UNITED STATES


SECURITIES AND EXCHANGE COMMISSION


Washington, D.C. 20549


Form 20-F




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


ýANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
  For the fiscal year ended December 31, 2010
  OR
   ̈TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
  OR
   ̈SHELL COMPANY REPORT PURSUANT  TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
  Commission File Number 000-30668


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)







Weizmann Science Park, Einstein St., Building 22, 2nd Floor, Ness-Ziona, Israel


(Address of principal executive offices)







Dror David, +972-8-9387572, +972-8-9407776, P.O.B 266, Rehovot 76100, Israel


(Name, Telephone, E-mail and/or Facsimile number and Address of the Registrant’s Contact Person)




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




Title of each class
Name of each exchange on which registeredOrdinary Shares, nominal value NIS 0.01 per shar
The NASDAQ Global Market




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




None




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: 25,374,844 ordinary shares, NIS 0.01 nominal (par) value per share, as of December 31, 2010.




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




Yes o                     No x




If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.




Yes o                     No x










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





Yes x                    No o




Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).




Yes o                    No o




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




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




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





U.S. GAAP x





International Financing Reporting Standards as issued by the International Accounting Standards Board o





Other o




If “Other” has been checked in response to the previous question, indicate by check mark which financial statement item the registrant has elected to follow:




Item 17 o                      Item 18 o





If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).





Yes o                     No x








TABLE OF CONTENTS




PageIntroduction
iiPART I
1Item 1.  Identity of Directors, Senior Management and Advisors
1Item 2.  Offer Statistics and Expected Timetable
1Item 3.  Key Information
1Item 4.  Information on the Company
12Item 4A. Unresolved Staff Comments
24Item 5.  Operating and Financial Review and Prospects
24Item 6.  Directors, Senior Management and Employees
34Item 7.  Major Shareholder and Related Party Transactions
41Item 8.  Financial Information
44Item 9.  The Offer and Listing
45Item 10. Additional Information
46Item 11. Quantitative and Qualitative Disclosures About Market Risk
62Item 12. Description of Securities Other than Equity Securities
63PART II
63Item 13. Defaults, Dividend Arrearages and Delinquencies
63Item 14. Material Modification to the Rights of Security Holders and Use of Proceeds
63Item 15.  Controls and Procedures
63Item 16A.  Audit Committee Financial Expert
64Item 16B.  Code of Ethics
64Item 16C.  Principal Accountant Fees and Services
64Item 16D.  Exemptions from the Listing Standards for Audit Committees
65Item 16E.  Purchases of Equity Securities by the Issuer and Affiliates Purchasers
65Item 16F.  Changes in Registrant’s Certifying Accountant
65Item 16G.  Corporate Governance
65PART III
65Item 17.    Financial Statements
65Item 18.    Financial Statements
65Item 19.    Exhibits
65Financial Statements
F-1Signatures




- i -











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.




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 ASC 830 Foreign Currency Matters. 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 without limitation, statements relating to our anticipated sales, revenues and expenses in 2011, our expectations with respect to our business and operations and our ability to gain market share 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 and factors related to the conditions of the global markets and the global economy. Various other factors that could cause our actual results to differ materially are set forth in “Risk Factors” starting on page 2 and elsewhere herein.




- ii -





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




3A.          Selected Financial Data




The following selected consolidated financial data as of December 31, 2009 and 2010 and for the years ended December 31, 2008, 2009 and 2010 have been derived from our audited consolidated financial statements included elsewhere in this annual report. These financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”), and audited by our independent registered public accounting firm. The consolidated selected financial data as of December 31, 2008, 2007 and 2006 and for the years ended December 31, 2007 and 2006 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 annual report on Form 20-F.




Summary of Consolidated Financial Data





Year ended December 31,2006


2007


2008


2009


2010(in thousands, except per share data)Consolidated Statement of Operations Data:Revenues

$
48,292


$
58,077


$
38,969


$
39,318


$
86,620Cost of revenues


27,743



33,251



25,986



21,731



39,204Gross profit


20,549



24,826



12,983



17,587



47,416Operating expenses:Research and development expenses, net


9,166



9,143



8,606



6,865



12,445Sales and marketing expenses


8,754



10,175



7,503



6,014



10,133General and administrative expenses


5,136



4,830



3,199



2,240



2,968Other operating expenses


-



3,831



633



-



-Total operating expenses


23,056



27,979



19,941



15,119



25,546Operating income (loss)


(2,507
)


(3,153
)


(6,958
)


2,468



21,870Financing income (expenses), net


573



(764
)


1,537



163



305Net income (loss) for the year

$
(1,934
)

$
(3,917
)

$
(5,421
)

$
2,631


$
22,175Income (loss) per share:Basic

$
(0.12
)

$
(0.21
)

$
(0.28
)

$
0.14


$
0.91Diluted

$
(0.12
)

$
(0.21
)

$
(0.28
)

$
0.13


$
0.86Shares used in calculation of net income (loss) per share:Basic


15,976



18,606



19,369



19,473



24,448Diluted


15,976



18,606



19,369



20,089



25,692





1





December 31,2006


2007


2008


2009


2010(in thousands)Consolidated Balance Sheet Data:Working capital


15,873



20,660



20,246



25,067



65,442Total assets


44,419



48,385



35,791



40,924



93,377Capital stock (including additional paid-in capital)


76,735



83,456



84,024



85,696



104,646Shareholders’ equity


24,575



27,584



22,341



26,915



68,384




3B.
Capitalization and Indebtedness




Not applicable.




3C.
Reasons for the Offer and Use of Proceeds




Not applicable.




3D.
Risk Factors




Risks Related to Our Business and Our Industry




Because substantially most of our current sales are dependent on two specific product lines, factors that adversely affect the pricing and demand for these product lines could substantially reduce our sales.




We are currently dependent on two process control product lines. We expect revenues from these product lines to continue to account for a substantial portion of our revenues for at least the next 12 months. As a result, factors adversely affecting the pricing of, or demand for, these product lines, such as competition and technological change, could significantly 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 a steep upturn in 2010, after a significant decline in sales in 2008 and 2009. According to Gartner, Inc., a market research company, the forecast for year 2011 predicts a 3.4% increase in wafer fab equipment (WFE) spending. Although we rely on market research companies, we cannot predict the length and strength of the downturns or expansions.


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




Historically, we have derived all of our revenues, and we expect to continue to derive practically 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. Specifically, during 2010, the semiconductor industry experienced a steep upturn of over 100%, which followed a severe downturn in 2008 and 2009. During cyclical downturns, as those we have experienced in the past and are likely to experience in the future, material reductions in the demand for the type of capital equipment and process technology that we offer may result in a decline in our sales. In addition, our ability to significantly 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:




Ÿ
our continuing need to invest in research and development;




Ÿ
our continuing need to market our new products to new and existing customers; and




Ÿ
our extensive ongoing customer service and support requirements worldwide.




