The law is highly complex. Its features
that are material to us can be described as follows:

| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | A special tax adjustment for the preservation of
  equity whereby corporate assets are classified broadly into fixed, or
  inflation immune assets and non-fixed, or soft assets. Where a companys equity
  exceeds the depreciated cost of its fixed assets, the company may take a
  deduction from taxable income, including tax-exempt income, that reflects the
  effect of multiplication of the annual rate of inflation on this excess, up
  to a ceiling of 70% of taxable income, including tax exempt income, in any
  single tax year, with the unused portion carried forward on a linked basis.
  If the depreciated cost of fixed assets exceeds a companys equity, then the
  excess multiplied by the annual rate of inflation is added to taxable income.
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |  | Depreciation deductions on fixed assets and losses
  carried forward are generally adjusted for inflation based on the increase of
  the Israeli consumer price index.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |  | Gains on traded securities, which are normally
  exempt from tax, are taxable in specified circumstances. However, the regular
  tax rules governing business income in Israel apply to dealers in securities.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               

In
accordance with an amendment to the Inflationary Adjustments Law, the Minister
of Finance may, with the approval of the Knesset Finance Committee, determine
by order, during a certain fiscal year (or until February 28th of the following
year), in which the rate of increase of the price index would not exceed or
shall not have exceeded, as applicable, 3%, that all or some of the provisions
of this law shall not apply to such fiscal year, or, that the rate of increase
of the price index relating to such fiscal year shall be deemed to be 0%, and
to make the adjustments required to be made as a result of such determination.

Capital
Gains Tax

Israeli
law imposes a capital gains tax on the sale of capital assets. The law
distinguishes between the inflationary surplus and the real gain. The
inflationary surplus is a portion of the total capital gain, which is
equivalent to the increase of the relevant assets purchase price that is
attributable to the increase in the Israeli consumer price index between the
date of purchase and the date of sale. The real gain is the excess of the total
capital gain over the inflationary surplus. Inflationary surplus accumulated
after December 31, 1993 is exempt from any capital gains tax in Israel. The
real gain is added to ordinary income, which is taxed at ordinary rates of 30%
to 50% for individuals and 36%, up to December 31, 2002 and 25% thereafter for
corporations. Prior to the reform, individuals were exempt from capital gains
tax on the sale of shares listed for trade in certain stock exchanges,
including Nasdaq under certain conditions.

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As
a result of the recent tax reform legislation in Israel, gains from the sale of
our ordinary shares and warrants to purchase our ordinary shares derived from
January 1, 2003 and on will in general be liable to capital gains tax of up to
15% so long as our shares are eligible for sale on a designated foreign stock
market such as Nasdaq. However, according to the tax reform subordinate
legislation, non-residents of Israel will be exempt from any capital gains tax
from the sale of our securities so long as the gains are not derived through a
permanent establishment that the non-resident maintains in Israel, and so long
as our securities remain listed for trading as described above. These
provisions dealing with capital gains exemptions are not applicable to a person
whose gains from selling or otherwise disposing of our securities are: (i)
deemed to be business income (such as a broker or dealer); (ii) whose taxable
income is determined pursuant to the Israeli Income Tax Law (Inflation
Adjustments), 1985; or (iii) who purchased our shares prior to our initial
public offering. The Israeli Income Tax Law (Inflation Adjustments) would not
normally be applicable to non-resident shareholders who have no business
activity in Israel.

In
any event, under the US-Israel Tax Treaty, a US treaty resident may only be liable
for Israeli capital gains tax on the sale of our ordinary shares (subject to
the provisions of Israeli domestic law as described above) if that US treaty
resident holds 10% or more of the voting power in our company.

Under
a treaty between the governments of the United States and Israel, Israeli
capital gains tax does not apply to the sale, exchange or disposition of
ordinary shares by a person who qualifies as a resident of the United States
within the meaning of the treaty and who is entitled to claim the benefits
afforded to such resident by the treaty. This exemption does not apply if the
person holds, directly or indirectly, ordinary shares representing 10% or more
of our voting power during any part of the 12-month period preceding the
applicable sale, exchange or disposition. However, the person would be
permitted to claim a credit for the capital gains tax paid in Israel against
the U.S. income tax imposed for the applicable sale, exchange or disposition,
subject to the limitations in U.S. laws applicable to foreign tax credits. The
U.S.-Israel Tax Treaty does not relate to the U.S. state or local taxes.

Taxation
of the Ordinary Income of Non-Resident Holders of Our Shares

Non-residents
of Israel pay income tax on income accrued or derived from sources 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, or stock dividends, income tax
at the rate of 25% is withheld at source. If the income out of which the
dividend is being paid is attributable to an approved enterprise, the rate is
15%. A different rate may be provided in a treaty between Israel and the
shareholders country of residence. Under the U.S.-Israel Tax Treaty, the
maximum tax on dividends paid to a U.S. resident is 25% however, the 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 companys voting power during a
certain period preceding the distribution of the dividend. Also, under the
treaty with the U.S., if the income out of which the dividend is being paid is
attributable to an approved enterprise and the non-resident is a U.S. corporation
that holds 10% of the companys voting power, the rate is 15%.

A
non-resident of Israel who receives interest, dividend or royalty income
derived from or accrued in Israel, from which tax was withheld at the source,
is generally exempt from the duty to file tax returns in Israel on such income,
provided that income was not derived from a business conducted in Israel by the
taxpayer.

Under
Israeli law, non-Israeli corporations might be required to pay Israeli taxes on
the sale of traded securities in an Israeli Company, taking into consideration
the provisions of any applicable double taxation treaty.

Foreign
Exchange Regulations

Non-residents
of Israel who hold our ordinary shares are able to receive any dividends, and
any amounts payable upon the dissolution, liquidation and winding up of our
affairs, freely repatriable in non-Israeli currency at the rate of exchange
prevailing at the time of conversion. However, Israeli income tax is required
to have been paid or withheld on these amounts. In addition, there are
currently no Israeli currency control restrictions on the proceeds from the
sale of ordinary shares. However, legislation remains in effect by which
currency controls can be imposed by administrative action at any time.

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U.S.
TAXATION

The
following describes the material United States federal income tax consequences
of the purchase, ownership and disposition of our ordinary shares to a U.S.
holder.

For
purposes of this discussion, a U.S. holder is:

| |   |                                                                                                                                                                                                  
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | a natural person who is a citizen or resident of the
  United States;                                                                                                                            
| |   |                                                                                                                                                                                                  
| |  | a corporation or another entity taxable as a
  corporation created or organized under the laws of the United States or any
  political subdivision of the United States;                         
| |   |                                                                                                                                                                                                  
| |  | an estate, the income of which is includable in
  gross income for United States federal income tax purposes regardless of its
  source; or                                                      
| |   |                                                                                                                                                                                                  
| |  | a trust, if (a) a U.S. court is able to exercise
  primary supervision over its administration and (b) one or more U.S. persons
  have the authority to control all of its substantial decisions.

This
summary is for general information purposes only and does not purport to be a
comprehensive description of all of the U.S. federal income tax considerations
that may be relevant to a decision to purchase, hold or dispose of the ordinary
shares. This summary generally considers only U.S. holders that will own the
ordinary shares as capital assets and does not consider the U.S. tax
consequences to a person that is not a U.S. holder or the tax treatment of
persons who hold the ordinary shares through a partnership or other
pass-through entity. In addition, the possible application of U.S. federal
estate or gift taxes or any aspect of state, local or non-U.S. tax laws is not
considered. This discussion is based on current provisions of the Internal Revenue
Code of 1986, as amended (the Code), current and proposed Treasury
Regulations promulgated under the Code, and administrative and judicial
interpretations of the Code, all as in effect today and all of which may
change, possibly with a retroactive effect.

This
discussion does not address all aspects of U.S. federal income taxation that
may be relevant to any particular U.S. holder based on the holders particular
circumstances, such as,

| |   |                                                                                                         
| | - | --------------------------------------------------------------------------------------------------------
| |  | persons who own, directly, indirectly or
  constructively, 10% or more of our outstanding voting shares;
| |   |                                                                                                         
| |  | persons who hold the ordinary shares as part of a
  hedging, straddle or conversion transaction;        
| |   |                                                                                                         
| |  | persons whose functional currency is not the dollar;                                                    
| |   |                                                                                                         
| |  | persons who acquire their ordinary shares in a
  compensatory transaction;                              
| |   |                                                                                                         
| |  | broker-dealers;                                                                                         
| |   |                                                                                                         
| |  | insurance companies;                                                                                    
| |   |                                                                                                         
| |  | tax-exempt organizations;                                                                               
| |   |                                                                                                         
| |  | financial institutions; and                                                                             
| |   |                                                                                                         
| |  | persons subject to the alternative minimum tax.                                                         

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Availability of Reduced Tax Rates

U.S.
legislation enacted in 2003 reduced to 15% the maximum U.S. Federal income
tax rate on certain long-term capital gains and on qualifying
dividends. Long-term capital gains from the sale of our ordinary shares
would be eligible for this reduced rate. Dividends, if any, would also be
eligible for this reduced rate, provided that we do not constitute a
passive foreign investment company.

Distributions on the
Ordinary Shares

We
currently do not intend to pay dividends for at least the next several years.
However, if we make any distributions of cash or other property to a U.S.
holder of our ordinary shares, the amount of the distribution for U.S. federal
income tax purposes will equal the amount of cash and the fair market value of
any property distributed and will also include the amount of Israeli taxes
withheld, if any, as described above under Taxation of the Ordinary Income of
Non-Resident Holders of Our Shares starting on page 60. In general, a distribution
paid by us on the ordinary shares to a U.S. holder will be treated as dividend
income if the distribution does not exceed our current or accumulated earnings
and profits, as determined for U.S. federal income tax purposes. The amount of
any distribution which 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 to the extent thereof, and then as capital gain from the deemed
disposition of the ordinary shares. Corporate holders generally will not be
allowed a deduction for dividends received on the ordinary shares.

A
dividend paid by us in NIS will be included in the income of U.S. holders at
the U.S. dollar value of the dividend, based upon the spot rate of exchange in
effect on the date of the distribution. 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 subsequent gain or loss resulting from exchange rate fluctuations between
the day the dividend was included in income of U.S. holders and the day the NIS
are converted into U.S. dollars or otherwise are disposed of, will be taxable
as ordinary income, gain or loss from U.S. sources.

Dividends
paid by us generally will be foreign source passive income for U.S. foreign
tax credit purposes or, in the case of a U.S. holder that is a financial
services entity, financial services income. U.S. holders may elect to claim
as a foreign tax credit against their U.S. federal income tax liability the
Israeli income tax withheld from dividends received on the ordinary shares. The
Code provides limitations on the amount of foreign tax credits that a U.S.
holder may claim. U.S. holders that do not elect to claim a foreign tax credit
may instead claim a deduction for Israeli income tax withheld, but only for a
year in which these U.S. holders elect to do so for all foreign income taxes.
The rules relating to foreign tax credits are complex, and you should consult
your tax advisor to determine whether and if you would be entitled to this
credit.

Sale or Exchange of
the Ordinary Shares

Upon
the sale or exchange of the ordinary shares, a U.S. holder generally will
recognize capital gain or loss in an amount equal to the difference between the
amount realized on the sale or exchange and the U.S. holders tax basis in the
ordinary shares. The gain or loss recognized on the sale or exchange of the
ordinary shares generally will be long-term capital gain or loss if the U.S.
holders holding period of the ordinary shares is more than one year at the
time of the disposition.

Gain
or loss recognized by a U.S. holder on a sale or exchange of ordinary shares
generally will be treated as U.S. source income or loss for U.S. foreign tax
credit purposes. Under the tax treaty between the United States and Israel,
gain derived from the sale, exchange or other disposition of ordinary shares by
a holder who is a resident of the 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.

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Passive Foreign
Investment Companies

In
general, a foreign (that is, non-U.S.) corporation will be a passive foreign
investment company (a PFIC) for any taxable year if either (1) 75% or more of
its gross income in the taxable year is passive income, or (2) 50% or more of
the average value of its gross assets in the taxable year is held for the
production of, or produces, passive income. For purpose of the income test,
passive income includes dividends, interest, royalties, rents, annuities and
net gains from the disposition of assets, which produce passive income. For
purposes of the assets test, assets held for the production of passive income
include assets held for the production of, or that produce dividends,
interest, royalties, rents, annuities, and other income included in the income
test. The income test is conducted at the taxable year-end. The asset test is
conducted on a quarterly basis and the quarterly results are then averaged
together.

If
a corporation is treated as a PFIC for any year during a U.S. holders holding
period and the U.S. holder does not timely elect to treat the corporation as a
qualified electing fund under Section 1295 of the Code or elect to mark its
ordinary shares to market (both as described below), any gain on the
disposition of the shares will be treated as ordinary income, rather than
capital gain, and the holder will be required to compute its tax liability on
that gain, as well as on dividends and other distributions, as if the income
had been earned ratably over each day in the U.S. holders holding period for
the shares. The portion of the gain and distributions allocated to prior
taxable years in which a corporation was a PFIC will be taxed at the highest
ordinary income tax rate in effect for each taxable year to which this portion
is allocated. An interest charge will be imposed on the amount of the tax
allocated to these taxable years. A U.S. holder may elect to treat a
corporation as a qualified electing fund only if the corporation complies with
requirements imposed by the IRS to enable the shareholder and the IRS to
determine the corporations ordinary income and net capital gain. Additionally,
if a corporation is a PFIC, a U.S. holder who acquires shares in the
corporation from a decedent will be denied the normally available step-up in
tax basis to fair market value for the shares at the date of death and instead
will have a tax basis equal to the decedents tax basis if lower than fair
market value.

Status
of Nova as a PFIC. Under the income test, less than 75% of our gross income
was passive income in 2005. The determination of our status under the asset
test is more difficult because that test requires a quarterly determination of
the fair market value of our passive and non-passive assets and there is
no definitive method set forth in the Code, U.S. Treasury Regulations or
administrative or judicial interpretations thereof for determining the value of
a foreign corporations assets under the asset test. While there are no
definitive rules, the legislative history of the U.S. Taxpayer Relief Act of
1997 indicates that for purposes of the PFIC assets 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.

For
2005, while we continued to have substantial amounts of cash and short-term
deposits and the market value of our ordinary shares continued to decrease, a
determination of the value of our assets by reference to the market value of
our ordinary shares and our liabilities results in a conclusion that the
average value of our passive assets did not exceed 50% of the average value of
our gross assets in 2005. Nonetheless, there is a risk that we were a PFIC in
2005 or we will be a PFIC in 2006 or subsequent years because, as indicated
above, there are no definitive rules regarding the manner in which a company
should value its assets for purposes of the PFIC asset test.

Available
Elections.
If we will be treated as a PFIC
for any taxable year, U.S. holders should consider whether or not to elect to
treat us as a qualified electing fund or to elect to mark-to-market their
ordinary shares. If a U.S. holder makes a qualified electing fund election (a
QEF election) for all taxable years that the U.S. holder holds our ordinary
shares and during which we are treated as a PFIC, the U.S. holder will be required for each
taxable year to include in income a pro rata share of our undistributed
ordinary earnings and net capital gain, if any, as ordinary income and
long-term capital gain, respectively. In order to make (or maintain) a QEF
election, the U.S. holder must annually complete and file IRS From 8621. In
addition, we must make certain information regarding our net capital gains and
ordinary earnings available to the U.S. holder and permit our books and
recorded to be examined to verify such information. Therefore, if you determine
that we are a PFIC for any year and make a request to us in writing at the
address on the cover our latest Annual Report on Form 20-F, Attention Chief
Financial Officer, for the information required to make a QEF election, we will
promptly make the information available to you and comply with any other
applicable requirements of the Code.

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A
QEF election, once made with respect to us, applies to the tax year for which
it was made and to all subsequent tax years, unless the election is invalidated
or terminated, or the IRS consents to revocation of the election. If you make a
QEF election and we cease to qualify as a PFIC in a subsequent tax year, the
QEF election will remain in effect, although it will not be applicable during
those tax years in which we do not qualify as a PFIC. Therefore, if we - after
ceasing to qualify as a PFIC - again qualify as a PFIC in a subsequent tax
year, the QEF election will be effective and you will again be subject to the
rules described above for US holders making QEF elections in such tax year and
any subsequent tax years in which we qualify as a PFIC. A QEF election also
remains in effect even after you dispose of all of your direct and indirect
interest in our ordinary shares. As a result, if you subsequently acquire any
of our ordinary shares or an interest in any of our ordinary shares, you will
again be subject to the rules described above for US holders making a QEF
election for each tax year in which we qualify as a PFIC.

Alternatively,
if a U.S. holder elects to mark-to-market its ordinary shares, the U.S.
holder will generally include in its income any excess of the fair market value
of our ordinary shares at the close of each taxable year over the holders
adjusted basis in such ordinary shares. A U.S. holder generally will be allowed
an ordinary deduction for the excess, if any, of the adjusted tax basis of the
ordinary shares over the fair market value of the ordinary shares as of the
close of the taxable year, or the amount of any net mark-to-market gains
recognized for prior taxable years, whichever is less. A U.S. holders adjusted
tax basis in the ordinary shares will generally be adjusted to reflect the
amounts included or deducted under the mark-to-market election. Additionally,
any gain on the actual sale or other disposition of the ordinary shares
generally will be treated as ordinary income. Ordinary loss treatment also will
apply to any loss recognized on the actual sale or other disposition of
ordinary shares to the extent that the amount of such loss does not exceed the
net mark-to-market gains previously included with respect to such ordinary
shares. An election to mark-to-market generally will apply to the taxable year
in which the election is made and all subsequent taxable years. A
mark-to-market election applies to the tax year for which the election is made
and to each subsequent year, unless our ordinary shares cease to be marketable,
as specifically defined, or the IRS consents to revocation of the election. No
view is expressed regarding whether our ordinary shares are marketable for
these purposes or whether the election will be available.

If
a U.S. holder makes either the QEF election or the mark-to-market election,
distributions and gain will not be recognized ratably over the U.S. holders
holding period or be subject to an interest charge as described above. Further,
the denial of basis step-up at death described above will not apply. If a U.S.
holder elects to treat us as a qualified electing fund, gain on the sale of
the ordinary shares will be characterized as capital gain. However, U.S.
holders making one of these two elections may experience current income
recognition, even if we do not distribute any cash. The elections must be made
with the U.S. holders federal income tax return for the year of election,
filed by the due date of the return (as it may be extended) or, under certain
circumstances provided in applicable Treasury Regulations, subsequent to that
date.

The
foregoing discussion relating to the QEF election and mark-to-market elections
assumes that a U.S. holder makes the applicable election with respect to the
first year in which Nova qualifies as a PFIC. If the election is not made for
the first year in which Nova qualifies as a PFIC, the procedures for making the
election and the consequences of election will be different.

A
number of specific rules and requirements apply to both the QEF election and the
mark-to-market election, and you are urged to consult your tax advisor
concerning our PFIC status and the various elections you can make.

United States
Information Reporting and Backup Withholding

Dividend
payments and proceeds from the sale or disposal of ordinary shares may be
subject to information reporting to the Internal Revenue Service and possible
U.S. federal backup withholding at the rate of 28%. Backup withholding will not
apply, however, to a holder who furnishes a correct taxpayer identification
number or certificate of foreign status and makes any other required
certification or who is otherwise exempt from backup withholding (for example,
if you are a corporation). Any U.S. holder who is required to establish exempt
status generally must file Internal Revenue Service Form W-9 (Request for
Taxpayer Identification Number and Certification). Finalized Treasury
Regulation, which are applicable to payments made after December 31, 2000, have
generally expanded the circumstances under which information reporting and
backup withholding may apply.

Amounts
withheld as backup withholding may be credited against a U.S. holders federal
income tax liability. A U.S. holder may obtain a refund of any excess amounts
withheld under the backup withholding rules by filing the appropriate claim for
refund with the Internal Revenue Service and furnishing any required
information.

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Documents on Display

The
documents referred to herein, including our memorandum and articles of association,
can be obtained from the Company at its registered office at Weizmann Science
Park, Building 22, 2nd Floor, Ness-Ziona 76100, Israel. In addition, the
Company is subject to certain informational requirements of the Securities
Exchange Act of 1934 and the rules and regulations promulgated thereunder. In
accordance therewith, the Company files reports with the United States
Securities and Exchange Commission (SEC). Reports and other information
provided to the SEC by the Company may be inspected and copied at the public
reference facilities maintained by the SEC at Room 1024, 450 Fifth Street,
N.W., Washington, D.C. 20549. Information on the operation of the public
reference facilities may be obtained by calling the SEC at 1-800-SEC-0330. In
addition, certain of the Companys reports filed with the SEC are available
on-line at www.sec.gov.

Item
11. Quantitative and Qualitative Disclosures About Market Risk

Market risk

Market
risk represents the risk of loss that may impact the consolidated financial
position, results of operations or cash flows of the Company. The Company is
exposed to market risk in the area of foreign exchange rates, as described
below.

The
Company does not utilize financial instruments for trading purposes and holds
no derivative financial instruments that could expose it to significant market
risk.

Impact of Inflation
and Currency Fluctuation

Substantially
all of our sales are made in U.S. dollars. Over 50% of our expenses in 2005
were in dollars or in NIS linked to the dollar. Most of the remaining expenses
were in NIS. The dollar cost of our operations in Israel is influenced by any
increase and the timing of such increase, in the rate of inflation in Israel
that is not offset by the devaluation of the NIS in relation to the dollar
During 2005, the value of the NIS decreased against the dollar by 5.6%, while
the consumer price index in Israel increased 2.39%. During 2004, the value of
the NIS increased against the dollar by 1.62%, while the consumer price index
in Israel increased 2.38%. During 2003, the value of the NIS increased against
the dollar by 7.6%, while the consumer price index in Israel decreased 1.9%. We
believe that the rate of inflation in Israel has had a minor effect on our
business to date. However, our dollar costs in Israel will increase if
inflation in Israel exceeds the devaluation of the NIS against the dollar or if
the timing of this devaluation lags behind inflation in Israel. As of December
31, 2005, the majority of our net monetary assets were denominated in dollars
and the remainder was denominated mainly in NIS. Net monetary assets that are
not denominated in dollars or dollar-linked NIS are affected by the risk of
currency fluctuations. In addition, approximately 5% of our expenses are in
Euros. During 2005, the value of the Euro decreased against the dollar by
approximately 15%. The strength of the dollar against the Euro and the NIS has
decreased the average dollar value of expenses valued in those currencies.

Based
upon historical US dollar currency movement, the Company does not believe that
reasonably possible near-term changes in the US dollar currency of 5% will
result in a material effect on future earnings, financial position or cash
flows of the Company.

In
2003, the Company entered into currency-forward and currency-put options
transactions (NIS/dollar) to insure (NIS/dollar) the rate in 2003. The total
accumulated sum insured in the year was approximately $4 million, and the
results of these transactions did not have, as expected, any material effect on
the operational results of the Company.

In
2004, the Company entered into currency-forward and currency-put options
transactions (NIS/dollar) to insure (NIS/dollar) the rate in 2004. The total
accumulated sum insured in the year was approximately $7.7 million with
settlement dates through 2005, and the results of these transactions did not
have, as expected, any material effect on the operational results of the
Company.

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In
2005, the Company entered into currency-forward and currency-put and currency
call options transactions (NIS/dollar, Euro/dollar, Yen/dollar) to insure
(NIS/dollar, Euro/dollar, Yen/dollar) the rate in 2005. The total accumulated
sum insured in the year was approximately $4.25 million with settlement dates
through 2005, and the results of these transactions did not have, as expected,
any material effect on the operational results of the Company.

Item
12. Description of Securities Other than Equity Securities

Not
applicable.

PART II

Item
13. Defaults, Dividend Arrearages and Delinquencies

None.

Item
14. Material Modification to the Rights of Security Holders and Use of Proceeds

The
effective date of the Securities Act registration statement for which use of
proceeds is being disclosed is April 11, 2000. The commission file number
assigned to that registration statement is 333-11640.

We
sold 3,000,000 ordinary shares for consideration of $54 million. The net
proceeds amounted to $49.2 million. As of March 31, 2006, approximately $29
million of the net proceeds had been used for working capital requirements and
$5.5 million for capital expenditures.

Item
15. Evaluation of disclosure controls and procedures

Based
on their evaluation as of the end of the period covered by this Annual Report
on Form 20-F, the Companys President and Chief Executive Officer and Chief
Financial Officer initially concluded that the Companys disclosure controls
and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the
Securities Exchange Act of 1934 (the Exchange Act)) were effective so as to
provide reasonable assurance that information required to be disclosed by the
Company in the reports that it files or submits under the Exchange Act is
recorded, processed, summarized, and reported within the time periods specified
in the Securities and Exchange Commissions rules and forms.

In
early 2006, and before publishing the financial results for year 2005, we initiated
a review of our recognition of revenues in 2004 and for the first three
quarters of 2005. As a result of this review, we concluded that we did not
properly recognize revenues from multiple deliverables sales arrangements in
2004 which included upgrade commitments or trade-in rights. We also concluded
that we did not properly recognize revenues in the first three quarters of 2005
from multiple deliverables sales arrangements that included upgrade commitments
or trade-in rights, and in the first quarter of 2005 from extended warranty
contracts. This review led us to restate our 2004 financial statements, as
described in Note 14 to our Consolidated Financial Statements for the year
ended December 31, 2005 contained elsewhere in the report, and to correct our
financial results for the first three quarters of 2005.

In
connection with the restatement of our 2004 financial results, our management,
under the supervision and with the participation of our President and Chief
Executive Officer and our Chief Financial Officer re-evaluated our disclosure
controls and procedures as of December 31, 2005. Based upon the
re-evaluations, our President and Chief Executive Officer and our Chief
Financial Officer concluded that our disclosure controls and procedures were
not effective as of December 31, 2005 because at that time we did not have
effective controls designed and in place to ensure that revenues relating to
multiple deliverables sales arrangements were properly recognized in accordance
with generally accepted accounting principles.

- 66 -

---

---



In
order to address the failure to have effective controls designed and in place
as described above, we implemented several additional disclosure controls in
2006, including a quarterly review of all purchase orders and agreements
governing the purchase orders, stricter controls to ensure that all multiple
deliverables sales arrangements are properly approved by management in writing,
and monitoring of the accuracy and proper use of new computer systems which are
used to allocate revenue from warranty contracts.

There
is no assurance that the disclosure controls and procedures will operate
effectively under all circumstances. Nevertheless, our President and Chief
Executive Office and our Chief Financial Officer believe that with the
implementation of the above remedial and corrective actions, the controls and
procedures are now effective so as to provide reasonable assurance that
information required to be disclosed by us in the reports we file or submit
under the Exchange Act is recorded, processed, summarized, and reported within
the time periods specified in the Securities and Exchange Commissions rules
and forms.

Changes
in internal controls

During
the fiscal year ended December 31, 2005 there were no changes in our internal
controls over financial reporting that materially affected, or is reasonably
likely to materially affect, our internal controls over financial reporting.
However, as discussed above, in early 2006, we implemented several new internal
controls and over financial reporting.

Item
16. Reserved

Reserved.

Item
16A. Audit Committee Financial Expert

Our
Board of Directors has determined that our Audit Committee includes one audit
committee financial expert, as defined by Item 16A of Form 20-F, Ms. Lauri
Hanover. Ms. Hanover is an independent director as such term is defined by Rule
4200(15) of the NASDAQ Stock Market.

Item
16B. Code of Ethics

The
Company has adopted a written code of conduct that applies to all Company
employees, including the Companys directors, principal executive officer,
principal financial officer and principal accounting officer.

You
may review our code of conduct on our website, http://nova.co.il under About
Nova.

Item
16C. Principal Accountant Fees and Services

During
each of the last two fiscal years, Brightman Almagor & Co., an independent
registered accounting firm and a member firm of Deloitte Touche Tohmatsu
(Deloitte & Touche) has acted as the Companys registered public
accounting firm and independent auditors.

AUDIT
FEES

Deloitte
& Touche billed the Company approximately $38,000 for audit services for
fiscal 2004, including fees associated with the annual audit and reviews of the
Companys quarterly financial results submitted on Form 6-K, consultations on
various accounting issues and performance of local statutory audits. Deloitte
& Touche billed the Company approximately $43,000 for audit services in fiscal
2005.

AUDIT-RELATED
FEES

Deloitte
& Touche did not bill for any audit-related services in 2005 or 2004,
except as included under the caption AUDIT FEES.

- 67 -

---

---



TAX
FEES

Deloitte
& Touche billed the Company approximately $2,000 for tax advice, including
fees associated with tax compliance services, tax planning services and other
tax consulting services for fiscal 2004. Deloitte & Touche billed the
Company approximately $2,000 for tax advice in fiscal 2005.

ALL
OTHER FEES

Deloitte
& Touche billed the Company approximately $5,000 for services other than
Audit Fees and Tax Fees described above for fiscal 2004. In fiscal 2004, such
other services included consulting for Office of the Chief Scientist grants
refund and consulting regarding investment center application. Deloitte &
Touche billed the Company approximately $5,000 for SEC compliance related
services other than Audit Fees and Tax Fees described above for fiscal 2005.

PRE-APPROVAL
POLICIES FOR NON-AUDIT SERVICES

Prior
to the engagement of Deloitte & Touche each year, the engagement is
approved by the Audit Committee of the Board of Directors. The Companys Audit
Committee rules of procedure provide for a process with respect to the prior
approval of all services, including non-audit services, to be performed by the
independent auditors for the Company. In fiscal 2005 and 2004, the Companys
Audit Committee approved all of the services provided by Deloitte & Touche.

Item
16D. Exemptions from the Listing Standards for Audit Committees

The
Company has not obtained any exemption from applicable audit committee listing
standards.

Item
16E. Purchases of Equity Securities by the Issuer and Affiliates Purchasers

In 2005,
neither the Company nor any affiliated purchaser (as defined in the Exchange
Act) purchased any of the Companys ordinary shares.

PART III

Item
17. Financial Statements

Not
applicable.

Item
18. Financial Statements

See
pages F-1 through F-24.

Item 19.
Exhibits

|       |  |                                                                                                                                                                    
|------ |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Number |  | Description                                                                                                                                                        
|       |  |                                                                                                                                                                    
|       |  |                                                                                                                                                                    
|1.1    |  | Articles of
  Association (incorporated by reference to exhibit 3.1 to the Companys
  Registration Statement on Form F-1 (registration number 333-11640))         
|      
|1.2    |  | First Amendment
  to the Companys Articles of Association (incorporated by reference to the
  Companys Current Report on Form 6-K filed on June 4, 2002)         
|      
|1.3    |  | Second
  Amendment to the Companys Articles of Association (incorporated by reference
  to the Companys Current Report on Form 6-K filed on December 16, 2004).  
|      
|4.1    |  | 1997 Stock
  Option Plan (Plan 2) (incorporated by reference to exhibit 10.1 to the
  Companys Registration Statement on Form F-1 (registration number 333-11640))
|      
|4.2    |  | Option Plan
  3 (incorporated by reference to exhibit 10.2 to the Companys Registration
  Statement on Form F-1 (registration number 333-11640))                  

- 68 -

---

---



|       |  |                                                                                                                                                                                                                                                                                                                                                                   
|------ |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Number |  | Description                                                                                                                                                                                                                                                                                                                                                       
|       |  |                                                                                                                                                                                                                                                                                                                                                                   
|       |  |                                                                                                                                                                                                                                                                                                                                                                   
|4.3    |  | Option Plan
  4A and 4B (incorporated by reference to exhibit 10.3 to the Companys
  Registration Statement on Form F-1 (registration number 333-11640))                                                                                                                                                                                                         
|      
|4.4    |  | Option Plan
  5 (incorporated by reference to Exhibit 4.4 to the Companys Annual Report
  for 20-F for 2002 filed May 9, 2002                                                                                                                                                                                                                                    
|      
|4.5    |  | Option Plan
  6 (incorporated by reference to Exhibit 4.1 to the Companys Registration
  Statement on Form S-8 filed December 24, 2002 (registration number
  333-102193))                                                                                                                                                                                       
|      
|4.6    |  | Employment
  Agreement between Nova and Giora Dishon (incorporated by reference to exhibit
  10.4 to the Companys Registration Statement on Form F-1 (registration number
  333-11640))                                                                                                                                                                          
|      
|4.7    |  | Employment
  Agreement between Nova and Moshe Finarov (incorporated by reference to
  exhibit 10.6 to the Companys Registration Statement on Form F-1
  (registration number 333-11640))                                                                                                                                                                         
|      
|4.8    |  | Employment
  Agreement between Nova and Chai Toren (incorporated by reference to exhibit
  10.7 to the Companys Registration Statement on Form F-1 (registration number
  333-11640))                                                                                                                                                                            
|      
|4.9    |  | Employment
  Agreement between Nova and Ronen Frish (incorporated by reference to exhibit
  10.8 to the Companys Registration Statement on Form F-1 (registration number
  333-11640))                                                                                                                                                                           
|      
|4.10   |  | Agreements
  between Nova and the Office of the Chief Scientist in Israel (incorporated by
  reference to exhibit 10.10 to the Companys Registration Statement on Form
  F-1 (registration number 333-11640))                                                                                                                                                    
|      
|4.11   |  | Certificate
  of Approval from the Investment Center in Israel (incorporated by reference
  to exhibit 10.11 to the Companys Registration Statement on Form F-1
  (registration number 333-11640))                                                                                                                                                               
|      
|4.12   |  | Lease
  Agreement between Nova and Ef-Shar Ltd. (incorporated by reference to Exhibit
  4.14 to the Companys Annual Report on Form 20-F filed on May 9, 2002)                                                                                                                                                                                                    
|      
|4.13   |  | Summary of
  Lease Agreement between Nova and Ef-Shar Ltd. (incorporated by reference to
  Exhibit 4.15 to the Companys Annual Report on Form 20-F filed on May 9,
  2002)                                                                                                                                                                                       
|      
|4.14   |  | Letter
  Agreement between Barry Cox and the Company dated May 15, 2003 (incorporated
  by reference to Exhibit 4.1 to the Companys Registration Statement on Form
  S-8 filed on May 17, 2004 (registration number 333-115556))                                                                                                                                 
|      
|4.15   |  | Employee
  Stock Purchase Plan 1 (incorporated herein by reference to Exhibit 4.1 to the
  Companys Registration Statement on Form S-8 filed on March 24, 2003 (File
  No. 33-103981))                                                                                                                                                                           
|      
|4.16   |  | Letter of
  Indemnification and Exculpation for certain directors, officers and/or
  employees (incorporated herein by reference Annex A to the Companys Current
  Report on Form 6-K filed on October 8, 2002)                                                                                                                                                  
|      
|4.17   |  | Option Plan
  7A (incorporated by reference to Exhibit 4.1. to the Companys Registration
  Statement on Form S-8 filed on May 17, 2004 (registration number 333-115554))                                                                                                                                                                                         
|      
|4.18   |  | Option Plan
  7B (incorporated by reference to Exhibit 4.1 to the Companys Registration
  Statement on Form S-8 filed on March 7, 2005 (registration number 333-123158)                                                                                                                                                                                          
|      
|4.19   |  | Asset Purchase
  Agreement dated April 24, 2006 by and among Nova, HyperNex, Inc. and the
  Stockholders listed on Schedule 4(a) therein, including a list of omitted
  schedules and exhibits (filed herewith). The Company agrees to furnish
  supplementary a copy of any omitted schedule or exhibit to the Securities and
  Exchange Commission upon request.
|      
|4.20   |  | Option Plan
  7C (filed herewith).                                                                                                                                                                                                                                                                                                                                
|      
|4.21   |  | Option Plan
  8 (incorporated by reference to Exhibit 4.1 to the Companys Registration
  Statement on Form S-8 filed on December 29, 2005 (registration number
  333-130745).                                                                                                                                                                                    
|      
|8      |  | List of
  Subsidiaries (filed herewith)                                                                                                                                                                                                                                                                                                                           
|      
|12.1   |  | Certification
  required by Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended
  (filed herewith)                                                                                                                                                                                                                                                  
|      
|12.2   |  | Certification
  required by Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended
  (filed herewith)                                                                                                                                                                                                                                                  
|      
|13.1   |  | Certification
  Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith)                                                                                                                                                                                                                                                                        