As a result, we may have difficulty achieving continued profitability.




2





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 have an adverse affect on 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 depend on OEM suppliers for sales of our integrated metrology systems, and the loss of our OEM suppliers as customers or as business partners could harm our business.




We believe that sales of integrated metrology systems will continue to be an important source of our revenues. Sales of our integrated metrology systems depend upon the ability of OEMs (original equipment manufacturers) to sell semiconductor equipment products that are able to include our metrology systems as components. If our OEMs are unable to sell such products, or if they choose to focus their attention on products that do not integrate our systems, our business could suffer. If we were to lose our OEMs as customers or as business partners for any reason, our inability to realize sales from integrated metrology systems could harm our business. We may not be able to develop or market new products, which could slow or prevent our growth.


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 be adversely affected.




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 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 be harmful to 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 ongoing 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 provide assurances 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 adversely affect our reputation and may impair the market acceptance of our products.




We have historically generated losses and may incur future losses.




Since our inception in 1993, we have had several years of losses and only three profitable years. We may incur a net loss in future years. As of December 31, 2010, we had an accumulated deficit of approximately $37 million. We plan to increase our aggregate operating expenses in 2011 relative to 2010. However, our ability to generate profits is dependent mainly on our ability to increase sales. In the future, our sales may not grow and we may not achieve profitability.


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.




3





Because shipment dates may be changed and customers may cancel or delay orders with little or no penalty, our backlog may not be a reliable indicator of actual sales.




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




Our quarterly operating results have fluctuated significantly in the past. This trend may 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, the timing of shipments of systems, and the 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 depend on a small number of large customers, and the loss of one or more of them would lower our revenues.




Like our peers serving the semiconductor market, 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 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.




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 mainly with Nanometrics, Inc., Rudolph Technologies, Inc., and KLA-Tencor Corp. which manufacture and sell integrated and/or stand-alone process control systems. In addition, we compete with original semiconductor equipment manufacturers, such as Tokyo Electron Ltd., which manufactures integrated metrology products and with original semiconductor equipment manufacturers, such as Applied Materials, Inc., which develop in-situ sensors and products. Established companies, both domestic and foreign, compete with our product lines, and new competitors enter our market from time to time. 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:




Ÿ
the contribution of our equipment to the customers’ productivity;




4




Ÿ
our product quality and performance;




Ÿ
our global technical service and support;




Ÿ
the return on investment (ROI) of our equipment and its cost of ownership;




Ÿ
the breadth of our product line;




Ÿ
our success in developing and marketing new products; and




Ÿ
the extendibility of our 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 capital equipment suppliers have been acquired by larger equipment manufacturers. For example, in 2005 Rudolph Technologies, Inc. acquired August Technologies, Inc., in 2006 Nanometrics acquired Soluris, Inc. and Accent Technologies, Inc., and in 2007 KLA-Tencor Corp. acquired Therma-Wave, Inc. and Nanometrics acquired Tevet Ltd. 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, intellectual property and support resources, of competitors involved in these acquisitions could allow 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.




We may not be successful 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.




Any future acquisitions may involve many risks, including the risks of:




Ÿ
diverting management’s attention and other resources from our ongoing business concerns;




Ÿ
entering markets in which we have no direct prior experience;




Ÿ
improperly evaluating new services, products and markets;




Ÿ
being unable to maintain uniform standards, controls, procedures and policies;




Ÿ
being unable to integrate new technologies or personnel;




Ÿ
incurring the expenses of any undisclosed or potential liabilities; and




Ÿ
the departure of key management and employees.




If we are unable to successfully complete future acquisitions or to effectively integrate 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.




A couple of our major customers have no cancellation fee with regard to cancellation of orders, and we have been facing difficulties to collect cancellation fees from another customer.




Our supply agreements with some of our largest customers do not include cancellation fee provisions with regard to cancellation of these customer’s orders. In addition, during the recent slowdown in the semiconductors industry, another customer cancelled its orders and we were unable to collect cancelation fees from that customer. Due to this reason, our ability to rely on our backlog for future forecasting and planning is limited, which in turn may hamper our ability to forecast our financial results.


5





Some of our contracts and arrangements potentially subject us to the risk of significant or non-limited liability.




We produce highly complex optical and electronic components and, accordingly, there is a risk that defects may occur in any of our products. Such defects can give rise to significant costs, including expenses relating to recalling products, replacing defective items, writing down defective inventory and loss of potential sales. In addition, the occurrence of such defects may give rise to product liability and warranty claims, including liability for damages caused by such defects.




In our commercial relationship with customers, we attempt to negotiate waivers of consequential damages arising from damages for loss of use, loss of product, loss of revenue and loss of profit caused by our products. Similarly, with respect to our commercial relationship with subcontractors and suppliers, we attempt to negotiate arrangements which do not include a limitation of liabilities and limitation of consequential damages. However, some contracts and arrangements we are bound by expose us to product liability claims resulting in personal injury or death, up to an unlimited amount, and the incurrence of the risk of material penalties for consequential or liquidated damages. Additionally, under such contracts and arrangements, we may be named in product liability claims even if there is no evidence that our products caused the damage in question, and such claims could result in significant costs and expenses relating to attorneys’ fees and damages.




Although we have not incurred material penalties for consequential or liquidated damages during the past, we may incur such penalties in the future. Such penalties for consequential or liquidated damages may be significant and could negatively affect our financial condition or results of operations.




Because of our small size, 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 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 normal sales cycle takes between six to 12 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 limited control.




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.




As of March 1, 2011, we have been granted 91 U.S. patents and have 22 U.S. patent applications pending. In addition, we have been granted approximately 40 non-U.S. patents and have 26 non-U.S. patent applications pending.


We cannot assure that:




Ÿ
pending patent applications will be approved;




Ÿ
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




Ÿ
the patents of others will not have an adverse effect on our ability to do business.




6





We also cannot assure that others will not independently develop similar products, duplicate our products or, if patents are issued to us, design around these patents. Furthermore, because patents may afford less protection under foreign law than is available under U.S. law, we cannot assure 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, see “Intellectual Property” starting on page 20 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 such 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:




Ÿ
result in our loss of proprietary rights;




Ÿ
subject us to significant liabilities, including treble damages in some instances;




Ÿ
require us to seek licenses from third parties, which licenses may not be available on reasonable terms or at all; or




Ÿ
prevent us from selling our products.




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, available funds, competitive position and ability to develop and market new and existing products.  For additional information on our intellectual property, see “Intellectual Property” on page 20 of this annual 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 (due to several factors, including, but not limited to, work stoppages, acts of war, terrorism, fire, earthquake, energy shortages, flooding or other natural disasters), and these disruptions could have at least a temporary adverse effect on our operations. Although we generally maintain an inventory of critical components used in the manufacture and assembly of our systems, such supplies may not be sufficient to avoid potential delays that could have an adverse effect on our business.