- 69 -

---

---



|       |  |                                                                                           
|------ |  | ------------------------------------------------------------------------------------------
|Number |  | Description                                                                               
|       |  |                                                                                           
|       |  |                                                                                           
|13.2   |  | Certification
  Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith)
|      
|14.1   |  | Consent of
  Brightman Almagor & Co. (filed herewith)                                     

- 70 -

---

---



Signatures

Pursuant
to the requirements of Section 12 of the Securities Exchange Act of 1934, the
registrant certifies that it meets all of the requirements for filing on Form
20-F and has duly caused this annual report to be signed on its behalf by the
undersigned, thereunto duly authorized.

|                                 | 
|-------------------------------- | 
|NOVA MEASURING INSTRUMENTS, LTD. | 

|    |                                                     | 
|--- | --------------------------------------------------- | 
|By: | /s/ Giora
  Dishon                                  | 
|    |                                                     | 
|    | Giora Dishon, President and Chief Executive Officer

Date: June 29,
2006

- 71 -

---

---



NOVA MEASURING INSTRUMENTS LTD.

CONSOLIDATED FINANCIAL STATEMENTS
AS OF DECEMBER 31, 2005

---

---



NOVA MEASURING INSTRUMENTS LTD.

CONSOLIDATED FINANCIAL STATEMENTS
AS OF DECEMBER 31, 2005

|                                                                                                             |  |       
|------------------------------------------------------------------------------------------------------------ |  | ------
|Contents                                                                                                    
|                                                                                                             |  | Page  
|                                                                                                             |  |       
|Report of Independent Registered Public Accounting Firm                                                      |  | F-1   
|                                                                                                             |  |       
|Consolidated
  Financial Statements                                                                          |  |       
|                                                                                                             |  |       
|Balance
  Sheets December 31, 2005 and 2004                                                                  |  | F-2   
|                                                                                                             |  |       
|Statements
  of Operations - Years Ended December 31, 2005, 2004 and 2003                                    |  | F-3   
|                                                                                                             |  |       
|Statements
  of Shareholders Equity and Comprehensive Loss - Years Ended December 31,
  2005, 2004 and 2003 |  | F-4   
|                                                                                                             |  |       
|Statements
  of Cash Flows - Years Ended December 31, 2005, 2004 and 2003                                    |  | F-5-6 
|                                                                                                             |  |       
|Notes to
  Financial Statements                                                                              |  | F-7-24

---

---



REPORT OF
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

TO THE
SHAREHOLDERS OF

NOVA MEASURING INSTRUMENTS LTD.

We have audited the
accompanying consolidated balance sheets of Nova Measuring Instruments Ltd.
(the Company) and its subsidiaries as of December 31, 2005 and 2004, and the
related consolidated statements of operations, shareholders equity and
comprehensive loss and cash flows for each of the three years in the period
ended December 31, 2005. These financial statements are the responsibility of the
Companys management. Our responsibility is to express an opinion on these
financial statements based on our audits.

We conducted our audits in
accordance with the standards of the Public Company Accounting Oversight Board
(United States). Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. The company is not required to have, nor were we engaged
to perform, an audit of its internal control over financial reporting. Our
audits included consideration of internal control over financial reporting as a
basis for designing audit procedures that are appropriate in the circumstances,
but not for the purpose of expressing an opinion on the effectiveness of the
Companys internal control over financial reporting. Accordingly, we express no
such opinion. An audit also includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management, as
well as evaluating the overall financial statement presentation. We believe
that our audits provide a reasonable basis for our opinion.

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

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

Tel Aviv, Israel
April 11, 2006

---

---



NOVA MEASURING INSTRUMENTS LTD.CONSOLIDATED BALANCE SHEETS(In thousands, except share and per share data)

|                                                                                                                                            |  |                    |         |      |   |         |  
|------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------ | ------- | ---- | - | ------- | -
|                                                                                                                                            |  | As of December 31, |        
|                                                                                                                                            |  |                    |        
|                                                                                                                                            |  | 2005               |         | 2004 |  
|                                                                                                                                            |  |                    |         |      |  
|CURRENT ASSETS                                                                                                                              |  |                    |         |      |   |         |  
|                                                                                                                                            |  |                    |         |      |   |         |  
|Cash and cash equivalents                                                                                                                   |  | $                  | 5,776   |      | $ | 12,171  |  
|Short-term interest-bearing bank deposits                                                                                                   |  |                    | 1,206   |      |   | 1,916   |  
|Short-term investments                                                                                                                      |  |                    | 3,500   |      |   | -       |  
|Held to maturity securities                                                                                                                 |  |                    | 4,388   |      |   | 8,583   |  
|Trade accounts receivable (net of $14 and $0
allowance for doubtful
  accounts, respectively)                                               |  |                    | 6,841   |      |   | 6,850   |  
|Inventories (Note 3)                                                                                                                        |  |                    | 6,606   |      |   | 6,354   |  
|Other current assets                                                                                                                        |  |                    | 1,141   |      |   | 1,169   |  
|                                                                                                                                            |  |                    |         |      |   |         |  
|                                                                                                                                            |  |                    | 29,458  |      |   | 37,043  |  
|                                                                                                                                            |  |                    |         |      |   |         |  
|LONG-TERM ASSETS                                                                                                                            |  |                    |         |      |   |         |  
|Long-term interest-bearing bank deposits                                                                                                    |  |                    | 2,974   |      |   | 2,145   |  
|Held to maturity securities                                                                                                                 |  |                    | 4,952   |      |   | 5,989   |  
|Other long-term assets                                                                                                                      |  |                    | 262     |      |   | 382     |  
|Severance pay funds (Note 6)                                                                                                                |  |                    | 2,186   |      |   | 2,288   |  
|                                                                                                                                            |  |                    |         |      |   |         |  
|                                                                                                                                            |  |                    | 10,374  |      |   | 10,804  |  
|                                                                                                                                            |  |                    |         |      |   |         |  
|                                                                                                                                            |  |                    |         |      |   |         |  
|FIXED ASSETS, NET (Note 4)                                                                                                                  |  |                    | 2,507   |      |   | 2,119   |  
|                                                                                                                                            |  |                    |         |      |   |         |  
|                                                                                                                                            |  |                    |         |      |   |         |  
|Total assets                                                                                                                                |  | $                  | 42,339  |      | $ | 49,966  |  
|                                                                                                                                            |  |                    |         |      |   |         |  
|                                                                                                                                            |  |                    |         |      |   |         |  
|CURRENT LIABILITIES                                                                                                                         |  |                    |         |      |   |         |  
|Trade accounts payable                                                                                                                      |  | $                  | 5,744   |      | $ | 4,795   |  
|Other current liabilities (Note 5)                                                                                                          |  |                    | 8,880   |      |   | 6,539   |  
|                                                                                                                                            |  |                    |         |      |   |         |  
|                                                                                                                                            |  |                    | 14,624  |      |   | 11,334  |  
|                                                                                                                                            |  |                    |         |      |   |         |  
|LONG-TERM LIABILITIES                                                                                                                       |  |                    |         |      |   |         |  
|Liability for employee termination benefits (Note
6)                                                                                        |  |                    | 2,907   |      |   | 3,075   |  
|Deferred income                                                                                                                             |  |                    | 1,264   |      |   | 3,831   |  
|Other long-term liability                                                                                                                   |  |                    | 100     |      |   | 145     |  
|                                                                                                                                            |  |                    |         |      |   |         |  
|                                                                                                                                            |  |                    | 4,271   |      |   | 7,051   |  
|                                                                                                                                            |  |                    |         |      |   |         |  
|COMMITMENTS AND CONTINGENCIES (Note 7)                                                                                                      |  |                    |         |      |   |         |  
|                                                                                                                                            |  |                    |         |      |   |         |  
|SHAREHOLDERS EQUITY (Note 8)                                                                                                               |  |                    |         |      |   |         |  
|Ordinary shares, NIS 0.01 par value - authorized
40,000,000 shares,
  issued and outstanding 15,457,471 and 15,308,544 shares, respectively |  |                    | 46      |      |   | 46      |  
|Additional paid-in capital                                                                                                                  |  |                    | 73,636  |      |   | 73,333  |  
|Accumulated other comprehensive income
(loss)                                                                                               |  |                    | (18     | )    |   | 8       |  
|Accumulated deficit                                                                                                                         |  |                    | (50,220 | )    |   | (41,806 | )
|                                                                                                                                            |  |                    |         |      |   |         |  
|Total shareholders equity                                                                                                                  |  |                    | 23,444  |      |   | 31,581  |  
|                                                                                                                                            |  |                    |         |      |   |         |  
|                                                                                                                                            |  |                    |         |      |   |         |  
|Total liabilities and shareholders
equity                                                                                                  |  | $                  | 42,339  |      | $ | 49,966  |  
|                                                                                                                                            |  |                    |         |      |   |         |  

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

F-2

---

---



NOVA MEASURING INSTRUMENTS LTD.CONSOLIDATED STATEMENTS OF OPERATIONS(In thousands, except shares and per share data)

|                                                                                                                                               |  |                         |        |      |   |        |   |   |        |  
|---------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------------- | ------ | ---- | - | ------ | - | - | ------ | -
|                                                                                                                                               |  | Year ended December 31, |       
|                                                                                                                                               |  |                         |       
|                                                                                                                                               |  | 2005                    |        | 2004 |   | 2003   |  
|                                                                                                                                               |  |                         |        |      |   |        |  
|                                                                                                                                               |  |                         |        |      |   |        |   |   |        |  
|REVENUES:                                                                                                                                      |  |                         |        |      |   |        |   |   |        |  
|Product sales                                                                                                                                  |  | $                       | 21,985 |      | $ | 29,274 |   | $ | 21,152 |  
|Services                                                                                                                                       |  |                         | 8,157  |      |   | 7,532  |   |   | 5,536  |  
|                                                                                                                                               |  |                         |        |      |   |        |   |   |        |  
|                                                                                                                                               |  |                         | 30,142 |      |   | 36,806 |   |   | 26,688 |  
|                                                                                                                                               |  |                         |        |      |   |        |   |   |        |  
|                                                                                                                                               |  |                         |        |      |   |        |   |   |        |  
|COST OF REVENUES:                                                                                                                              |  |                         |        |      |   |        |   |   |        |  
|Product sales                                                                                                                                  |  |                         | 11,413 |      |   | 14,396 |   |   | 10,270 |  
|Services                                                                                                                                       |  |                         | 7,893  |      |   | 6,715  |   |   | 6,265  |  
|                                                                                                                                               |  |                         |        |      |   |        |   |   |        |  
|                                                                                                                                               |  |                         | 19,306 |      |   | 21,111 |   |   | 16,535 |  
|                                                                                                                                               |  |                         |        |      |   |        |   |   |        |  
|GROSS PROFIT                                                                                                                                   |  |                         | 10,836 |      |   | 15,695 |   |   | 10,153 |  
|                                                                                                                                               |  |                         |        |      |   |        |   |   |        |  
|                                                                                                                                               |  |                         |        |      |   |        |   |   |        |  
|OPERATING EXPENSES:                                                                                                                            |  |                         |        |      |   |        |   |   |        |  
|                                                                                                                                               |  |                         |        |      |   |        |   |   |        |  
|Research and development expenses, net of participation by the Office
  of Chief Scientist of $1,896, $1,926 and $2,321, respectively (Note 7) |  |                         | 9,301  |      |   | 8,665  |   |   | 8,561  |  
|Sales and marketing expenses                                                                                                                   |  |                         | 6,950  |      |   | 6,647  |   |   | 6,534  |  
|General and administrative expenses                                                                                                            |  |                         | 3,626  |      |   | 2,331  |   |   | 1,898  |  
|Other operating income (Note 9)                                                                                                                |  |                         | -      |      |   | -      |   |   | (2,203 | )
|                                                                                                                                               |  |                         |        |      |   |        |   |   |        |  
|                                                                                                                                               |  |                         | 19,877 |      |   | 17,643 |   |   | 14,790 |  
|                                                                                                                                               |  |                         |        |      |   |        |   |   |        |  
|                                                                                                                                               |  |                         |        |      |   |        |   |   |        |  
|OPERATING LOSS                                                                                                                                 |  |                         | (9,041 | )    |   | (1,948 | ) |   | (4,637 | )
|                                                                                                                                               |  |                         |        |      |   |        |   |   |        |  
|INTEREST INCOME, NET                                                                                                                           |  |                         |        |      |   |        |   |   |        |  
|(net of expenses of $35, $56 and $28,
respectively)                                                                                            |  |                         | 627    |      |   | 528    |   |   | 425    |  
|                                                                                                                                               |  |                         |        |      |   |        |   |   |        |  
|                                                                                                                                               |  |                         |        |      |   |        |   |   |        |  
|NET LOSS FOR THE YEAR                                                                                                                          |  | $                       | (8,414 | )    | $ | (1,420 | ) | $ | (4,212 | )
|                                                                                                                                               |  |                         |        |      |   |        |   |   |        |  
|                                                                                                                                               |  |                         |        |      |   |        |   |   |        |  
|LOSS PER SHARE:                                                                                                                                |  |                         |        |      |   |        |   |   |        |  
|                                                                                                                                               |  |                         |        |      |   |        |   |   |        |  
|Basic and diluted loss per share                                                                                                               |  | $                       | (0.55  | )    | $ | (0.09  | ) | $ | (0.28  | )
|                                                                                                                                               |  |                         |        |      |   |        |   |   |        |  
|                                                                                                                                               |  |                         |        |      |   |        |   |   |        |  
|Shares used in calculation of basic and diluted loss per
share                                                                                 |  |                         | 15,437 |      |   | 15,259 |   |   | 14,994 |  
|                                                                                                                                               |  |                         |        |      |   |        |   |   |        |  
|                                                                                                                                               |  |                         |        |      |   |        |   |   |        |  

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

F-3

---

---



|                                                                                            
|--------------------------------------------------------------------------------------------
|NOVA MEASURING INSTRUMENTS LTD.                                                             
|CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS EQUITY
  AND COMPREHENSIVE INCOME (LOSS)
|                                                                                            
|(In
  thousands)                                                                            

|                                                   |  |                   |    |                                |   |                                       |   |                                                     |      |                       |   |       |   |   |         |   |   |        |  
|-------------------------------------------------- |  | ----------------- | -- | ------------------------------ | - | ------------------------------------- | - | --------------------------------------------------- | ---- | --------------------- | - | ----- | - | - | ------- | - | - | ------ | -
|                                                   |  | Ordinary
  shares |    | Additional
  Paid-in
  Capital |   | Deferred
  stock-based
  compensation |   | Accumulated
  other
  Comprehensive
  Income (loss) |      | Accumulated
  Deficit |   | Total |  
|                                                   |  |                   |    |                                |   |                                       |   |                                                     |      |                       |   |       |  
|Balance as of January 1, 2003                      |  | $                 | 46 |                                | $ | 72,614                                |   | $                                                   | (809 | )                     | $ | -     |   | $ | (36,174 | ) | $ | 35,677 |  
|                                                   |  |                   |    |                                |   |                                       |   |                                                     |      |                       |   |       |   |   |         |   |   |        |  
|Employee share-based plans                         |  | (*)               | -  |                                |   | 318                                   |   |                                                     |      |                       |   |       |   |   |         |   |   | 318    |  
|Amortization of deferred stock- based
compensation |  |                   |    |                                |   |                                       |   |                                                     | 540  |                       |   |       |   |   |         |   |   | 540    |  
|Forfeiture of employee share options               |  |                   |    |                                |   | (147                                  | ) |                                                     | 147  |                       |   |       |   |   |         |   |   | -      |  
|Increase in fair market value of
derivatives       |  |                   |    |                                |   |                                       |   |                                                     |      |                       |   | 13    |   |   |         |   |   | 13     |  
|Loss for the year                                  |  |                   |    |                                |   |                                       |   |                                                     |      |                       |   |       |   |   | (4,212  | ) |   | (4,212 | )
|                                                   |  |                   |    |                                |   |                                       |   |                                                     |      |                       |   |       |   |   |         |   |   |        |  
|Total comprehensive loss                           |  |                   |    |                                |   |                                       |   |                                                     |      |                       |   |       |   |   |         |   |   | (4,199 | )
|                                                   |  |                   |    |                                |   |                                       |   |                                                     |      |                       |   |       |   |   |         |   |   |       
|                                                   |  |                   |    |                                |   |                                       |   |                                                     |      |                       |   |       |   |   |         |   |   |        |  
|Balance as of December 31, 2003                    |  | $                 | 46 |                                | $ | 72,785                                |   | $                                                   | (122 | )                     | $ | 13    |   | $ | (40,386 | ) | $ | 32,336 |  
|                                                   |  |                   |    |                                |   |                                       |   |                                                     |      |                       |   |       |   |   |         |   |   |        |  
|Employee share-based plans                         |  | (*)               | -  |                                |   | 548                                   |   |                                                     |      |                       |   |       |   |   |         |   |   | 548    |  
|Amortization of deferred stock- based
compensation |  |                   |    |                                |   |                                       |   |                                                     | 122  |                       |   |       |   |   |         |   |   | 122    |  
|Decrease in fair market value of
derivatives       |  |                   |    |                                |   |                                       |   |                                                     |      |                       |   | (5    | ) |   |         |   |   | (5     | )
|Net loss for the year                              |  |                   |    |                                |   |                                       |   |                                                     |      |                       |   |       |   |   | (1,420  | ) |   | (1,420 | )
|                                                   |  |                   |    |                                |   |                                       |   |                                                     |      |                       |   |       |   |   |         |   |   |        |  
|Total comprehensive loss                           |  |                   |    |                                |   |                                       |   |                                                     |      |                       |   |       |   |   |         |   |   | (1,425 | )
|                                                   |  |                   |    |                                |   |                                       |   |                                                     |      |                       |   |       |   |   |         |   |   |        |  
|                                                   |  |                   |    |                                |   |                                       |   |                                                     |      |                       |   |       |   |   |         |   |   |        |  
|Balance as of December 31, 2004                    |  | $                 | 46 |                                | $ | 73,333                                |   | $                                                   | -    |                       | $ | 8     |   | $ | (41,806 | ) | $ | 31,581 |  
|                                                   |  |                   |    |                                |   |                                       |   |                                                     |      |                       |   |       |   |   |         |   |   |        |  
|Employee share-based plans                         |  | (*)               | -  |                                |   | 275                                   |   |                                                     |      |                       |   |       |   |   |         |   |   | 275    |  
|Deferred stock-based compensation                  |  |                   |    |                                |   | 28                                    |   |                                                     | (28  | )                     |   |       |   |   |         |   |   | -      |  
|Amortization of stock-based
compensation           |  |                   |    |                                |   |                                       |   |                                                     | 28   |                       |   |       |   |   |         |   |   | 28     |  
|Decrease in fair market value of
derivatives       |  |                   |    |                                |   |                                       |   |                                                     |      |                       |   | (26   | ) |   |         |   |   | (26    | )
|Loss for the year                                  |  |                   |    |                                |   |                                       |   |                                                     |      |                       |   |       |   |   | (8,414  | ) |   | (8,414 | )
|                                                   |  |                   |    |                                |   |                                       |   |                                                     |      |                       |   |       |   |   |         |   |   |        |  
|Total comprehensive loss                           |  |                   |    |                                |   |                                       |   |                                                     |      |                       |   |       |   |   |         |   |   | (8,440 | )
|                                                   |  |                   |    |                                |   |                                       |   |                                                     |      |                       |   |       |   |   |         |   |   |        |  
|                                                   |  |                   |    |                                |   |                                       |   |                                                     |      |                       |   |       |   |   |         |   |   |        |  
|Balance as of December 31, 2005                    |  | $                 | 46 |                                | $ | 73,636                                |   | $                                                   | -    |                       | $ | (18   | ) | $ | (50,220 | ) | $ | 23,444 |  
|                                                   |  |                   |    |                                |   |                                       |   |                                                     |      |                       |   |       |   |   |         |   |   |        |  

(*) Less than $1

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

F-4

---

---



NOVA MEASURING INSTRUMENTS LTD.CONSOLIDATED STATEMENTS OF CASH FLOWS(In thousands)

|                                                                                                       |  |                           |        |         |   |         |   |   |         |  
|------------------------------------------------------------------------------------------------------ |  | ------------------------- | ------ | ------- | - | ------- | - | - | ------- | -
|                                                                                                       |  | Year ended
  December 31, |       
|                                                                                                       |  |                           |       
|                                                                                                       |  | 2 0 0 5                   |        | 2 0 0 4 |   | 2 0 0 3 |  
|                                                                                                       |  |                           |        |         |   |         |  
|CASH FLOWS  OPERATING ACTIVITIES                                                                      |  |                           |        |         |   |         |   |   |         |  
|                                                                                                       |  |                           |        |         |   |         |   |   |         |  
|Net loss for the year                                                                                  |  | $                         | (8,414 | )       | $ | (1,420  | ) | $ | (4,212  | )
|Adjustments to reconcile net loss for the
  year to net cash used in operating activities  Schedule A |  |                           | 1,033  |         |   | (418    | ) |   | (1,320  | )
|                                                                                                       |  |                           |        |         |   |         |   |   |         |  
|                                                                                                       |  |                           |        |         |   |         |   |   |         |  
|Net cash  operating activities                                                                        |  |                           | (7,381 | )       |   | (1,838  | ) |   | (5,532  | )
|                                                                                                       |  |                           |        |         |   |         |   |   |         |  
|                                                                                                       |  |                           |        |         |   |         |   |   |         |  
|CASH FLOWS  INVESTING ACTIVITIES                                                                      |  |                           |        |         |   |         |   |   |         |  
|                                                                                                       |  |                           |        |         |   |         |   |   |         |  
|Decrease (increase) in short-term
  interest-bearing bank deposits                                     |  |                           | 931    |         |   | (1,205  | ) |   | (89     | )
|Increase in short term investments                                                                     |  |                           | (3,500 | )       |   | -       |   |   | -       |  
|Proceeds from held to maturity securities                                                              |  |                           | 5,612  |         |   | 4,530   |   |   | 1,019   |  
|Investment in short-term held to maturity
  securities                                                 |  |                           | -      |         |   | (1,948  | ) |   | (4,296  | )
|Investment in long-term held to maturity
  securities                                                  |  |                           | -      |         |   | (12,549 | ) |   | -       |  
|Investment in long-term interest-bearing
  bank deposits                                               |  |                           | (1,050 | )       |   | (759    | ) |   | (1,386  | )
|Additions to fixed assets                                                                              |  |                           | (1,282 | )       |   | (1,242  | ) |   | (364    | )
|                                                                                                       |  |                           |        |         |   |         |   |   |         |  
|                                                                                                       |  |                           |        |         |   |         |   |   |         |  
|Net cash  investing activities                                                                        |  |                           | 711    |         |   | (13,173 | ) |   | (5,116  | )
|                                                                                                       |  |                           |        |         |   |         |   |   |         |  
|                                                                                                       |  |                           |        |         |   |         |   |   |         |  
|CASH FLOWS  FINANCING ACTIVITIES                                                                      |  |                           |        |         |   |         |   |   |         |  
|                                                                                                       |  |                           |        |         |   |         |   |   |         |  
|Shares issued under employee share-based
  plans                                                       |  |                           | 275    |         |   | 548     |   |   | 318     |  
|                                                                                                       |  |                           |        |         |   |         |   |   |         |  
|                                                                                                       |  |                           |        |         |   |         |   |   |         |  
|Net cash  financing activities                                                                        |  |                           | 275    |         |   | 548     |   |   | 318     |  
|                                                                                                       |  |                           |        |         |   |         |   |   |         |  
|                                                                                                       |  |                           |        |         |   |         |   |   |         |  
|Decrease in cash and cash equivalents                                                                  |  |                           | (6,395 | )       |   | (14,463 | ) |   | (10,330 | )
|Cash and cash equivalents  beginning of
  year                                                        |  |                           | 12,171 |         |   | 26,634  |   |   | 36,964  |  
|                                                                                                       |  |                           |        |         |   |         |   |   |         |  
|                                                                                                       |  |                           |        |         |   |         |   |   |         |  
|Cash and cash equivalents  end of year                                                                |  | $                         | 5,776  |         | $ | 12,171  |   | $ | 26,634  |  
|                                                                                                       |  |                           |        |         |   |         |   |   |         |  
|                                                                                                       |  |                           |        |         |   |         |   |   |         |  
|SUPPLEMENTAL SCHEDULE OF CASH FLOW
  INFORMATION:                                                      |  |                           |        |         |   |         |   |   |         |  
|                                                                                                       |  |                           |        |         |   |         |   |   |         |  
|Taxes paid                                                                                             |  | $                         | 62     |         | $ | 65      |   | $ | 67      |  
|                                                                                                       |  |                           |        |         |   |         |   |   |         |  

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

F-5

---

---



NOVA
MEASURING INSTRUMENTS LTD.CONSOLIDATED STATEMENTS OF CASH FLOWS(In thousands)

|              |                                                                                     
|------------- | ------------------------------------------------------------------------------------
|SCHEDULE A   | ADJUSTMENTS TO RECONCILE LOSS TO
  NET LOSS TO NET CASH USED IN OPERATING ACTIVITIES

|                                                                                 |  |                           |        |         |   |         |   |   |        |  
|-------------------------------------------------------------------------------- |  | ------------------------- | ------ | ------- | - | ------- | - | - | ------ | -
|                                                                                 |  | Year ended
  December 31, |       
|                                                                                 |  |                           |       
|                                                                                 |  | 2 0 0 5                   |        | 2 0 0 4 |   | 2 0 0 3 |  
|                                                                                 |  |                           |        |         |   |         |  
|Income and expense items not involving cash flows:                               |  |                           |        |         |   |         |   |   |        |  
|                                                                                 |  |                           |        |         |   |         |   |   |        |  
|Depreciation and
  amortization                                                  |  | $                         | 894    |         | $ | 548     |   | $ | 716    |  
|                                                                                 |  |                           |        |         |   |         |   |   |        |  
|Net recognized
  gains on investments                                            |  |                           | (380   | )       |   | (309    | ) |   | (25    | )
|                                                                                 |  |                           |        |         |   |         |   |   |        |  
|Amortization of
  deferred stock-based compensation                              |  |                           | -      |         |   | 122     |   |   | 540    |  
|                                                                                 |  |                           |        |         |   |         |   |   |        |  
|Increase
  (decrease) in liability for employee
  termination benefits, net      |  |                           | (66    | )       |   | 310     |   |   | 168    |  
|                                                                                 |  |                           |        |         |   |         |   |   |        |  
|Stock options
  acceleration                                                     |  |                           | 28     |         |   | -       |   |   | -      |  
|                                                                                 |  |                           |        |         |   |         |   |   |        |  
|                                                                                 |  |                           | 476    |         |   | 671     |   |   | 1,399  |  
|                                                                                 |  |                           |        |         |   |         |   |   |        |  
|                                                                                 |  |                           |        |         |   |         |   |   |        |  
|Changes in assets and liabilities:                                               |  |                           |        |         |   |         |   |   |        |  
|                                                                                 |  |                           |        |         |   |         |   |   |        |  
|Decrease
  (increase) in trade accounts receivable                               |  |                           | 9      |         |   | (1,046  | ) |   | (2,902 | )
|                                                                                 |  |                           |        |         |   |         |   |   |        |  
|Decrease
  (increase) in other current assets and other long-term assets         |  |                           | 148    |         |   | (70     | ) |   | (336   | )
|                                                                                 |  |                           |        |         |   |         |   |   |        |  
|Increase in
  inventories                                                        |  |                           | (252   | )       |   | (2,202  | ) |   | (1,002 | )
|                                                                                 |  |                           |        |         |   |         |   |   |        |  
|Increase
  (decrease) in trade accounts payables and other long-term liabilities |  |                           | 904    |         |   | (624    | ) |   | 2,011  |  
|                                                                                 |  |                           |        |         |   |         |   |   |        |  
|Increase
  (decrease) in long-term deferred income                               |  |                           | (2,567 | )       |   | 3,568   |   |   | 24     |  
|                                                                                 |  |                           |        |         |   |         |   |   |        |  
|Increase (decrease) in other current
  liabilities                               |  |                           | 2,315  |         |   | (715    | ) |   | (514   | )
|                                                                                 |  |                           |        |         |   |         |   |   |        |  
|                                                                                 |  |                           | 557    |         |   | (1,089  | ) |   | (2,719 | )
|                                                                                 |  |                           |        |         |   |         |   |   |        |  
|                                                                                 |  | $                         | 1,033  |         | $ | (418    | ) | $ | (1,320 | )
|                                                                                 |  |                           |        |         |   |         |   |   |        |  

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

F-6

---

---



NOVA MEASURING INSTRUMENTS LTD.NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS(in thousands, except share and per share data)

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

| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | A. | Business
  Description                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| |    | Nova Measuring Instruments
  (the Company) was incorporated in May 1993 and commenced operations in
  October 1993 in the design, development and production of integrated process
  control systems, used in the manufacturing of semiconductors. In October
  1995, the Company began manufacturing and marketing its systems. In addition,
  the Company is continuing research and development for the next generation of
  its products and additional applications for such products. The Company
  operates in one operating segment.                                                                                                                                                     
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| |    | The Company has wholly
  owned subsidiaries in the United States of America (the U.S.), Japan, The
  Netherlands and Taiwan. All companies (the subsidiaries) are engaged in
  pre-sale activities and providing technical support to customers.                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| |    | The industry in which the
  Company operates is characterized by rapid technological development in a
  competitive environment. Substantially most of the Companys current sales
  are derived from a single product line for usage exclusively by the
  semiconductor industry, whose business is highly cyclical. The Company
  depends on a limited number of suppliers, and at times a sole supplier. Any
  disruption or termination of the suppliers operations may adversely affect
  the Companys production capabilities. In addition, certain of the Companys
  development projects are in the early stages and there can be no assurance
  that these projects will be successful.
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| |    | The ordinary shares of the
  Company are traded on the NASDAQ National Market System since April, 2000.
  The ordinary shares are also traded on the Tel-Aviv Stock Exchange, since
  June, 2002.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| | B. | Use of
  Estimates in the Preparation of Financial Statements                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| |    | The preparation of
  financial statements in conformity with generally accepted accounting
  principles requires management to make estimates and assumptions that affect
  the reported amounts of assets and liabilities and disclosure of contingent
  assets and liabilities as of the date of the financial statements, and the
  reported amounts of revenues and expenses during the reporting periods.
  Actual results could differ from those estimates.                                                                                                                                                                                                                                 