To date, we have not experienced any material disruption or termination of our supply sources. However, on March 11, 2011, an earthquake followed by a tsunami devastated the north-east coast of Japan, causing thousands of deaths and extensive damage, as well as a potential nuclear disaster. Although our direct suppliers in Japan reported that damage to their physical assets was not significant on a consolidated basis and therefore we have no evidence that continuous supply will be interrupted, the damages caused to Japan’s energy supplies, local infrastructure and distribution channels could potentially adversely affect us in the future.




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.




7





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 Taiwan, South Korea, China, the United States, Germany, Japan and Singapore, 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. Additionally, the Asian-Pacific region is susceptible to the occurrence of natural disasters, such as earthquakes, cyclones, tsunamis and flooding. We have a subsidiary in Taiwan and we have significant customers in Japan and South Korea as well as in China. An outbreak of hostilities or other political upheaval, economic downturns or the occurrence of a natural disaster 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 shares, 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 or warrants, the market price of our ordinary shares may fall. As of March 1, 2011, we had 26,157,505 ordinary shares outstanding. Based on reports filed with the Securities and Exchange Commission, which we also refer to herein as the Commission or SEC, information provided to us by our transfer agent and information provided by certain shareholders, our largest shareholder held approximately 8.0% of our outstanding ordinary shares as of March 1, 2011.


Certain shareholders may control the outcome of matters submitted to a vote of our shareholders, including the election of directors.




To the best of our knowledge, approximately 25% of our outstanding ordinary shares are held by four of our shareholders. 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 Amended and Restated Articles of Association. Even if these four shareholders do not vote together, some of which have the ability to influence the outcome of corporate actions requiring the vote of shareholders as set in the Company’s Amended and Restated Articles of Association. For additional information on our major shareholders, see “Major shareholders” on page 41.


The market price of our ordinary shares may be affected by a limited trading volume and may fluctuate significantly.




In the past there has been a limited public market for our ordinary shares and there can be no assurance that an active trading market for our ordinary shares will continue. An absence of an active trading market could adversely affect our shareholders’ ability to sell our ordinary shares in short time periods. Our ordinary shares have experienced, and are likely to experience in the future, significant price and volume fluctuations, which could adversely affect the market price of our ordinary shares without regard to our operating performance.




We manage our available cash through various bank institutions and invest large portions of our cash reserves in bank deposits. Recently, following the global financial crisis, several bank institutions announced bankruptcy or were on the verge of bankruptcy. A bankruptcy of one of the banks in which or through which we hold or invest our cash reserves, might prevent us to access that cash for an uncertain period of time.




We manage our available cash through various bank institutions and invest large portions of our cash reserves in bank deposits. Recently, following the global financial crisis, several bank institutions announced bankruptcy or were on the verge of bankruptcy. As of December 31, 2010, approximately 93% of our cash reserves were invested in Israeli based bank institutions, and approximately 7% of our cash was invested in or through U.S. based bank institutions. A bankruptcy of one of the banks in which we hold our cash reserves or through which we invest our cash reserves, might prevent us to access that cash for an uncertain period of time.


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We may fail to maintain effective internal control over financial reporting in accordance with Section 404 of the Sarbanes-Oxley Act of 2002.




The Sarbanes-Oxley Act of 2002 imposes certain duties on us and our executives and directors. Our efforts to comply with the requirements of Section 404, which started in connection with our Annual Report on Form 20-F for the fiscal year ended December 31, 2007, have resulted in increased general and administrative expense and a diversion of management time and attention, and we expect these efforts to require the continued commitment of resources. Section 404 of the Sarbanes-Oxley Act of 2002 requires (i) management’s annual review and evaluation of our internal control over financial reporting and (ii) an attestation report issued by an independent registered public accounting firm on our internal control over financial reporting, in connection with the filing of our Annual Report on Form 20-F for each fiscal year.  We have documented and tested our internal control systems and procedures in order for us to comply with the requirements of Section 404. While our assessment of our internal control over financial reporting resulted in our conclusion that as of December 31, 2010, our internal control over financial reporting was effective, we cannot predict the outcome of our testing in future periods. If we fail to maintain the adequacy of our internal controls, we may not be able to ensure that we can conclude on an ongoing basis that we have effective internal controls over financial reporting. Failure to maintain effective internal control over financial reporting could result in investigation or sanctions by regulatory authorities, and could have a material adverse effect on our operating results, investor confidence in our reported financial information, and the market price of our ordinary shares.




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 occurred between Israel and its Arab neighbors. In July 2006, there have been extensive hostilities along Israel’s northern border with Lebanon and to a lesser extent in the Gaza Strip. Since June 2007, the Hamas militant group has taken over the Gaza Strip from the Palestinian Authority, and the hostilities along Israel’s border with the Gaza Strip have increased, escalating to a wide scale attack by Israel in December 2008, in retaliation to rocket attacks into southern 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 a negative effect on our business and harm our growth and revenues. For further detail see “Political and economic conditions in Israel” starting on page 23.




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 84 days of military reserve service on a three year basis until the age of 40 for soldiers and until the age of 45 for officers. This time-period may be extended by the Military Chief of the 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. 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.




Provisions of our Amended and Restated Articles of Association and Israeli law may delay, prevent or make difficult an acquisition of Nova, which could prevent a change of control and negatively affect the price of our ordinary shares.




Israeli corporate law regulates mergers, requires tender offers for acquisitions of shares above specified thresholds, requires special approvals for transactions involving directors, officers or significant shareholders and regulates other matters that may be relevant to these types of transactions. Furthermore, Israeli tax considerations may make potential transactions unappealing to us or to some of our shareholders. See Item 10.B, “Additional Information – Memorandum and Articles of Association.” for a more detailed discussion regarding some anti-takeover effects of Israeli law.




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




9




The rights and responsibilities of our shareholders are governed by Israeli law and differ in some respects from the rights and responsibilities of shareholders under U.S. law.




We are incorporated under Israeli law. The rights and responsibilities of holders of our ordinary shares are governed by our Amended and Restated Articles of Association and by the Israeli Companies Law, 5759-1999 (the “Companies Law”). These rights and responsibilities differ in some respects from the rights and responsibilities of shareholders in typical U.S. corporations. In particular, pursuant to the Companies Law each shareholder of an Israeli company has to act in good faith in exercising his or her rights and fulfilling his or her obligations toward the company and other shareholders and to refrain from abusing his power in the company, including, among other things, in voting at the general meeting of shareholders and class meetings, on amendments to a company’s articles of association, increases in a company’s authorized share capital, mergers, and transactions requiring shareholders’ approval under the Companies Law. In addition, a controlling shareholder of an Israeli company or a shareholder who knows that it possesses the power to determine the outcome of a shareholder vote or who has the power to appoint or prevent the appointment of a director or officer in the company, or has other powers toward the company has a duty of fairness toward the company. However, Israeli law does not define the substance of this duty of fairness. Because Israeli corporate law has undergone extensive revision in recent years, there is little case law available to assist in understanding the implications of these provisions that govern shareholder behavior.