F-7

---

---



NOVA MEASURING INSTRUMENTS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS(in thousands, except share and per share data)

|              |                                  
|------------- | ---------------------------------
|NOTE
  2     | SIGNIFICANT
  ACCOUNTING POLICIES

| |                                                                                                                                                                              |                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | The companys consolidated
  financial statements have been prepared in accordance with generally accepted
  accounting principles (GAAP) in the United States of America.
| | The following is a summary
  of the significant accounting policies, which were applied in the preparation
  of these financial statements, on a consistent basis:          
| |                                                                                                                                                                              |                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | A.                                                                                                                                                                           | Financial
  Statements in U.S. Dollars                                                                                                                                                                                                                                                                                                                                                                                                                                        
| |                                                                                                                                                                              |                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |                                                                                                                                                                              | The currency of the primary
  economic environment in which the operations of the Company and its
  subsidiaries are conducted is the U.S. dollar (the dollar). Accordingly,
  the Company use the dollar as its functional and reporting currency. Certain
  of the dollar amounts in the financial statements may represent the dollar
  equivalent of other currencies, including the New Israeli Shekel (NIS), and
  may not be exchangeable for dollars.             
| |                                                                                                                                                                              | Transactions and balances
  denominated in dollars are presented at their dollar amounts. Non-dollar
  transactions and balances are remeasured into dollars in accordance with the
  principles set forth in Statement of Financial Accounting Standards (SFAS)
  No. 52, Foreign Currency Translation of the Financial Accounting Standards
  Board (FASB). Net financing income includes translation gains (losses),
  which were immaterial for all years presented.
| |                                                                                                                                                                              |                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | B.                                                                                                                                                                           | Principles
  of Consolidation                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| |                                                                                                                                                                              |                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |                                                                                                                                                                              | The Companys consolidated
  financial statements include the financial statements of the Company and its
  wholly owned subsidiaries (the Group), after elimination of material
  intercompany transactions and balances.                                                                                                                                                                                                                                                  
| |                                                                                                                                                                              |                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | C.                                                                                                                                                                           | Cash and
  Cash Equivalents                                                                                                                                                                                                                                                                                                                                                                                                                                                   
| |                                                                                                                                                                              |                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |                                                                                                                                                                              | Cash and cash equivalents
  are comprised of cash and demand deposits in banks and other short-term,
  highly liquid investments (primarily interest-bearing time deposits and commercial
  papers) with maturity dates not exceeding three months from the date of
  deposit.                                                                                                                                                                                                
| |                                                                                                                                                                              |                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | D.                                                                                                                                                                           | Allowance
  for Doubtful Accounts                                                                                                                                                                                                                                                                                                                                                                                                                                             
| |                                                                                                                                                                              |                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |                                                                                                                                                                              | The allowance for doubtful
  accounts is computed on the specific identification basis.                                                                                                                                                                                                                                                                                                                                                                                       
| |                                                                                                                                                                              |                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | E.                                                                                                                                                                           | Held to
  Maturity Securities                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| |                                                                                                                                                                              |                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |                                                                                                                                                                              | Securities held to maturity
  include investments in debt securities that the Company has positive intent
  and ability to hold to maturity. Securities held to maturity are measured at
  amortized cost.                                                                                                                                                                                                                                                                    
| |                                                                                                                                                                              |                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | F.                                                                                                                                                                           | Inventories                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
| |                                                                                                                                                                              |                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |                                                                                                                                                                              | Inventories are presented
  at the lower of cost or market. Cost is determined as follows:                                                                                                                                                                                                                                                                                                                                                                                    
| |                                                                                                                                                                              | Raw materials-on the
  average cost basis.                                                                                                                                                                                                                                                                                                                                                                                                                                    
| |                                                                                                                                                                              | Finished goods and work in
  process - on actual production cost basis (materials, labor and indirect
  manufacturing costs).                                                                                                                                                                                                                                                                                                                                                 

F-8

---

---



NOVA MEASURING INSTRUMENTS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS(in thousands, except share and per share data)

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

| |    |                                                                                                                                                                                                                                                                                                
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | G. | Fixed
  assets                                                                                                                                                                                                                                                                                 
| |    |                                                                                                                                                                                                                                                                                                
| |    | Fixed assets are presented
  at cost, net of accumulated depreciation. Annual depreciation is calculated
  based on the straight-line method over the shorter of the estimated useful
  lives of the related assets or terms of the related leases. Annual
  depreciation rates are as follows:

| |                                  |  |  |       | 
| | -------------------------------- |  |  | ----- | 
| |                                  |  |  | Years | 
| |                                  |  |  |       | 
| | Electronic equipment             |  |  | 2-5   | 
| | Office furniture and
  equipment |  |  | 7-15  | 
| | Leasehold improvements           |  |  | 5     | 

| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |    | In accordance with SFAS No.
  144, Accounting for Impairment or Disposal of Long-Lived Assets of the
  FASB, which supersedes SFAS No. 121, management reviews long-lived assets for
  impairment whenever events or changes in circumstances indicate that the
  carrying amount of an asset may not be recoverable based on estimated future
  undiscounted cash flows. If so indicated an impairment loss would be recognized
  for the difference between the carrying amount of the asset and its fair
  value.                                                                                                                                                                                                                                                                                                                                                                                                
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| | H. | Accrued
  Warranty Costs                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| |    | Accrued warranty costs are
  calculated in respect of the warranty period on the Companys products
  (generally one year) and are based on the Companys prior experience and in
  accordance with managements estimate. See Note 5B for disclosure with regard
  to accrued warranty costs.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| | I. | Revenue
  Recognition                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| |    | Revenues are recognized
  upon shipment of products to the customer or provision of support service
  provided that persuasive evidence of an arrangement exists, title has
  transferred, the price is fixed, collection of resulting receivables is
  probable and there are no remaining significant obligations. In addition to
  the above mentioned criteria, in cases of arrangements with multiple
  deliverables a Vendor-Specific Objective Evidence must exist to allocate a
  portion of the total fee to any undelivered elements of the arrangement. Such
  undelivered elements in these arrangements typically consist of services
  and/or upgrades. If vendor-specific objective evidence does not exist for the
  undelivered elements of the arrangement, all revenue is deferred until such
  evidence does exist, or until all elements are delivered, whichever is earlier.
  See also note 14.
| |    | Service contracts
  generally specify fixed payment amounts for periods longer than one month,
  and are recognized on a straight-line basis over the term of the contract.
  Revenue from sale of spare parts is usually recognized upon shipment of the
  parts.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| | J. | Research
  and Development                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| |    | Research and development
  costs are charged to operations as incurred. Amounts received or receivable
  from the Government of Israel through the Office of the Chief Scientist
  (OCS) as participation in certain research and development programs are
  offset against research and development costs. The accrual for grants
  receivable is determined based on the terms of the programs, provided that
  the criteria for entitlement have been met.                                                                                                                                                                                                                                                                                                                                                                                                                                                       

F-9

---

---



NOVA MEASURING INSTRUMENTS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS(in thousands, except share and per share data)

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

| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | K. | Income
  Taxes                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |    | The Group accounts for
  income taxes utilizing the asset and liability method in accordance with SFAS
  No. 109, Accounting for Income Taxes of the FASB. Current tax liabilities
  are recognized for the estimated taxes payable on tax returns for the current
  year. Deferred tax liabilities or assets are recognized for the estimated
  future tax effects attributable to temporary differences between the income
  tax bases of assets and liabilities and their reported amounts in the
  financial statements, and for tax loss carryforwards. Measurement of current
  and deferred tax liabilities and assets is based on provisions of enacted tax
  laws, and deferred tax assets are reduced, if necessary, by the amount of tax
  benefits, the realization of which is not considered likely based on
  available evidence.                                                                                                                            
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | L. | Stock-Based
  Compensation                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |    | The Group accounts for
  employee stock-based compensation in accordance with Accounting Principles
  Board Opinion No. 25, Accounting for Stock Issued to Employees and in
  accordance with FASB Interpretation No. 44. Pursuant to these accounting
  pronouncements, the Group records compensation for stock options granted to
  employees over the vesting period of the options based on the difference, if
  any, between the exercise price of the options and the market price of the
  underlying shares at the grant date. With respect to variable awards, changes
  in the market price of the underlying shares at each balance sheet date
  affect the aggregate amount of compensation recorded. Deferred compensation
  is amortized to compensation expense over the vesting period of the options.
  See below for pro forma disclosures required in accordance with SFAS No. 123,
  Accounting for Stock-Based Compensation, as amended by SFAS 148.
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |    | Pro forma
  Loss Per Share According to SFAS 123 and SFAS 148:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |    | For purposes of estimating
  fair value in accordance with SFAS 123, the Company utilized the
  Black-Scholes option-pricing model. The following assumptions were utilized
  in such calculations for 2004 and 2003. No stock options were granted during
  2005 (all in weighted averages):                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 

| |                            |  |  |           |  |  |           | 
| | -------------------------- |  |  | --------- |  |  | --------- | 
| |                            |  |  | 2004      |  |  | 2003      | 
| |                            |  |  |           |  |  |           | 
| | Risk-free interest rate    |  |  | 4%        |  |  | 1.4%      | 
| | Expected life of options   |  |  | 7
  years |  |  | 7
  years | 
| | Expected weekly volatility |  |  | 56%       |  |  | 82%       | 
| | Expected dividend yield    |  |  | none      |  |  | none      | 

F-10

---

---



NOVA MEASURING INSTRUMENTS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS(in thousands, except share and per share data)

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

| |    |                                                                                                                                                                                                                                                                                     
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | L. | Stock-Based
  Compensation (Cont.)                                                                                                                                                                                                                                                  
| |    |                                                                                                                                                                                                                                                                                     
| |    | Had compensation cost for
  the Companys stock option plans been determined based on fair value at the
  grant dates for all awards made in 2004 and 2003 in accordance with SFAS 123, as amended by SFAS 148, the
  Companys pro forma loss per share would have been as follows:

| |                                                              |  |         |         |         |   |         |   |   |        |  
| | ------------------------------------------------------------ |  | ------- | ------- | ------- | - | ------- | - | - | ------ | -
| |                                                              |  | 2 0 0 5 |         | 2 0 0 4 |   | 2 0 0 3 |  
| |                                                              |  |         |         |         |   |         |  
| |                                                              |  |         |         |         |   |         |   |   |        |  
| | Pro forma net loss                                           |  |         |         |         |   |         |   |   |        |  
| |                                                              |  |         |         |         |   |         |   |   |        |  
| | Net loss for the year, as reported                           |  | $       | (8,414  | )       | $ | (1,420  | ) | $ | (4,212 | )
| | Deduct   stock-based
  compensation determined under APB-25 |  |         | 28      |         |   | 122     |   |   | 540    |  
| | Add - stock-based compensation determined under SFAS 123     |  |         | (2,710  | )       |   | (1,258  | ) |   | (1,348 | )
| |                                                              |  |         |         |         |   |         |   |   |        |  
| | Pro forma net loss                                           |  | $       | (11,096 | )       | $ | (2,556  | ) | $ | (5,020 | )
| |                                                              |  |         |         |         |   |         |   |   |        |  
| |                                                              |  |         |         |         |   |         |   |   |        |  
| | Pro forma loss per share                                     |  |         |         |         |   |         |   |   |        |  
| |                                                              |  |         |         |         |   |         |   |   |        |  
| | Basic - as reported                                          |  | $       | (0.55   | )       | $ | (0.09   | ) | $ | (0.28  | )
| |                                                              |  |         |         |         |   |         |   |   |        |  
| | Basic - pro forma                                            |  | $       | (0.72   | )       | $ | (0.17   | ) | $ | (0.33  | )
| |                                                              |  |         |         |         |   |         |   |   |        |  

| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |    | In July 2005, the
  Companys Board of Directors approved a plan to accelerate the vesting of
  certain outstanding stock options.  Based on this action, most of the
  stock options outstanding as of December 29, 2005 were vested and became
  fully exercisable as of that date. Aside from the acceleration of the vesting
  date, the terms and the conditions of the stock option award agreements governing
  the underlying stock options grants remained unchanged. As a result of this
  plan, options to purchase approximately 1,126,145 shares became exercisable.
  This action results in stock option expense in the Consolidated Statements of
  Operations over the next three years in accordance with SFAS 123 (revised
  2004) Share-Based Payment (SFAS 123(R)) to be approximately $1,491
  thousand less (in the aggregate) than the expense would have been if the vesting had not been accelerated. As
a result of the accelerated
  vesting, the pro forma stock-based employee compensation expense for 2005
  increased by $28 thousand.
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| | M. | Loss per
  Share                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |    | Loss per share is
  presented in accordance with SFAS 128 of the FASB, Earnings per Share.
  Pursuant to this standard, basic earnings (loss) per share exclude the
  dilutive effects of convertible securities and are computed by dividing
  income (loss) available to common shareholders by the weighted-average number
  of common shares outstanding for the period. Diluted earnings (loss) per
  share reflect the potential dilutive effect of all convertible securities.
  Due to the anti-dilutive effect, basic loss per share was equal to diluted
  loss per share for years 2005, 2004 and 2003. The number of potentially
  dilutive securities excluded from diluted earnings per share due to the
  anti-dilutive effect amounted to 2,444,175, 754,109 and 2,608,475 in 2005,
  2004 and 2003, respectively.                                                                                                                                                                                                                                       

F-11

---

---



NOVA MEASURING INSTRUMENTS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS(in thousands, except share and per share data)

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

| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | N. | Derivative
  Financial Instruments                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |    | SFAS No. 133, Accounting
  for Derivative Instruments and Hedging Activities as amended by SFAS No. 138
  and SFAS 149, requires, principally, the presentation of all derivatives as
  either assets or liabilities on the balance sheet and the measurement of
  those instruments at fair value. Gains and losses resulting from changes in
  the fair values of derivative instruments would be accounted for depending on
  the use of the derivative and whether it qualifies for hedge accounting.
| |    | See Note 13 for disclosure
  of the derivative financial instruments in accordance with such
  pronouncements.                                                                                                                                                                                                                                                                                                                                                                                             
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| | O. | Reclassification                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |    | Certain amounts in prior
  years financial statements have been reclassified in order to conform to the
  2005 financial statements presentation.                                                                                                                                                                                                                                                                                                                                                          
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| | P. | New Accounting
Pronouncements                                                                                                                                                                                                                                                                                                                                                                                                                                                                              

| |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| | --- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | (1) | In December 2004, the
  Financial Accounting Standards Board (FASB) issued SFAS No. 123(R).
  SFAS No. 123(R) requires employee share-based equity awards to be
  accounted for under the fair value method, and eliminates the ability to
  account for these instruments under the intrinsic value method prescribed by
  APB Opinion No. 25 and allowed under the original provisions of
  SFAS No. 123. SFAS No. 123(R) requires the use of an
  option pricing model for estimating fair value, which is then amortized to
  expense over the service periods. Had the Company adopted SFAS 123(R) in
  prior periods, the impact of that standard would have approximated the impact
  of SFAS 123 as described in the disclosure of pro forma net income and income
  per share above. SFAS No. 123(R) allows for either prospective
  recognition of compensation expense or retrospective recognition.
| |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| |     | In January 2005, the SEC
  issued SAB No. 107, which provides supplemental implementation guidance for
  SFAS No. 123(R). SFAS No. 123(R) will be effective for the Company beginning
  in the first quarter of fiscal 2006. In the first quarter of 2006, the
  company began to apply the prospective recognition method and implemented the
  provisions of SFAS No. 123(R).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| |     | Management has recently
  commenced identifying the potential future impact of applying the provisions
  of SFAS 123(R), including each of its proposed transition methods, yet is
  currently unable to fully quantify the effect of this Standard on the
  Companys future financial position and results of operations. Nonetheless,
  it is expected that the adoption of SFAS 123(R) will increase the
  stock-based-award expenses the Company is to record in the future in
  comparison to the expenses recorded under the guidance currently applied by
  the Company.                                                                                                                                                                                                                                                                                                                               

F-12

---

---



NOVA MEASURING INSTRUMENTS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS(in thousands, except share and per share data)

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

| |  |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| |  | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | a. | In May 2005,
  the FASB issued SFAS No. 154, Accounting Changes and Error
  Corrections. SFAS No. 154 replaces APB Opinion No. 20. Accounting
  Changes and SFAS No. 3, Reporting Accounting Changes in Interim
  Financial Statements. SFAS No. 154 requires retrospective application
  to prior periods financial statements of changes in accounting principle,
  unless it is impracticable to determine either the period-specific effects or
  the cumulative effect of the change. The Company does not expect the adoption
  of SFAS No. 154 will have any material impact on its consolidated financial
  statements.                                                                                                                                                                                                                                    
| |  |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| |  | b. | In
  November 2005, the FASB issued FSP FAS 115-1 and FAS 124-1,
  The Meaning of Other-Than-Temporary Impairment and Its Application to
  Certain Investments (FSP 115-1 and 124-1), which clarifies when an
  investment is considered impaired, whether the impairment is other than
  temporary, and the measurement of an impairment loss. It also includes
  accounting considerations subsequent to the recognition of an
  other-than-temporary impairment and requires certain disclosures about unrealized
  losses that have not been recognized as other-than-temporary impairments. FSP
  115-1 and 124-1 are effective for all reporting periods beginning after
  December 15, 2005. The Company does not anticipate that the
  implementation of these statements will have a significant impact on its
  financial position or results of operations.

|            |            
|----------- | -----------
|NOTE 3     | INVENTORIES
|            |            
|            | A.         

| |                 |  |                    |       |         |   |       | 
| | --------------- |  | ------------------ | ----- | ------- | - | ----- | 
| |                 |  | As of December 31, |      
| |                 |  |                    |      
| |                 |  | 2 0 0 5            |       | 2 0 0 4 |  
| |                 |  |                    |       |         |  
|
| | Raw materials   |  | $                  | 931   |         | $ | 1,640 | 
| | Work in process |  |                    | 3,530 |         |   | 3,444 | 
| | Finished goods  |  |                    | 2,145 |         |   | 1,270 | 
| |                 |  |                    |       |         |   |       | 
| |                 |  | $                  | 6,606 |         | $ | 6,354 | 
| |                 |  |                    |       |         |   |       | 

| |    |                                                                                                                                   
| | -- | ----------------------------------------------------------------------------------------------------------------------------------
| | B. | In the years
  ended December 31, 2005 and 2004 the Company wrote-off inventories in the
  amounts of $116 and $250, respectively.