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




We generate most of our revenues in U.S. dollars, but incur a significant portion of our expenses in currencies other than U.S. dollars, and mainly New Israeli Shekels, commonly referred to as NIS. As a result, we are exposed to risk of devaluation of the U.S. dollar in relation to the NIS and other currencies. In that event, the dollar cost of our operations in countries other than the U.S. will increase and our dollar measured results of operations will be adversely affected. During 2010, the U.S. dollar depreciated against the NIS by 5.98%, after depreciating by approximately 2% in the previous three years. We cannot predict the future trends in the rate of devaluation or revaluation of the U.S. dollar against the NIS, and our operations also could be adversely affected if we are unable to hedge against currency fluctuations in the future.




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 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.




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 2009 and in 2008, we recorded an aggregate of $2.2 million and $2.0 million, respectively, in grants under Israeli government programs, and in 2010 we recorded $2.2 million in grants under Israeli government programs. As of December 31, 2010, our contingent liability to the Office of the Chief Scientist for grants received was approximately $14.6 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. Also, the Israeli government 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.


10





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 Global Market and on the Tel Aviv Stock Exchange, or TASE. This may result in price variations. Our ordinary shares are traded on these markets in different currencies, U.S. dollars on The NASDAQ Global Market and New Israeli Shekels on the TASE. 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” for U.S. income tax purposes, which could have significant and adverse tax consequences to U.S. shareholders.




Generally, if for any taxable year 75% or more of our gross income consists of specified types of passive income, or, on average, 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. Classification of Nova as a passive foreign investment company could result in adverse U.S. tax consequences to our U.S. shareholders, including having gain realized on the sale or other disposition of our shares being treated as ordinary income as opposed to capital gain income, and computing 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.  In addition, an interest charge will be imposed on the amount of the tax allocated to these taxable years.  It may be possible for U.S. holders of common shares to mitigate certain of these consequences by making an election to treat us as a “qualified electing fund” under Section 1295 of the Internal Revenue Code of 1986, as amended (the “Code”) or a “mark-to-market election” under Section 1296 of the Code. 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 2010 we were not a passive foreign investment company (“PFIC”). Nonetheless, because  the determination of whether we are, or will be, a PFIC for a taxable year depends, in part, on the application of complex U.S. federal income tax rules, which are subject to various interpretations, there is a risk that we were a passive foreign investment company in 2010. Absent one of the elections described above, if we are a PFIC for any taxable year during which a U.S. holder holds our ordinary shares, we generally will continue to be treated as a PFIC regardless of whether we cease to meet the PFIC tests in one or more subsequent years. Currently we expect that we will not be a passive foreign investment company in 2011. However, passive foreign investment company status is determined based on our assets and income over the course of each taxable year, and is dependent on a number of factors, including the value of a corporation’s assets, the trading price of our ordinary shares 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, 2011, or any future year, or that the Internal Revenue Service will not challenge any determination made by us concerning our passive foreign investment company status.  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.”


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Item 4.  Information on the Company




4.A
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 April 2000, we conducted an initial public offering and our shares were listed for trading on The NASDAQ Global Market (formally known as The NASDAQ National Market).




In June 2002, we listed our shares on the TASE, pursuant to legislation which enables Israeli companies whose shares are traded on certain stock exchanges outside of Israel to be registered on the TASE, while reporting, in substance, in accordance with the provision of the relevant foreign securities law applicable to the Company.




During 2003, we began expanding our product offerings to include stand-alone systems. The new offerings of stand-alone products have contributed over $10 million to our sales in each of the years 2010 and 2009.




Until 2008, most of our products were sold to original equipment manufacturers such as Applied Materials, Inc. and Ebara Corp., which later sold these products to semiconductor manufacturers. In recent years, however, we have completely changed our business model, selling most of our products directly to semiconductor manufacturers. Through this process, which has also enabled us to introduce to these customers additional products and features, we have improved our products gross margins from 49% in year 2007 to 59% in year 2010.




On February 9, 2010, we successfully completed an underwritten public follow-on offering of 4,427,500 ordinary shares in consideration of approximately $17.0 million in net proceeds.




We have five fully owned subsidiaries in the U.S., Japan, Taiwan, Korea and the 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.




4.B
Business Overview




We are a worldwide leading designer, developer and producer of integrated process control metrology systems and design, manufacture and sell leading edge stand-alone metrologyused in the manufacturing process of semiconductors. Metrology systems measure various thin film properties and critical circuit dimensions 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. Our systems were first installed in 1995 and, since that time, we have sold more than 2,000 metrologysystems.




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 before or after each process step with metrology tools such as those we produce.




Prior to the introduction of our integrated metrology systems, process control was solely 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 that in several instances during the manufacturing process, 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.




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We have always emphasized our integrated metrology solutions as this continues to be an area where we have a leading position.  In addition, in the past few years, we developed and started manufacturing stand-alone metrology systems, leveraging our technology, methods, metrology expertise and market position in the integrated metrology field to expand our offerings of stand-alone metrology systems. Today, both stand-alone and integrated metrology solutions have reached a level of maturity allowing semiconductor manufactures to choose how to use either technology and make decisions based on merit specific to the process step in question, always balancing between the amount of data attained and the use made of the data for capabilities such as automated process control. 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 and used in a customized way to meet specific customer needs.




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 through the years, 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 and the demands of semiconductor manufacturers for process equipment that provides better film uniformity, shrinking process geometries resulting in increased dimensional control, tool-to-tool matching and within-tool uniformity.




Our Market




Semiconductor Industry and the Metrology Market




The increased use of semiconductors has been accompanied by an 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.




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 $4 billion in 2010 for facilities capable of manufacturing 300 mm wafers.  We believe that the process control equipment market, which includes the metrology segment, will grow in the future at a rate greater than the overall process equipment market since the challenges of meeting process design goals will become increasingly difficult such that process control equipment is in the future expected to consume a larger portion of the overall costs of semiconductor manufacturing equipment.




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 well over a dozen 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 dies.  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.




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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 isthen 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.




Tomeet 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 World Economy - Update




Global Insight, the analyst company, forecasts the world GDP to grow by 3.1% in 2011 compared to a decline of 2.7% in 2010, and forecasts the U.S. GDP to grow by 2.3% in 2011.




Analyst company Gartner forecasts semiconductor revenues to increase by 4.6% in 2011, following an estimated increase of 31.5% in 2010. Gartner forecasts WFE sales in 2011 to decrease by 3.4% following the major increase of 133% in 2010.




According to research reports, future demand drivers for semiconductors include Tablet PC’s, Smartphones, Netbooks, Solid State Drives (SSD) and other electronic equipment.




The Need for Greater Overall Equipment Efficiency




We believe that one of the major challenges to achieving improvements in semiconductor manufacturing cost efficiency 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 continuously find ways to improve overall equipment efficiency.




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Process Control.  The steps used to create semiconductors are 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 though in some steps where process stability if difficult to achieve, the number of sampled wafers will increase.  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.




The Need for Effective Process Control Tools.  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 45 nm and 28nm 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.




·
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.




·
Transition to High-K Metal Gate. In order to overcome limitations in the continued shrink of transistor dimensions, leading edge integrated circuit manufacturers are introducing new materials in the transistor gate stack. The use of high-k dielectrics, combined with metal layers, requires new processing and metrology equipment and thus represents challenging developments for the semiconductor manufacturing industry.




·
Increase in Foundry Manufacturing.Asa result of the rising investment needed for semiconductor process development and production as well as 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. This trend of shifting to foundries for manufacturing needs has progressed even further during recent years.




·
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.




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.




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We believe that in certain process steps, 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 process steps will continue to rely upon stand-alone equipment, we intend to continue leveraging 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 or a combination of both stand-alone and integrated metrology.




Expected equipment spending in 2011




We believe that in 2011 equipment spending will be focused around three main areas:




1.
Technology buys of equipment enabling semiconductor manufacturers to move to the next technology node maintaining competitiveness, reducing cost and improving product performance.




2.
Expansion within not fully populated fab shells and initial population of new fabs.




3.
Retrofits of equipment that will improve yield or efficiency reduce overall manufacturing cost or enable using older process equipment for advanced technology nodes.




Metrology plays an important role in all of the above. We believe that we are well positioned for technology as well as expansion buys and retrofit opportunities with our newer stand-alone products, the NovaScan 3090Next and the Nova T500, and our state of the art integrated metrology products, the NovaScan 3090Next IM and the new generation Nova i500.




The Nova Approach




Integrated Metrology




Our integrated metrology systems provide semiconductor manufacturers with 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 as well as Optical CD 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 lifetime 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 on our NovaReady integration package, later adopted by process equipment manufacturers, allows process equipment manufacturers to prepare their equipment to accept our measurement systems, which can then be integrated with a simple plug-and-play installation.




16





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;




·
perform the measurements without removing the wafer from the process equipment, increasing the efficiency of the process and decreasing the risk of contamination;




·
reduce manufacturing equipment processing variability through the use of wafer to wafer measurements and closed loop control based on automated feedback of process variability;




·
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.




In prior years, most of our integrated metrology products were sold through process equipment manufacturers (such as Applied Materials, Inc. and Ebara Corporation). These products are later sold by the process equipment manufacturers to the semiconductor manufacturers. In recent years, we have made efforts to sell our integrated metrology products directly to the semiconductor manufacturers, in order to provide more favorable commercial terms to end users, OEM’s and our Company as well as deepen our technological cooperation with the end users. These efforts resulted in a significant shift towards direct sales of our integrated metrology products in 2009 and 2010. We can not foresee the long-term impact of a move to direct sales, due to the competitive landscape and overall market conditions.




Stand-Alone Metrology




As stated above, we pioneered the area of integrated metrology and to-date revenues from that product continue to represent the larger portion of our overall revenues. With the adoption of our technology and the formation of long standing relationships with leading manufacturers, we have come to realize that our technology can be extended beyond integrated metrology into areas such as stand-alone metrology. Accordingly, in the past few years we developed a stand-alone metrology tool to perform measurements similar to those performed by our integrated metrology tools. The expression “stand-alone metrology” generically describes free standing metrology equipment which sits inline, i.e., next to the processing equipment and receives cassettes or FOUPS of wafers to allow sampling of a few or several wafers from each cassette it receives. There are several types of stand-alone metrology tools each of which performs a distinct type of measurement, e.g., defect inspection, electrical performance, microscopic analysis, cross sections, etc. Our specific focus is in the area of optical CD measurement which is generally utilized in order to characterize critical dimensions on a wafer, their width, shape and profile. This technology is utilized today in several areas of the fab such as photolithography, etch, CMP, selective deposition of thin films, etc. The key advantage offered by this technique is that it provides visualization of the full cross-section-like profile of the structure, while remaining non-destructive and extremely fast with very high accuracy and repeatability.




We introduced this concept in 2006 and we were successful in penetrating several accounts through 2009 and 2010, allowing us to see a significant increase in our overall customer base with the stand-alone products. With the introduction of stand alone metrology, we have expanded our addressable markets and are now able to provide metrology solutions for four of the five critical manufacturing steps, as opposed to the one or two we were previously able to provide, when our product offering was limited.




17





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 dielectric CMP, copper CMP, Tungsten CMP, Etch and  lithography processes as well as Cu electroplating and sputtering of Cu barrier and seed materials. 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.




Our scatterometry capabilities have enabled us to penetrate new customers with Stand-Alone Optical CD metrology systems. Our combined offering of advanced measurement hardware and advanced modeling software place us in a position to offer an advantageous solution to our customers.




In addition to the above applications, in 2010, we commenced the development of a standalone product for the emerging 3D-interconnect market.  This internal development effort is based on an extension of our existing technologies.




Our suite of technological capabilities includes:




·
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 a 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 technology. These systems use a 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 rules, down to 22 nm and below. A key component in scatterometry technology is the modeling software which converts raw spectra coming from the measurement tool into useful information in terms of customer parameters. This segment of the technology is where we currently focus our attention and where we have also acquired specific advantages due to our unique solutions.




·
Imaging and image processing.  This technology has three different applications: (1) navigating on product wafers to perform measurements on very small selected 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 techniques used in our metrology products are unique and protected by a number of patents.




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. Our systems have also been recognized by the industry: in 1998 we received the prestigious Editors’ Choice Best Product Award from Semiconductor International magazine for our NovaScan 420 integrated thickness measurement tool for CMP process monitoring, in 2004 we received the award for our NovaScan 2020Cu and 3030Cu for Copper CMP process monitoring, in 2007 we received the award for our NovaScan 3090CD for thin-film metrology of dielectric CMP and copper applications, CD control and shape profiling and in 2009 we received this award for NovaMARS modeling SW.




Products




Our products include metrology systems for thin film measurement in chemical mechanical polishing and chemical vapor deposition applications; optical CD and Metal Line Thickness (MLT) 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 process 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 conventional chemical mechanical polishing equipment as well as to newer, high throughput polishers. Following is a summary of our products:




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Thin Film Process Control




·
The NovaScan 2040 is 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 2040 model was introduced to the market at 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 since then.




·
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.




·
The NovaScan 3090Next is currently our main product. Targeted at 45nm and 32nm technology nodes this tool was released in 2006 and provided significant improvements in throughput, accuracy, tool to tool matching and spectral range over the older NovaScan 3090. It also improved overall tool reliability. The NovaScan 3090Next is available as integrated metrology and as stand-alone metrology systems for both thin film and Optical CD (scatterometry) applications.