|            |                  
|----------- | -----------------
|NOTE 4     | FIXED ASSETS, NET

| |                                            |  |                    |       |         |   |       | 
| | ------------------------------------------ |  | ------------------ | ----- | ------- | - | ----- | 
| |                                            |  | As of December 31, |      
| |                                            |  |                    |      
| |                                            |  | 2 0 0 5            |       | 2 0 0 4 |  
| |                                            |  |                    |       |         |  
|
| | Cost:                                      |  |                    |       |         |   |       | 
| | Electronic equipment                       |  | $                  | 5,552 |         | $ | 4,341 | 
| | Office furniture and equipment             |  |                    | 616   |         |   | 597   | 
| | Leasehold improvements                     |  |                    | 1,802 |         |   | 1,750 | 
| |                                            |  |                    |       |         |   |       | 
| |                                            |  |                    | 7,970 |         |   | 6,688 | 
| | Accumulated depreciation and
amortization: |  |                    |       |         |   |       | 
| | Electronic equipment                       |  |                    | 3,778 |         |   | 3,140 | 
| | Office furniture and equipment             |  |                    | 429   |         |   | 354   | 
| | Leasehold improvements                     |  |                    | 1,256 |         |   | 1,075 | 
| |                                            |  |                    |       |         |   |       | 
| |                                            |  |                    | 5,463 |         |   | 4,569 | 
| |                                            |  |                    |       |         |   |       | 
| | Net book value                             |  | $                  | 2,507 |         | $ | 2,119 | 
| |                                            |  |                    |       |         |   |       | 

F-13

---

---



NOVA MEASURING INSTRUMENTS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS(in thousands, except share and per share data)

|            |                           |             
|----------- | ------------------------- | ------------
|NOTE 5     | OTHER CURRENT LIABILITIES
|            |                           |             
|            | A.                        | Consists of:

| |                                        |  |                    |       |         |   |       | 
| | -------------------------------------- |  | ------------------ | ----- | ------- | - | ----- | 
| |                                        |  | As of December 31, |      
| |                                        |  |                    |      
| |                                        |  | 2 0 0 5            |       | 2 0 0 4 |  
| |                                        |  |                    |       |         |  
|
| | Accrued
  salaries and fringe benefits |  | $                  | 2,229 |         | $ | 2,667 | 
| | Accrued
  warranty costs (See B below) |  |                    | 1,864 |         |   | 2,915 | 
| | Deferred
  income                      |  |                    | 3,852 |         |   | -     | 
| | Governmental
  institutions            |  |                    | 917   |         |   | 933   | 
| | Other                                  |  |                    | 18    |         |   | 24    | 
| |                                        |  |                    |       |         |   |       | 
| |                                        |  | $                  | 8,880 |         | $ | 6,539 | 
| |                                        |  |                    |       |         |   |       | 

| |    |                        
| | -- | -----------------------
| | B. | Accrued warranty costs:

| |                                    |  |              |        |         |   |        |  
| | ---------------------------------- |  | ------------ | ------ | ------- | - | ------ | -
| |                                    |  | December 31, |       
| |                                    |  |              |       
| |                                    |  | 2 0 0 5      |        | 2 0 0 4 |  
| |                                    |  |              |        |         |  
|
| | Balance as
  of beginning of year  |  | $            | 2,915  |         | $ | 2,558  |  
| | Services
  provided under warranty |  |              | (3,090 | )       |   | (2,830 | )
| | Changes in
  provision             |  |              | 2,039  |         |   | 3,187  |  
| |                                    |  |              |        |         |   |        |  
| | Balance as
  of end of year        |  | $            | 1,864  |         | $ | 2,915  |  
| |                                    |  |              |        |         |   |        |  

|            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|----------- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 6     | LIABILITY FOR EMPLOYEE TERMINATION BENEFITS, NET                                                                                                                                                                                                                                                                                                                                                                                                                                       
|            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|            | Israeli law
  and labor agreements determine the obligations of the Company to make
  severance payments to dismissed employees and to employees leaving employment
  under certain other circumstances. The obligation for severance pay benefits,
  as determined by Israeli law, is based upon length of service and the
  employees most recent salary. The liability is partially covered through
  insurance policies purchased by the Company and deposits in a severance fund.
|           
|            | Severance-pay
  expense amounted to $597, $691 and $614 for 2005, 2004 and 2003, respectively.                                                                                                                                                                                                                                                                                                                                                                                         
|            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|NOTE 7     | COMMITMENTS AND CONTINGENT LIABILITIES                                                                                                                                                                                                                                                                                                                                                                                                                                                 

| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | A. | The Company
  has received grants in the aggregate amount of $8,945 from the OCS, as its
  participation of up to 50% of certain development costs. In consideration for
  such grants, the Company has undertaken to pay royalties amounting to 3%-3.5%
  of the net sales of products developed, directly or indirectly, from the
  projects financed, not to exceed 100% of the grants received. Refund of the
  grants thereon is contingent on future sales and the Company has no
  obligation to refund grants if sufficient sales are not generated. During the
  fourth quarter of 2003, the OCS has approved the Companys request to
  allocate $2,203 from the grants provided by OCS to a specific lithography
  project, to be repaid as royalties only from sales of lithography products.
  As a result, the Company has canceled a provision in the total amount of
  $2,203, made by it mainly in prior years. Such cancellation is included as
  Other Operating Income in the Statement of Operations for the year ended
  December 31, 2003. Royalty expense amounted to $ 0 for the years
  2005, 2004 and $ 656 for the year 2003. The
balance of the contingent liability to the OCS as of
  December 31, 2005 was approximately $ 5,741 (including $2,203 with respect to the
  lithography project, as mentioned above).

F-14

---

---



NOVA MEASURING INSTRUMENTS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS(in thousands, except share and per share data)

|            |                                                |                                                                                                                                                                                          
|----------- | ---------------------------------------------- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 7     | COMMITMENTS AND CONTINGENT LIABILITIES (Cont.)
|            |                                               
|            | B.                                             | The Group
  rents its facilities under various operating lease agreements, which expire
  on various dates, the latest of which is in 2010. The minimum rental payments
  are as follows:

| |  |      |      |                     |  |       | 
| |  | ---- | ---- | ------------------- |  | ----- | 
| |  | Year |      | Amount (US dollars) | 
| |  |      |      |                     | 
| |  |      | 2006 |                     |  | 1,087 | 
| |  |      | 2007 |                     |  | 1,072 | 
| |  |      | 2008 |                     |  | 27    | 

| |    |                                                                                                                                                                                       
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |    | Rental
  expense for the facilities amounted to $1,062, $1,248 and $851 for the years
  2005, 2004 and 2003, respectively.                                                            
| |    |                                                                                                                                                                                       
| | C. | The Company
  leases vehicles under various operating lease agreements, which expire on
  various dates, the latest of which is in 2008. The minimum rental payments
  are as follows:

| |  |      |      |                     |  |     | 
| |  | ---- | ---- | ------------------- |  | --- | 
| |  | Year |      | Amount (US dollars) | 
| |  |      |      |                     | 
| |  |      | 2006 |                     |  | 520 | 
| |  |      | 2007 |                     |  | 94  | 
| |  |      | 2008 |                     |  | 8   | 

| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                      
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |    | Vehicle
  lease expense amounted to $717, $669 and $516 for the years 2005, 2004 and
  2003, respectively.                                                                                                                                                                                                                                                                                                                           
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                      
| | D. | A major
  customer who was a related party until August 2001 (the Former Related
  Party), has notified the Company that a lawsuit has been filed against him
  by a third party. The suit alleges that the Former Related Party, while using
  the Companys products, has infringed upon numerous U.S. patents owned by the
  third party.                                                                                       
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                      
| |    | According to
  the agreement between the Company and the Former Related Party, the Company
  is to assume responsibility and to indemnify the Former Related Party for any
  losses with regard to such suit. The Company is unable to determine at this
  time with any certainty the ultimate outcome of the aforementioned issue and
  its effect, if any, on the Companys financial condition, operating results
  and business.

| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | E. | In 2004 the
  Israeli Tax Authorities approached Israeli public companies and other
  entities with a request to provide certain information relating the stamping
  of commercial documents in Israel. To the best of the Companys knowledge
  such companies and entities are arguing that the request contradicts the
  common practice in Israel. Management estimates that the Companys exposure,
  if any, in connection with this request is not expected to have a material
  effect on the Companys financial position and results of operations. In
  January 2006 the Stamp Tax was canceled.                                                                              
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| | F. | On March 9,
  2005 the Company filed a complaint in the United States District Court for
  the Northern District of California against one of its competitors
  (hereinafter-the Competitor) for infringing its US Patent. The patent
  relates to the Companys Integrated Metrology (IM) tools and the fundamental
  aspects of these systems. The Competitor has filed counter claim seeking an
  injunction that will determine that the patent is invalid. The Company is unable
  to determine at this time with any certainty the ultimate outcome of the
  aforementioned issue and its effect, if any, on the Companys financial
  condition, operating results and business.

F-15

---

---



NOVA MEASURING INSTRUMENTS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS(in thousands, except share and per share data)

|            |                      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|----------- | -------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 8     | SHAREHOLDERS EQUITY
|            |                     
|            | A.                   | Share Capital Transactions                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|            |                      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|            |                      | The Company
  sponsored an employee stock purchase plan (ESPP) for the benefit of its
  employees. Under the ESPP, substantially all employees were entitled to
  purchase the Companys ordinary shares through payroll deductions at a price
  equal to 85 percent of the lower of fair market value at the beginning or end
  of each six-month offering period. The ESPP ended on March 19, 2005. Total
  shares issued under the ESPP were 138,505, out of which 42,062 shares were
  issued under the ESPP in 2005. The Company issued 42,062, 52,858 and 43,585
  shares, in 2005, 2004 and 2003 respectively under the ESPP.
|            |                      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|            | B.                   | Rights of Shares                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|            |                      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|            |                      | Holders of
  ordinary shares are entitled to participate equally in the payment of cash
  dividends and bonus shares (stock dividends) and, in the event of the
  liquidation of the Company, in the distribution of assets after satisfaction
  of liabilities to creditors. Each ordinary share is entitled to one vote on
  all matters to be voted on by shareholders.                                                                                                                                                                                                                                                          
|            |                      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|            | C.                   | Share Option Plans                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|            |                      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|            |                      | The
  Companys Board of directors approves, from time to time, employee share
  option plans, the last of which was approved in December 2004. The options
  usually vest over four years and their term may not exceed 7 years. The
  exercise price of each option is usually the market price of the underling
  share at the date of each grant.                                                                                                                                                                                                                                                                               
|            |                      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|            |                      | Through
  December 31, 2005, 5,730,822 share options have been issued under the plans,
  of which 1,728,567 options have been exercised, 485,030 options have been
  forfeited, 338,221 have been terminated and 3,170,885 options were
  exercisable as of December 31, 2005.                                                                                                                                                                                                                                                                                                                                                      
|            |                      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|            |                      | The weighted
  average fair value (in dollars) of the options granted during 2004 and 2003,
  according to Black-Scholes option-pricing model, amounted to $2.11 and $1.43
  per option, respectively. Fair value was determined on the basis of the price
  of the Companys share.                                                                                                                                                                                                                                                                                                                                                
|            |                      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|            |                      | A summary of the status of the Companys share option plans as of
  December 31, 2005, 2004 and 2003, as well as changes during each of the years
  then ended, is presented below:                                                                                                                                                                                                                                                                                                                                                                                                                                                 

| |                                 |  |                  |           |                                          |   |                  |  |                                          |           |                  |   |                                       |  |  |           |   |   |      | 
| | ------------------------------- |  | ---------------- | --------- | ---------------------------------------- | - | ---------------- |  | ---------------------------------------- | --------- | ---------------- | - | ------------------------------------- |  |  | --------- | - | - | ---- | 
| |                                 |  | 2 0 0 5          |           | 2 0 0 4                                  |   | 2 0 0 3          | 
| |                                 |  |                  |           |                                          |   |                  | 
| |                                 |  | Share 
  options |           | Weighted 
  average 
  exercise 
  price |   | Share 
  options |  | Weighted 
  average 
  exercise 
  price |           | Share 
  options |   | Weighted 
  average 
  exercise price | 
| |                                 |  |                  |           |                                          |   |                  |  |                                          |           |                  |   |                                       | 
| | Outstanding - beginning of year |  |                  | 3,630,378 |                                          | $ | 3.57             |  |                                          | 2,621,213 |                  | $ | 3.38                                  |  |  | 1,922,402 |   | $ | 3.99 | 
|
| | Granted                         |  |                  | -         |                                          |   |                  |  |                                          | 1,250,000 |                  |   | 3.86                                  |  |  | 1,010,000 |   |   | 2.09 | 
| | Exercised                       |  |                  | (107,079  | )                                        |   | 1.51             |  |                                          | (138,640  | )                |   | 2.58                                  |  |  | (144,180  | ) |   | 1.66 | 
| | Terminated                      |  |                  | (173,965  | )                                        |   | 4.39             |  |                                          | (37,974   | )                |   | 5.81                                  |  |  | (72,240   | ) |   | 5.38 | 
| | Forfeited                       |  |                  | (170,330  | )                                        |   | 2.52             |  |                                          | (64,221   | )                |   | 2.30                                  |  |  | (94,769   | ) |   | 3.27 | 
| |                                 |  |                  |           |                                          |   |                  |  |                                          |           |                  |   |                                       |  |  |           |   |   |      | 
| | Outstanding - year end          |  |                  | 3,179,004 |                                          |   | 3.57             |  |                                          | 3,630,378 |                  |   | 3.57                                  |  |  | 2,621,213 |   |   | 3.38 | 
| |                                 |  |                  |           |                                          |   |                  |  |                                          |           |                  |   |                                       |  |  |           |   |   |      | 
|
| | Options exercisable at year-end |  |                  | 3,170,885 |                                          |   |                  |  |                                          | 1,575,108 |                  |   |                                       |  |  | 1,290,609 |   |   |      | 
| |                                 |  |                  |           |                                          |   |                  |  |                                          |           |                  |   |                                       |  |  |           |   |   |      | 

F-16

---

---



NOVA MEASURING INSTRUMENTS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share data)

|            |                              |                                                                                                      
|----------- | ---------------------------- | -----------------------------------------------------------------------------------------------------
|NOTE 8     | SHAREHOLDERS EQUITY (Cont.)
|            |                             
|            | C.                           | Share Option Plans (Cont.)                                                                           
|            |                              |                                                                                                      
|            |                              | The following table summarizes information about share options
  outstanding as of December 31, 2005:

| |                                       |           |                                       |  |                                                  |  |                                       |     |                      |  |                                       |  |  |           |  |  |        | 
| | ------------------------------------- | --------- | ------------------------------------- |  | ------------------------------------------------ |  | ------------------------------------- | --- | -------------------- |  | ------------------------------------- |  |  | --------- |  |  | ------ | 
| | Outstanding as of
  December 31, 2005 |           | Exercisable as of
  December 31, 2005 | 
| |                                       |           |                                       | 
| | Range of
  exercise
  prices          |           | Number
  outstanding                  |  | Weighted
  average
  remainingcontractual
  life |  | Weighted
  average
  exercise
  price |     | Number
  exercisable |  | Weighted
  average
  exercise
  price | 
| |                                       |           |                                       |  |                                                  |  |                                       |     |                      |  |                                       | 
| | (US dollars)                          |           |                                       |  | (in years)                                       |  | (US dollars)                          |     |                      |  | (US dollars)                          | 
| |                                       |           |                                       |  |                                                  |  |                                       |     |                      |  |                                       | 
| |                                       | 0.0025    |                                       |  | 4,000                                            |  |                                       | 0.5 |                      |  | 0.0025                                |  |  | 4,000     |  |  | 0.0025 | 
| |                                       | 2.06      |                                       |  | 720,829                                          |  |                                       | 4.2 |                      |  | 2.06                                  |  |  | 720,829   |  |  | 2.06   | 
| |                                       | 2.17-3.69 |                                       |  | 807,234                                          |  |                                       | 2.4 |                      |  | 2.69                                  |  |  | 799,115   |  |  | 2.69   | 
| |                                       | 3.4       |                                       |  | 590,500                                          |  |                                       | 5.9 |                      |  | 3.4                                   |  |  | 590,500   |  |  | 3.4    | 
| |                                       | 4.01      |                                       |  | 476,054                                          |  |                                       | 5.4 |                      |  | 4.01                                  |  |  | 476,054   |  |  | 4.01   | 
| |                                       | 5.15      |                                       |  | 60,000                                           |  |                                       | 5.2 |                      |  | 5.15                                  |  |  | 60,000    |  |  | 5.15   | 
| |                                       | 5.16      |                                       |  | 102,272                                          |  |                                       | 1.0 |                      |  | 5.16                                  |  |  | 102,272   |  |  | 5.16   | 
| |                                       | 6.27-7.37 |                                       |  | 418,115                                          |  |                                       | 1.5 |                      |  | 6.97                                  |  |  | 418,115   |  |  | 6.97   | 
| |                                       |           |                                       |  |                                                  |  |                                       |     |                      |  |                                       |  |  |           |  |  |        | 
| |                                       |           |                                       |  | 3,179,004                                        |  |                                       |     |                      |  |                                       |  |  | 3,170,885 |  |  |        | 
| |                                       |           |                                       |  |                                                  |  |                                       |     |                      |  |                                       |  |  |           |  |  |        | 

|            |                                   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|----------- | --------------------------------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 9     | OTHER OPERATING EXPENSES (INCOME)
|            |                                  
|            |                                   | The amount
  for the year ended December 31, 2003 represents cancellation of a provision
  with respect to royalties to the OCS (see Note 7A.).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|            |                                   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|NOTE 10    | INCOME TAXES                     
|            |                                  
|            | A.                                | Law for the Encouragement of Capital Investments  1959                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|            |                                   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|            |                                   | In October
  1995, the Company was granted approved enterprise status under the
  tax-exempt benefit track, as provided by the Israeli Law for the
  Encouragement of Capital Investments - 1959, for an investment program in the
  aggregate amount of $732 (the first program). The Company had completed the
  investments under the program, which received the approval of the Investments
  Center. The tax-exempt benefit track provides for a tax exemption on
  undistributed earnings derived from assets included in the approved
  enterprise investment program for the first four years of the seven-year
  benefit period and a 25% tax rate for the remaining three years of the
  benefit period. Pursuant to the tax-exempt benefit track, the Company is
  liable for tax at a 25% rate on distributions to shareholders of earnings
  subject to the exemption.

F-17

---

---



NOVA MEASURING INSTRUMENTS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share data)

|            |                      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|----------- | -------------------- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 10    | INCOME TAXES (Cont.)
|            |                     
|            | A.                   | Law for the Encouragement of Capital Investments  1959 (Cont.)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|            |                      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|            |                      | In December
  1999, the Company was granted another approved enterprise status for an
  investment expansion program in the aggregate amount of $3,229 (the second
  program) under the tax-exempt benefit track. The Company had completed the
  investments under the expansion program and filed the final report with
  respect to this plan. The tax-exempt benefit track provides for a tax
  exemption on undistributed earnings derived from assets included in the
  approved enterprise investment program for the first two years of the
  seven-year benefit period and a 25% tax rate for the remaining five years of
  the benefit period. Pursuant to the tax-exempt benefit track, the Company is
  liable for tax at a 25% rate on distributions to shareholders of earnings
  subject to the exemption.
|            |                      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|            |                      | In January
  2005, the Company granted another approved enterprise status for an
  investment expansion program in the aggregate amount of $1,000 (the third
  program) under the tax-exempt benefit track. The tax-exempt benefit track,
  once approved, provides for a tax exemption on undistributed earnings derived
  from assets included in the approved enterprise investment program for the
  first two years of the seven-year benefit period and a 25% tax rate for the
  remaining five years of the benefit period. Pursuant to the tax-exempt
  benefit track, the Company is liable for tax at a 25% rate on distributions
  to shareholders of earnings subject to the exemption.                                                                                                                      
|            |                      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|            |                      | The period
  in which the Company is entitled to the abovementioned tax benefits is
  limited to seven years from the first year that taxable revenues are
  generated, and such benefits must be utilized within 12 years from the year
  that operation (as defined) of the approved enterprise commences, or 14 years
  from the year the approval is granted, whichever is earlier. Accordingly,
  under the existing conditions, the tax benefits period under the above-mentioned
  first, second and third programs ends in 2006, 2012 and 2018, respectively.                                                                                                                                                                                                                                                        
|            |                      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|            |                      | Dividends
  paid from earnings that benefited from the approved enterprise tax status are
  subject to a 15% tax to the recipient (for a period of 12 years from the end
  of the seven-year benefit period), whereas dividends paid out of other
  earnings are subject to tax to the recipient at the rate of 25% (or lower if
  paid to a treaty country), except when paid to another Israeli company, in
  which case such dividends are exempt from tax.                                                                                                                                                                                                                                                                                                                                                               
|            |                      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|            |                      | The income
  of the Company that is not derived from assets, which are eligible for
  reduced taxation benefits, as described above, is taxed at the statutory rate
  for Israeli companies (see H below).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   

F-18

---

---



NOVA MEASURING INSTRUMENTS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share data)

|            |                      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|----------- | -------------------- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 10    | INCOME TAXES (Cont.)
|            |                     
|            | A.                   | Law for the Encouragement of Capital Investments  1959 (Cont.)                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|            |                      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|            |                      | The above
  tax benefits are conditioned upon fulfillment of the requirements stipulated
  by the aforementioned law and the regulations promulgated there under, as well
  as the criteria set forth in the certificates of approval. In the event of
  failure by the Company to comply with these conditions, the tax benefits
  could be canceled, in whole or in part, and the Company would be required to
  refund the amount of the canceled benefits, plus interest and certain
  inflation adjustments.
|            |                      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|            |                      | If the
  investments of non-Israeli investors (as such investments are defined by the
  Law) will exceed 25% then the seven-year benefit period mentioned above may
  be extended to ten years. If the investments of non-Israeli investors is 49%
  or more, then the rate of tax on earnings derived from assets included in the
  approved enterprise investment program will decrease to 10% - 20%, depending
  on the level of ownership by non-Israeli investors, examined on a yearly
  basis.            
|            |                      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|            |                      | In March
  2005, the government of Israel past an amendment to the Investment Law, in
  which it revised the criteria for investments qualified to receive tax
  benefits as an Approved Enterprise. Among other things, company that met the
  criteria of alternate package of tax benefits, will receive those benefits
  without a prior approval.                                                                                                                                                           
|            |                      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|            | B.                   | Law for the Encouragement of Industry (Taxation), 1969                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|            |                      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|            |                      | The Company
  is an industrial company under the Law for the Encouragement of Industry
  (Taxation), 1969 and, therefore, is entitled to certain tax benefits, mainly
  accelerated rates of depreciation.                                                                                                                                                                                                                                                                                                     
|            |                      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|            | C.                   | Taxation Under Inflationary Conditions                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|            |                      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|            |                      | The Company
  reports for tax purposes in accordance with the provisions of the Income Tax
  Law (Adjustments Due to Inflation) - 1985, under which taxable income is
  measured in terms of NIS adjusted for changes in the Israeli Consumer Price
  Index.                                                                                                                                                                                                                                                     
|            |                      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|            | D.                   | Deferred Taxes                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|            |                      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|            |                      | The Company
  has accumulated losses for Israeli tax purposes as of December 31, 2005 in
  the amount of approximately $50,000. At such date, other temporary
  differences were approximately $8,000.                                                                                                                                                                                                                                                                                                           
|            |                      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|            |                      | The Israeli
  tax loss carryforwards have no expiration date. The Company expects that
  during the period these losses are utilized, its undistributed earnings will
  be tax exempt. Since the Company has no intention to distribute such
  earnings, there will be no tax benefit available from such tax losses and no
  deferred taxes have been included in these financial statements for these
  losses.                                                                                                

F-19

---

---



NOVA MEASURING INSTRUMENTS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share data)

|            |                                      |                                                                                                                                                                                                                                                                                                                                                                                                                                             
|----------- | ------------------------------------ | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 10    | INCOME TAXES (Cont.)                
|            |                                     
|            | D.                                   | Deferred Taxes (Cont.)                                                                                                                                                                                                                                                                                                                                                                                                                      
|            |                                      |                                                                                                                                                                                                                                                                                                                                                                                                                                             
|            |                                      | As of
  December 31, 2005, the subsidiaries had a net operating loss carryforwards of
  approximately $883.                                                                                                                                                                                                                                                                                                                                 
|            |                                      |                                                                                                                                                                                                                                                                                                                                                                                                                                             
|            | E.                                   | Effective Tax Rates                                                                                                                                                                                                                                                                                                                                                                                                                         
|            |                                      |                                                                                                                                                                                                                                                                                                                                                                                                                                             
|            |                                      | The Companys
  effective tax rates differ from the statutory rates applicable to the Company
  for all years presented due primarily to its approved enterprise status (see
  A above) and the tax loss carryforwards.                                                                                                                                                                                                                     
|            |                                      |                                                                                                                                                                                                                                                                                                                                                                                                                                             
|            | F.                                   | Tax Assessments                                                                                                                                                                                                                                                                                                                                                                                                                             
|            |                                      |                                                                                                                                                                                                                                                                                                                                                                                                                                             
|            |                                      | The Company
  received final tax assessments until and including tax year 2001.                                                                                                                                                                                                                                                                                                                                                             
|            |                                      |                                                                                                                                                                                                                                                                                                                                                                                                                                             
|            | G.                                   | In light of
  losses for both financial reporting and tax purposes in 2002 and 2003, a
  reconciliation of the effective income tax rate has not been presented. In
  2004, theoretical income taxes on the Companys pre-tax income were
  primarily reduced by the utilization of tax loss carryforwards from prior
  years for which a deferred tax asset had not been recorded and reduced tax
  rates related to approved enterprise.
|            |                                      |                                                                                                                                                                                                                                                                                                                                                                                                                                             
|            | H.                                   | Tax Rates                                                                                                                                                                                                                                                                                                                                                                                                                                   
|            |                                      |                                                                                                                                                                                                                                                                                                                                                                                                                                             
|            |                                      | In 2005 the
  Israeli Knesset approved a law for the amendment of the Income Tax Ordinance,
  according to which the regular corporate tax rate is to be reduced gradually
  and annually from 35% in 2004 tax year to 34% in 2005 tax year, ending at 25%
  for 2010 tax year.                                                                                                                                                             
|            |                                      |                                                                                                                                                                                                                                                                                                                                                                                                                                             
|NOTE 11    | GEOGRAPHIC AREAS AND MAJOR CUSTOMERS
|            |                                     
|            | A.                                   | Sales by geographic area (as percentage of total sales):                                                                                                                                                                                                                                                                                                                                                                                    

|                                            |  |                         |     |         |  |         |  |  |     | 
|------------------------------------------- |  | ----------------------- | --- | ------- |  | ------- |  |  | --- | 
|                                            |  | Year ended December 31, |    
|                                            |  |                         |    
|                                            |  | 2 0 0 5                 |     | 2 0 0 4 |  | 2 0 0 3 | 
|                                            |  |                         |     |         |  |         | 
|                                            |  | %                       |     | %       |  | %       | 
|                                            |  |                         |     |         |  |         | 
|USA                                         |  |                         | 66  |         |  | 67      |  |  | 62  | 
|Europe -primarily Italy, France and Germany |  |                         | 11  |         |  | 11      |  |  | 10  | 
|Japan                                       |  |                         | 18  |         |  | 18      |  |  | 21  | 
|Other                                       |  |                         | 5   |         |  | 4       |  |  | 7   | 
|                                            |  |                         |     |         |  |         |  |  |     | 
|Total                                       |  |                         | 100 |         |  | 100     |  |  | 100 | 
|                                            |  |                         |     |         |  |         |  |  |     | 

F-20

---

---



NOVA MEASURING INSTRUMENTS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share data)

|            |                                              |                                                         
|----------- | -------------------------------------------- | --------------------------------------------------------
|NOTE 11    | GEOGRAPHIC AREAS AND MAJOR CUSTOMERS (Cont.)
|            |                                             
|            | B.                                           | Sales by major customers (as percentage of total sales):

|           |  |                         |     |         |  |         |  |  |     | 
|---------- |  | ----------------------- | --- | ------- |  | ------- |  |  | --- | 
|           |  | Year ended December 31, |    
|           |  |                         |    
|           |  | 2 0 0 5                 |     | 2 0 0 4 |  | 2 0 0 3 | 
|           |  |                         |     |         |  |         | 
|           |  | %                       |     | %       |  | %       | 
|           |  |                         |     |         |  |         | 
|Customer A |  |                         | 48  |         |  | 45      |  |  | 36  | 
|Customer B |  |                         | 16  |         |  | 18      |  |  | 29  | 
|Customer C |  |                         | 15  |         |  | 12      |  |  | 14  | 
|Other      |  |                         | 21  |         |  | 25      |  |  | 21  | 
|           |  |                         |     |         |  |         |  |  |     | 
|Total      |  |                         | 100 |         |  | 100     |  |  | 100 | 
|           |  |                         |     |         |  |         |  |  |     | 

|            |                                                |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|----------- | ---------------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|            | C.                                             | Assets by location                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|            |                                                |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|            |                                                | Substantially
  all fixed assets are located in Israel.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|            |                                                |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|NOTE 12    | TRANSACTIONS AND BALANCES WITH RELATED PARTIES
|            |                                               
|            |                                                | The total
  directors fees (including the Chairman of the Board) for the year 2005
  amounted to $114 (2004 - $103, 2003 -$122). Number of options granted to
  directors amounted 380,000 in 2004.                                                                                                                                                                                                                                                                                                                                      
|            |                                                |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|NOTE 13    | FINANCIAL INSTRUMENTS                         
|            |                                               
|            | A.                                             | Fair value of financial instruments                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|            |                                                |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|            |                                                | A financial
  instrument is defined as cash, evidence of an ownership interest in an
  entity, or a contract that impose on one entity a contractual obligation
  either to deliver cash or receive cash or another financial instrument to or
  from a second entity. Examples of financial instruments include cash and cash
  equivalents, short-term interest-bearing bank deposits, held to maturity
  securities, trade accounts receivable, investments, trade accounts payable,
  accrued expenses, options and forward contracts.
|            |                                                |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|            |                                                | At December
  31, 2005 and 2004 the fair market value of the Companys financial
  instruments did not materially differ from their respective book value.                                                                                                                                                                                                                                                                                                                                                                                
|            |                                                |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|            | B.                                             | Hedging activities                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|            |                                                |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|            |                                                | In 2003, the
  Company entered into currency-forward transaction (NIS/dollar) of $400 with
  settlement date of January 2004, designed to reduce cash-flow exposure to the
  impact of exchange-rate fluctuations on firm commitments of $400. In
  accordance with SFAS 133 the Company recorded in 2003 an increase of $13 in
  fair market value in Other Comprehensive Income. In 2004 this increase was
  charged to operations on the relevant settlement dates.                                                                  

F-21

---

---



NOVA MEASURING INSTRUMENTS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share data)

|            |                                     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|----------- | ----------------------------------- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 13    | FINANCIAL INSTRUMENTS (Cont.)      
|            |                                    
|            | B.                                  | Hedging activities (Cont.)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|            |                                     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|            |                                     | In 2004, the
  Company entered into currency-forward transaction, to currency-put option and
  to currency-call option (NIS/dollar, Euro/dollar, Yen/dollar) of 7,700 with
  settlement date through 2005, designed to reduce cash-flow exposure to the
  impact of exchange-rate fluctuations on firm commitments of 7,700. In
  accordance with SFAS 133 the Company recorded in 2004 an increase of $8 in
  fair market value in Other Comprehensive Income.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|            |                                     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|            |                                     | In 2005, the company entered into
  currency-forward transaction, to currency-put option and to currency-call
  option (NIS/dollar, Euro/dollar, Yen/dollar) of 4,250 with settlement date
  through 2005, designed to reduce cash-flow exposure to the impact of
  exchange-rate fluctuations on firm commitments of 4,250. In accordance with
  SFAS 133 the
  Company recorded in 2005 a decrease of $26 in fair market value in Other
  Comprehensive Income.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|            |                                     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|NOTE 14    | RESTATEMENT OF FINANCIAL STATEMENTS
|            |                                    
|            |                                     | Subsequent
  to the issuance of the 2004 financial statements, the Company decided to
  restate its financial statements for the fiscal year ended December 31, 2004,
  to correctly apply revenue recognition principles relating to certain sales
  transactions, as described below.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|            |                                     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|            |                                     | During 2004,
  the Company sold certain systems to several customers. These transactions
  included an option to upgrade the sold system free of charge once for an
  unlimited period or during a two year period. The Company recognized all
  revenues from the sales of these systems in 2004. EITF 00-21 Revenue
  Arrangements with Multiple Deliverables (EITF), requires evaluation of each
  deliverable to determine whether it should be a separate unit of accounting.
  Under the EITF these transactions are considered multiple deliverables
  arrangement, for which the upgrade right was not delivered. The Company was
  unable to establish a vendor specific objective evidence (VSOE) for the
  fair value of the upgrade right, therefore all revenues from the sale of
  these systems have been deferred until such an upgrade will be either
  exercised or expires. The restated financial statements include the effect of
  such deferral of revenues and costs related to these transactions.
|            |                                     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|            |                                     | In another
  instance in 2004 the Company granted to one of its customers trade in rights
  with decreasing rates of discounts over a period of 5 years. The trade-in
  right provided the customer with a discount toward the purchase price of a
  new system that is calculated based on the price of the originally sold
  systems as follows: if the trade-in is performed during the 1st and 2nd year
  after the sale  72% of the price of the originally bought systems; 3rd year
   47%; 4th year  31%; 5th year  14%.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|            |                                     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|            |                                     | The Company
  had recognized all revenues from the sales of these systems in 2004. The
  Company reached a conclusion that only the portion that is not subject to the
  discounts schedule above, is fixed and determinable. The Company recognized
  only that portion and will recognize the remaining balance in future periods
  based on the amounts released from the above discount schedule. The restated financial
  statements include the effect of such deferral and the directly related
  costs.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                