·
The Nova T500 is the latest addition to the stand-alone product family, targeted at technology nodes ranging from 32nm and smaller. The Nova T500 features improved metrology performance, improving both accuracy and tool to tool matching, providing industry leading throughput of 250WPH.




·
The new generation Nova i500 integrated metrology features the same metrology as the Nova T500 for complete stand-alone to integrated metrology compatibility. The Nova i500 features advanced metrology for technology nodes smaller then 32nm and high throughput that meets the standards of next generation polishers.




·
NovaMars is an advanced scatterometry modeling and application development software tool enabling complex 2D, 3D and in-die measurements. Process engineers can harness the power and flexibility of the tool to develop their own scatterometry applications by themselves thus keeping the details of their process within the fab. Its user interface and high level of automation provide for easier and faster application development and eliminate discrepancies between different developers, enabling the best solution, independent of user proficiency. The NovaMars is offered as an option together with the 3090, 3090Next, Nova T500 and Nova i500 product families.




·
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.




·
NovaHPC (High Power Computer) supports the NovaMars Application Development Tool and enables effective and timely calculations of attained spectra. Scalable and user configurable infrastructure with Nova’s proprietary task management software addresses the growing needs of IC manufacturing metrology. NovaHPC is just one of the few solutions available for cost effectiveness and computation power growth flexibility. The stand-alone modular rack includes:







§
HPC




19


§
TurboHPC




§
Grid computing connectivity enabled




§
Web-based management SW




NovaHPC Value-Added Benefits include: accelerated recipe set-up library building, Scalable infrastructure, invest as you grow and Low-cost entry level using grid computing with existing computation resources.




While we continue to emphasize our integrated metrology solutions, we offer our products as stand-alone equipment as well, thereby significantly expanding our potential available markets. While we have succeeded in penetrations of stand-alone metrology, our revenues remain substantially dependent on sales of our CMP integrated metrology 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 scatterometry, 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 100 highly skilled members, over 20 of which hold PhDs. In addition, we rely on independent subcontractors and consultants in various fields. Since June 2003, our research and development operations are certified as ISO9001/2000 quality standard.




The metrology and 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 lines 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 2008, 2009 and 2010, our research and development expenses, net of participation by the Office of the Chief Scientist of the Ministry of Industry, Trade and Labor, were $8.6 million, $6.8 million and $12.4 million respectively, representing, 22%, 17% and 14% of our respective total revenues for those years. The significant increase of R&D expenditures in 2010 represents our strategic choice to increase our market share in the growing Optical CD market as well as to develop new products beyond our existing fields. In the future, we plan to continue and expand our R&D investments in this area.




Our vision is to continue to be a market leader in the semiconductor process control market and become the leader in the stand-alone Optical CD metrology market, and our research and development policies and activities are designed to support this vision. Our research and development policy is based on a structured process of initiating new projects and on-going review of existing development projects. Project initiation is based on a detailed project plan, risk and market analysis. Each project is monitored throughout its life cycle in 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. As of March 1, 2011, our portfolio includes 91 U.S. patents and approximately 40 non-U.S. patents. The U.S. patents we hold have expiration dates ranging from 2014 to 2024. We also have 22 U.S. patent applications pending and 26 applications pending in other countries including 1 PCT application. 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 5 trademarks in the U.S. and 8 registered trademarks in countries other than the U.S.




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, business partners 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.




20





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




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 Measuring Instruments Inc., alleging infringement of its U.S. No. Re 34,783 Patent.  In October 2006, Nanometrics filed another lawsuit with the United States District Court for the Northern District of California alleging Nova is infringing U.S. Patent Numbers 5,867,276 and 7,115,858.




On August 18, 2006, we filed a request for re-examination of the Nanometrics’ U.S. No. Re 34,783 Patent with the U.S. Patent & Trademark Office (PTO). On May 25, 2007, the PTO rejected all five claims of U.S. No. Re 34,783 Patent filed by Nanometrics and, in view of Nanometrics failure to file an appropriate response to the rejection, on August 16, 2007, the PTO issued a Notice of Intent to Issue a Re-examination Certificate, cancelling all five claims of the patent.




In April 2007, we reached a settlement with Nanometrics regarding all three patent suits between the companies.  We agreed to dismiss, without prejudice, all pending patent litigation between the two parties, and have further agreed not to file patent suits against the other and/or any supplier or customer of the other party for patent infringement based on offers to sell, actual sales, manufacturing, purchase or use of any equipment of the other partyfor a period of one year. The settlement, which received the court approval, terminated the three lawsuits pending in the U.S. District Court for the Northern District of California. No permanent settlement has been reached in these suits. Should the disputes be reopened, even if we are ultimately successful, it could result in substantial costs and diversion of time and effort by our management.  This in and of itself could have a negative impact on us.




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. We are not presently involved in any material legal proceedings 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 a negative impact on us.




While we believe that we would be successful in any litigation seeking to enforce our patent rights, the ultimate outcome of any litigation or other legal proceedings cannot be predicted.




In September 2006, we invited companies to submit bids to license or buy some of our patents. These patents have substantial value because the industry is on the threshold of widespread adoption of integrated metrology and the methods covered by the patents are critical for advanced manufacturing of semiconductors. We were pioneering the use of an auction model to set a market price for patent licenses by offering to the highest bidder licenses for six of our patents pertaining to the use of a lithography tool with integrated metrology in semiconductor processing lines.  Participants in the auction also had the option to bid for full ownership of the patents, which represent only a small portion of Nova’s extensive patent portfolio.




In July 13, 2007, Nova reached an agreement to license the patents to a large semiconductor manufacturer for a total consideration of more than $1.0 million.




21





In addition to the successful monetizing of some our patents in 2007 by non-exclusive licensing to a large semiconductor manufacturer for more than $1.0 million, in June 2009 we initiated another intellectual property monetizing project, by offering several relevant companies to license or acquire an extended number of our patents. Although initial contact with potential customers had been made, our efforts did not yield a definitive transaction, in part due to the deep downturn the whole intellectual property monetizing market has been experiencing.  As a result, as of December 2010 we have formally terminated this process. 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, China and the U.S., with a total staff of 107 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, China the U.S. and various European countries.




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 31,2008


2009


2010(in thousands)U.S.

$
9,671


$
5,713


$
14,373Europe


3,712



1,288



2,409Japan


3,776



4,880



3,378Asia-Pacific (excluding Japan)


21,810



27,437



66,460Total

$
38,969


$
39,318


$
86,620




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.




22





Year ended December 31,2008


2009


2010Total revenues from five largest customers


67%



82%



78%Range of revenues from five largest customers


3%-37%



4%-46%



8%-24%




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 sales 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. We have gained market share with the successful launch of NovaScan 3090 platform but we expect our integrated products to face intense competition in the coming years. In the scatterometry field, we face intense competition in both integrated and stand-alone metrology, from both Nanometrics and KLA-Tencor.