F-22

---

---



NOVA MEASURING INSTRUMENTS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS(in thousands, except share and per share data)

|           |                                             |                                                                                                                                                                          
|---------- | ------------------------------------------- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 14   | RESTATEMENT OF FINANCIAL STATEMENTS (Cont.)
|           |                                             |                                                                                                                                                                          
|           |                                             | The tables
  below summarize the impact of the aforementioned restatement with respect to
  the financial statements as of December 31, 2004 and for the year then ended:

| |                                       |  |                                |        |          |   |               |   |   |        |  
| | ------------------------------------- |  | ------------------------------ | ------ | -------- | - | ------------- | - | - | ------ | -
| | Consolidated Statement of Operations: |  |                                |       
| |                                       |  |                                |       
| |                                       |  | Year ended
  December 31, 2004 |       
| |                                       |  |                                |       
| |                                       |  | Previously
  Reported          |        | Adjusted |   | As
  Restated |  
| |                                       |  |                                |        |          |   |               |  
| |                                       |  |                                |        |          |   |               |   |   |        |  
| | Revenues-Product
  sales              |  | $                              | 33,347 |          | $ | (4,073        | ) | $ | 29,274 |  
| |                                       |  |                                |        |          |   |               |   |   |        |  
| |                                       |  |                                |        |          |   |               |   |   |        |  
| | Cost of
  revenues-Product Sales      |  |                                | 15,361 |          |   | (965          | ) |   | 14,396 |  
| |                                       |  |                                |        |          |   |               |   |   |        |  
| |                                       |  |                                |        |          |   |               |   |   |        |  
| | Sales and
  marketing expenses        |  |                                | 6,868  |          |   | (221          | ) |   | 6,647  |  
| |                                       |  |                                |        |          |   |               |   |   |        |  
| |                                       |  |                                |        |          |   |               |   |   |        |  
| | Operating
  Profit (Loss)             |  |                                | 939    |          |   | (2,887        | ) |   | (1,948 | )
| |                                       |  |                                |        |          |   |               |   |   |        |  
| |                                       |  |                                |        |          |   |               |   |   |        |  
| | Net income
  (loss)                   |  |                                | 1,467  |          |   | (2,887        | ) |   | (1,420 | )
| |                                       |  |                                |        |          |   |               |   |   |        |  
| |                                       |  |                                |        |          |   |               |   |   |        |  
| | Basic
  earning (loss) per share      |  | $                              | 0.10   |          | $ | (0.19         | ) | $ | (0.09  | )
| |                                       |  |                                |        |          |   |               |   |   |        |  

Consolidated Balance Sheet:

| |                              |  |                         |        |                            |   |               |   |   |        | 
| | ---------------------------- |  | ----------------------- | ------ | -------------------------- | - | ------------- | - | - | ------ | 
| |                              |  | As of December 31, 2004 |       
| |                              |  |                         |       
| |                              |  | Previously
  Reported   |        | Adjusted
  andReclassified |   | As
  Restated |  
| |                              |  |                         |        |                            |   |               |  
| |                              |  |                         |        |                            |   |               |   |   |        | 
| |                              |  |                         |        |                            |   |               |   |   |        | 
| | Trade
  Accounts Receivables |  | $                       | 7,461  |                            | $ | (611          | ) | $ | 6,850  | 
| |                              |  |                         |        |                            |   |               |   |   |        | 
| |                              |  |                         |        |                            |   |               |   |   |        | 
| | Inventories                  |  |                         | 5,239  |                            |   | 1,115         |   |   | 6,354  | 
| |                              |  |                         |        |                            |   |               |   |   |        | 
| |                              |  |                         |        |                            |   |               |   |   |        | 
| | Total
  Current Assets       |  |                         | 36,539 |                            |   | 504           |   |   | 37,043 | 
| |                              |  |                         |        |                            |   |               |   |   |        | 
| |                              |  |                         |        |                            |   |               |   |   |        | 
| | Total Assets                 |  |                         | 49,462 |                            |   | 504           |   |   | 49,966 | 
| |                              |  |                         |        |                            |   |               |   |   |        | 
| |                              |  |                         |        |                            |   |               |   |   |        | 
| | Trade
  Accounts Payables    |  |                         | 5,016  |                            |   | (221          | ) |   | 4,795  | 
| |                              |  |                         |        |                            |   |               |   |   |        | 
| |                              |  |                         |        |                            |   |               |   |   |        | 
| | Other
  Current Liabilities  |  |                         | 6,389  |                            |   | 150           |   |   | 6,539  | 
| |                              |  |                         |        |                            |   |               |   |   |        | 
| |                              |  |                         |        |                            |   |               |   |   |        | 
| | Total
  Current Liabilities  |  | $                       | 11,405 |                            | $ | (71           | ) | $ | 11,334 | 
| |                              |  |                         |        |                            |   |               |   |   |        | 

F-23

---

---



NOVA MEASURING INSTRUMENTS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS(in thousands, except share and per share data)

|           |                                            
|---------- | -------------------------------------------
|NOTE 14   | RESTATEMENT OF FINANCIAL STATEMENTS (Cont.)

| |                                         |  |                           |         |          |   |               |   |   |         |  
| | --------------------------------------- |  | ------------------------- | ------- | -------- | - | ------------- | - | - | ------- | -
| | Consolidated Balance Sheet (Cont.):     |  |                           |        
| |                                         |  |                           |        
| |                                         |  | As of
  December 31, 2004 |        
| |                                         |  | Previously
  Reported     |         | Adjusted |   | As
  Restated |  
| |                                         |  |                           |         |          |   |               |  
| |                                         |  |                           |         |          |   |               |   |   |         |  
| | Long Term
  Liabilities-Deferred Income |  | $                         | 369     |          | $ | 3,462         |   | $ | 3,831   |  
| |                                         |  |                           |         |          |   |               |   |   |         |  
| |                                         |  |                           |         |          |   |               |   |   |         |  
| | Total Long
  Term Liabilities           |  |                           | 3,589   |          |   | 3,462         |   |   | 7,051   |  
| |                                         |  |                           |         |          |   |               |   |   |         |  
| |                                         |  |                           |         |          |   |               |   |   |         |  
| | Accumulated
  Deficit                   |  |                           | (38,919 | )        |   | (2,887        | ) |   | (41,806 | )
| |                                         |  |                           |         |          |   |               |   |   |         |  
| |                                         |  |                           |         |          |   |               |   |   |         |  
| | Total
  Shareholders Equity             |  | $                         | 34,468  |          | $ | (2,887        | ) | $ | 31,581  |  
| |                                         |  |                           |         |          |   |               |   |   |         |  

|           |                  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|---------- | ---------------- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 15   | SUBSEQUENT EVENT
|           |                  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|           |                  | In April
  2006, the Companys Competitor, against whom The Company has filed civil
  action for patent infringement, has filed a civil action in the United States
  District Court against the Company and the Companys wholly-owned US
  subsidiary, seeking to enforce its United States Patent. The Company has
  filed a response declaring the patent invalid and asserting that neither it
  nor the Companys wholly-owned subsidiary, infringe the patent. The Company
  is unable to determine at this time with any certainty the ultimate outcome
  of the aforementioned issue and its effect, if any, on the Companys
  financial condition, operating results and business.

F-24

---

---



EXHIBIT INDEX

|       |  |             |                                                                                                                                                                                                                                                                                                                                                                    |             |    
|------ |  | ----------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ | ----------- | ---
|Number |  | Description |                                                                                                                                                                                                                                                                                                                                                                    | Page Number
|       |  |             |                                                                                                                                                                                                                                                                                                                                                                    |            
|       |  |             |                                                                                                                                                                                                                                                                                                                                                                    |            
|1.1    |  |             | Articles of Association
  (incorporated by reference to exhibit 3.1 to the Companys Registration
  Statement on Form F-1 (registration number 333-11640))                                                                                                                                                                                                         |             |    
|       |  |             |                                                                                                                                                                                                                                                                                                                                                                    |             |    
|1.2    |  |             | First Amendment to the
  Companys Articles of Association (incorporated by reference to the Companys
  Current Report on Form 6-K filed on June 4, 2002)                                                                                                                                                                                                         |             |    
|       |  |             |                                                                                                                                                                                                                                                                                                                                                                    |             |    
|1.3    |  |             | Second Amendment to the
  Companys Articles of Association (incorporated by reference to the Companys
  Current Report on Form 6-K filed on December 16, 2004).                                                                                                                                                                                                  |             |    
|       |  |             |                                                                                                                                                                                                                                                                                                                                                                    |             |    
|4.1    |  |             | 1997 Stock Option Plan
  (Plan 2) (incorporated by reference to exhibit 10.1 to the Companys
  Registration Statement on Form F-1 (registration number 333-11640))                                                                                                                                                                                                |             |    
|       |  |             |                                                                                                                                                                                                                                                                                                                                                                    |             |    
|4.2    |  |             | Option Plan 3 (incorporated
  by reference to exhibit 10.2 to the Companys Registration Statement on Form
  F-1 (registration number 333-11640))                                                                                                                                                                                                                  |             |    
|       |  |             |                                                                                                                                                                                                                                                                                                                                                                    |             |    
|4.3    |  |             | Option Plan 4A and 4B
  (incorporated by reference to exhibit 10.3 to the Companys Registration
  Statement on Form F-1 (registration number 333-11640))                                                                                                                                                                                                          |             |    
|       |  |             |                                                                                                                                                                                                                                                                                                                                                                    |             |    
|4.4    |  |             | Option Plan 5 (incorporated
  by reference to Exhibit 4.4 to the Companys Annual Report for 20-F for 2002
  filed May 9, 2002                                                                                                                                                                                                                                     |             |    
|       |  |             |                                                                                                                                                                                                                                                                                                                                                                    |             |    
|4.5    |  |             | Option Plan 6 (incorporated
  by reference to Exhibit 4.1 to the Companys Registration Statement on Form
  S-8 filed December 24, 2002 (registration number 333-102193))                                                                                                                                                                                          |             |    
|       |  |             |                                                                                                                                                                                                                                                                                                                                                                    |             |    
|4.6    |  |             | Employment Agreement
  between Nova and Giora Dishon (incorporated by reference to exhibit 10.4 to
  the Companys Registration Statement on Form F-1 (registration number
  333-11640))                                                                                                                                                                           |             |    
|       |  |             |                                                                                                                                                                                                                                                                                                                                                                    |             |    
|4.7    |  |             | Employment Agreement
  between Nova and Moshe Finarov (incorporated by reference to exhibit 10.6 to
  the Companys Registration Statement on Form F-1 (registration number
  333-11640))                                                                                                                                                                          |             |    
|       |  |             |                                                                                                                                                                                                                                                                                                                                                                    |             |    
|4.8    |  |             | Employment Agreement
  between Nova and Chai Toren (incorporated by reference to exhibit 10.7 to the
  Companys Registration Statement on Form F-1 (registration number 333-11640))                                                                                                                                                                               |             |    
|       |  |             |                                                                                                                                                                                                                                                                                                                                                                    |             |    
|4.9    |  |             | Employment Agreement
  between Nova and Ronen Frish (incorporated by reference to exhibit 10.8 to the
  Companys Registration Statement on Form F-1 (registration number 333-11640))                                                                                                                                                                              |             |    
|       |  |             |                                                                                                                                                                                                                                                                                                                                                                    |             |    
|4.10   |  |             | Agreements between Nova and
  the Office of the Chief Scientist in Israel (incorporated by reference to
  exhibit 10.10 to the Companys Registration Statement on Form F-1
  (registration number 333-11640))                                                                                                                                                     |             |    
|       |  |             |                                                                                                                                                                                                                                                                                                                                                                    |             |    
|4.11   |  |             | Certificate of Approval
  from the Investment Center in Israel (incorporated by reference to
  exhibit 10.11 to the Companys Registration Statement on Form F-1
  (registration number 333-11640))                                                                                                                                                                |             |    
|       |  |             |                                                                                                                                                                                                                                                                                                                                                                    |             |    
|4.12   |  |             | Lease Agreement between
  Nova and Ef-Shar Ltd. (incorporated by reference to Exhibit 4.14 to the
  Companys Annual Report on Form 20-F filed on May 9, 2002)                                                                                                                                                                                                     |             |    
|       |  |             |                                                                                                                                                                                                                                                                                                                                                                    |             |    
|4.13   |  |             | Summary of Lease Agreement
  between Nova and Ef-Shar Ltd. (incorporated by reference to Exhibit 4.15 to
  the Companys Annual Report on Form 20-F filed on May 9, 2002)                                                                                                                                                                                          |             |    
|       |  |             |                                                                                                                                                                                                                                                                                                                                                                    |             |    
|4.14   |  |             | Letter Agreement between
  Barry Cox and the Company dated May 15, 2003 (incorporated by reference to
  Exhibit 4.1 to the Companys Registration Statement on Form S-8 filed on May
  17, 2004 (registration number 333-115556))                                                                                                                                  |             |    
|       |  |             |                                                                                                                                                                                                                                                                                                                                                                    |             |    
|4.15   |  |             | Employee Stock Purchase
  Plan 1 (incorporated herein by reference to Exhibit 4.1 to the Companys
  Registration Statement on Form S-8 filed on March 24, 2003 (File No.
  33-103981))                                                                                                                                                                            |             |    
|       |  |             |                                                                                                                                                                                                                                                                                                                                                                    |             |    
|4.16   |  |             | Letter of Indemnification
  and Exculpation for certain directors, officers and/or employees
  (incorporated herein by reference Annex A to the Companys Current Report on
  Form 6-K filed on October 8, 2002)                                                                                                                                                   |             |    
|       |  |             |                                                                                                                                                                                                                                                                                                                                                                    |             |    
|4.17   |  |             | Option Plan 7A
  (incorporated by reference to Exhibit 4.1. to the Companys Registration
  Statement on Form S-8 filed on May 17, 2004 (registration number 333-115554))                                                                                                                                                                                          |             |    
|       |  |             |                                                                                                                                                                                                                                                                                                                                                                    |             |    
|4.18   |  |             | Option Plan 7B
  (incorporated by reference to Exhibit 4.1 to the Companys Registration
  Statement on Form S-8 filed on March 7, 2005 (registration number 333-123158)                                                                                                                                                                                           |             |    
|       |  |             |                                                                                                                                                                                                                                                                                                                                                                    |             |    
|4.19   |  |             | Asset Purchase Agreement
  dated April 24, 2006 by and among Nova, HyperNex, Inc. and the Stockholders
  listed on Schedule 4(a) therein, including a list of omitted schedules and
  exhibits (filed herewith). The Company agrees to furnish supplementary a copy
  of any omitted schedule or exhibit to the Securities and Exchange Commission
  upon request. |             | E-3
|       |  |             |                                                                                                                                                                                                                                                                                                                                                                    |             |    
|4.20   |  |             | Option Plan 7C (filed
  herewith).                                                                                                                                                                                                                                                                                                                                 |             | E-4
|       |  |             |                                                                                                                                                                                                                                                                                                                                                                    |             |    
|4.21   |  |             | Option Plan 8 (incorporated
  by reference to Exhibit 4.1 to the Companys Registration Statement on Form
  S-8 filed on December 29, 2005 (registration number 333-130745).                                                                                                                                                                                       |             |    
|       |  |             |                                                                                                                                                                                                                                                                                                                                                                    |             |    
|8      |  |             | List of Subsidiaries (filed
  herewith)                                                                                                                                                                                                                                                                                                                            |             | E-5

E-1

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|       |  |             |                                                                                                                  |             |     
|------ |  | ----------- | ---------------------------------------------------------------------------------------------------------------- | ----------- | ----
|Number |  | Description |                                                                                                                  | Page Number
|       |  |             |                                                                                                                  |            
|       |  |             |                                                                                                                  |             |     
|12.1   |  |             | Certification required by
  Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended (filed
  herewith) |             | E-6 
|       |  |             |                                                                                                                  |             |     
|12.2   |  |             | Certification required by
  Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended (filed
  herewith) |             | E-7 
|       |  |             |                                                                                                                  |             |     
|13.1   |  |             | Certification Pursuant to
  Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith)                       |             | E-8 
|       |  |             |                                                                                                                  |             |     
|13.2   |  |             | Certification Pursuant to
  Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith)                       |             | E-9 
|       |  |             |                                                                                                                  |             |     
|14.1   |  |             | Consent of Brightman
  Almagor & Co. (filed herewith)                                                            |             | E-10

E-2

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