Manufacturing




In order to leverage the relatively high volume of integrated and stand-alone systems we manufacture, and in order 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.In 2010, we received the formal certification of ISO 14001:2004.




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 subassemblies 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, optical components and other 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 our own manufacturing facility, which is located in Ness-Ziona, Israel, divided into two buildings. 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.




Capital Expenditures




Our capital expenditures are primarily for network infrastructure, computer hardware and software, leasehold improvements of our facilities and system demonstration and development 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 31.




Political and Economic Conditions in Israel




We are incorporated under the laws of the State of Israel, and our principal offices and manufacturing facilities are located in Israel. We are, 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 our business, financial condition and results of operations. Additionally, many of our male employees in Israel are currently obligated to perform annual reserve duty in the Israel Defense Force and virtually all such employees are subject to being called to active duty at any time under emergency circumstances. While we have operated effectively under these requirements since we began our operations, no assessment can be made as to the full impact of such requirements on our workforce or business if conditions should change, and no prediction can be made as to the effect of the expansion or reduction of such obligations.




23





Government Regulation




For information relating to the impact of certain government regulations on our business, see“Grants from the Office of the Chief Scientist” starting on page 32.




4.C
Organizational Structure




Our Subsidiaries




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




Name of Subsidiary

Country of IncorporationNova Measuring Instruments Inc.

Delaware, U.S.Nova Measuring Instruments K.K.

JapanNova Measuring Instruments Taiwan Ltd.

TaiwanNova Measuring Instruments Netherlands B.V.

NetherlandsNova Measuring Instruments Korea Ltd.

Korea





4.D
Property, Plant and Equipment




Our main facilities, located in Ness-Ziona, Israel, occupy approximately 5,600 square meters, including: approximately 1,200 square meters of production facilities, approximately 3,200 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 January 2013.




Our subsidiaries lease offices in various locations, for use as a service and pre-sale facility. Our U.S. subsidiary leases approximately 300 square meters, our Japanese subsidiary leases approximately 200 square meters, our Taiwanese subsidiary leases approximately 400 square meters and our Korean subsidiary leases approximately 175 square meters.




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




Item 4A. Unresolved Staff Comments




Not applicable.




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.




24





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 the recent five years (2006-2010), we were able to present Cumulative Annual Growth Rate (CAGR) of approximately 26%, while WFE experienced CAGR of 2%. We believe that this improved performance is attributed mainly to our focus on high growth segments of metrology and Optical CD and to our move to a direct sales business model.  Specifically, in 2009, in which WFE as a whole declined by approximately 50%, we were able to increase our products’ revenues by approximately 10%, and in 2010, in which WFE as a whole increased by approximately 130%, we were able to increase our products’ revenues by approximately 140%. Industry forecasts indicate flat to modest increase in WFE spending in the next two years, and we believe we are well positioned to continue to grow as we continue our focus on high growth segments within the industry.




We derive our revenues principally from sales of our metrology systems and services relating to our systems. In 2010, product sales accounted for 83% of our total revenues and services accounted for 17%. Presently, we have no significant long-term debt, and during 2010 we increased our overall cash reserves by $42.6 million, through raising $17 million in a secondary public offering and through generating positive cash flow from operating activities. As of the end of 2010, we had overall cash reserves of $61.6 million and working capital of $65.4 million.




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.




When evaluating the performance of the Company, our management tends to focus on several financial metrics and qualitative areas, including  market share, gross margins, operating margins, inventory turns and days sales outstanding. Blended gross margins in 2010 were approximately 54.7%, while product sales presented gross margins of approximately 59% and services presented gross margins of approximately 32%. Our average inventory levels in 2010 were approximately 10% of annual sales. In 2010, average days sales outstanding for total revenues were 51 and ranged between 64 and 43 days over the four quarters of 2010.




Significant Events in 2010 and Outlook for 2011




The year 2010 had several significant events:




·
Penetration into several new strategic customers for our stand-alone products.




·
Significant proliferation of our integrated metrology solutions among existing customers.




·
Introduction of our new integrated metrology product the i500.




·
Completion of a successful secondary offering.




·
Establishment of our SA tool, T500, as an advanced SA tool for complicated and smaller structures.




In 2011, Nova plans to focus on the following:




·
Significant proliferation of our stand-alone solutions following the extensive customer penetrations made during 2010.




·
Continuing the development of our current technology for both stand-alone and integrated metrology products both in hardware and software.




·
Introducing new generations of our current products as well as new products to address the advancing technology trends toward feature sizes of 22 nm and below as well as new processes and materials such as 3-D interconnect.




·
Leveraging the increased need for monitoring and controlling which results from decreasing feature sizes, and the accelerated move to new materials.




25





The challenges and risks we face in meeting our plans include:




·
On time delivery of “the right” process control solutions to meet the needs of our existing and new customers.




·
Correctly understanding the market trends and competitive landscape to ensure our products retain proper differentiation to win customer confidence.




·
Creating aggressive and competitive roadmap deliverables at reasonable costs in order to properly control expenses.




In order to address these risks and challenges, we are working closely with leading customers’ process development 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 their current and future metrology and process control needs and tune the roadmap to support such needs.




Currently, our main revenue generator continues to be the CMP integrated metrology product line. In previous years, most of the integrated metrology sales to CMP supported the polishing of dielectric layers. After several years of developing a solution for Copper CMP and given the strong market transition to Copper as the main conducting material (instead of Tungsten and Aluminum) we are seeing a large portion of sales coming from this sector. This is the case both in the foundry sector as well as in high end memory manufacturing. We believe the design wins we have had in this area will continue to provide us with growth opportunities in the future.




In the past few years we have also worked collaboratively with two of the three leading etch manufacturers to integrate our metrology for a process control scheme similar to the concept used in CMP. Though this integration offers advanced capabilities, its adoption in the market place has been slow. We expect the adoption of stand alone Optical CD metrology for process control of the etch, lithography and high end CVD process steps to increase in conjunction with the continued design rule shrinks as the need for non destructive 3D measurements continues to grow.




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 in 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 from the sale of products when all the following criteria have been met: a persuasive evidence of an arrangement exists, delivery has occurred, the price is fixed or determinable, collection of resulting receivables is probable and there are no remaining significant obligations.




In accordance with ASC 605-25 “Multiple Element Arrangements”, selling price of each element is determined based on specific objective evidence and revenue is allocated to each element based on its estimated selling price. The revenue allocated to the undelivered elements is deferred until delivery of such element. If specific objective evidence of fair value does not exist for all elements to support the allocation of the total fee among all delivered and undelivered elements of the arrangement.


When the Company is unable to establish relative selling price using VSOE (Vendor Specific Objective Evidence) or TPE (Third Party Evidence), the Company uses ESP (Estimated Selling Price) in its allocation of arrangement consideration. The objective of ESP is to determine the price at which the Company would transact a sale if the product or service were sold on a stand-alone basis. ESP could potentially be used for new or customized products.


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.




26





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.  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.




Inventories Write-Off




We carry our inventory at the lower of either 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 2008, 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.




5.A
Operating Results




Overview




A significant portion of our revenues historically has been derived from customers and OEM partners in the U.S. However, in recent years, the U.S. sales as a percentage of total revenues have decreased as a result of the shift to manufacturing of IC in Asia as well as the reduction of sales through US based OEM partners given the transition to direct sales to IC manufacturers.




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.




27








2008


2009


2010USA


25
%


15
%


16
%Europe


9
%


3
%


3
%Japan


10
%


12
%


4
%Asia-Pacific (excluding Japan)


56
%


70
%


77
%Total


100
%


100
%


100
%





Historically, a substantial portion of our revenues has come from a small number of customers. In 2008, 2009 and 2010 our five largest customers accounted for 67%, 82% and 78% of our revenues, respectively. In 2008, 2009 and 2010 our single largest customer accounted for 37%, 46% and 24% 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.




The sales cycle for our systems typically ranges from 6 to 12 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 specific timing of fab expansions.  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 2010, our inventory levels at the end of each quarter ranged from $6.1 million to $10.8 million. We planned our 2010 inventories under the assumption that the NovaScan 3090Next would account for most of our product sales. Actual sales in 2010 were similar to this plan. In 2011, we anticipate that the NovaScan 3090 Next product will continue to account for the majority of our product sales, yet we expect to see larger scale proliferation of the new T500 and i500 products.




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.




Our revenues increased by 120% in 2010 following a 1% increase in 2009 and a 33% decrease in 2008.




28





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 RevenuesYear ended December 31,2008


2009


2010Revenues from product sales


65.9
%


75.4
%


82.9
%Revenues from services


34.1
%


24.6
%


17.1
%Total revenues


100.0
%


100.0
%


100
%Cost of products sale


32.2
%


32.4
%


33.5
%Inventory write-off and inventory purchase commitments losses


3.6
%


--



--Cost of services


30.9
%


22.9
%


11.7
%Total cost of revenues


66.7
%


55.3
%


45.3
%Gross profit


33.3
%


44.7
%


54.7
%Operating expenses:Research and development expenses, net


22.1
%


17.4
%


14.4
%Sales and marketing expenses


19.2
%


15.3
%


11.7
%General and administrative expenses


8.2
%


5.7
%


3.4
%Impairment loss on intangibles and equipment related to

HyperNex assets and liabilities acquisition


1.7
%


--



--Total operating expenses


51.2
%


38.4
%


29.5
%Operating profit (loss)


(17.9
)%


6.3
%


25.2
%Financing income (expenses), net


4.0
%


0.4
%


0.4
%Net income (loss)


(13.9
)%


6.7
%


25.6
%





Comparison of Years Ended December 31, 2010 and 2009




Revenues.Our revenues in 2010 increased by $47.3 million, or 120.3%, compared to 2009, with revenues attributable to product sales accounting for $71.8 million, an increase of $42.2 million, or 142.2%, compared to 2009, and revenues attributable to services accounting for $14.8 million, an increase of $5.2 million, or 53.2%, compared to 2009. The increase in product sales revenue in 2010 was attributed to a combination of the significant growth in capital spending throughout the industry, exposure to the right customers, market share gains and to the completion of our transition to direct sales. The increase in services revenues is attributed mainly to the higher utilization rates of customers manufacturing sites and the related sales of parts and repair to these sites.


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 provisions for estimated future warranty costs for systems we have sold. Our cost of revenues attributable to product sales in 2010 was $29.1 million, an increase of $16.3 million, or 128.2%, compared to 2009. Our cost of revenues attributable to product sales, as a percentage of product revenues in 2010, was 40.4%, compared to 42.9% in 2009. Our gross margin attributable to product revenues in 2010 was 59.5%, compared to 57.1% in 2009. This increase in gross margins in 2010 is mainly related to the overall increase in sales volume utilizing an already existing infrastructure and to the completion of our transition to direct sales.




Our cost of revenues attributable to services in 2010 was $10.1 million, an increase of $1.1 million, or 12.8%, compared to 2009. This increase is mainly attributable to the increase in the cost of parts and repair which were sold to customers. Our gross margin attributable to services revenues in 2010 was 31.6%, compared to 7% in 2009 as a result of higher revenues utilizing an already existing infrastructure.




29





Our overall gross profit increased by 169.6% to $47.4 million in 2010, compared to $17.5 million in 2009. Our overall gross margin was 54.7% and 44.7% of our total revenues in 2010 and 2009, respectively. The increase in overall gross margins in year 2010 is mainly attributable to the increase in revenues resulting from the overall growth in semiconductors equipment market and to the completion of our transition to direct sales.




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 grants received or receivable from the Office of the Chief Scientist. Our net research and development expenses increased by 81.3% to $12.5 million in 2010, compared to $6.9 million in 2009, after offsetting grants received or receivable from the Office of the Chief Scientist of $2.2 million in 2010 and $2.2 million in 2009. In 2010, net research and development expenses represented 14.4% of our revenues compared to 17.4% of our revenues in 2009. This increase in research and development expenses is mainly attributed to the increase in headcount to support our products roadmap and to the increase in materials expenditures for building new products prototypes during 2010.




Approximately $8 million of our net research and development expenses in 2010 resulted from our research and development efforts relating to current integrated metrology and stand-alone products activities. Approximately $4.4 million of our net research and development expenses in 2010 were related to developing a technology infrastructure for next generation metrology tools platforms, mainly for stand-alone metrology products, and to further enhance the technology infrastructure for scatterometry based metrology solutions.




Sales and Marketing.Sales and marketing expenses are mainly comprised of salaries and related costs for sales and marketing personnel, travel related expenses and overhead. They also include commissions to our representatives and sales personnel and royalties. Our sales and marketing expenses increased by 68.5% to $10.1 million in 2010, compared to $6.0 million in 2009. The increase in sales and marketing expenses is mainly attributed to an increase in revenue based incentive payments and to costs related to customers product evaluation processes during 2010. Sales and marketing expenses represented 11.7% and 15.3% of our revenues in 2010 and 2009, respectively. The decrease as a percentage of revenue is mainly related to the significant increase in revenues in 2010.




General and Administrative. General and administrative expenses are comprised of salaries and related expenses and other non-personnel related expenses such as legal expenses. Our general and administrative expenses increased by 32.5% to $2.9 million in 2010, compared to $2.2 million in 2009. This increase in mainly attributed to the increase in our activities during 2010 compared to 2009. General and administrative expenses represented 3.4% and 5.7% of our revenues in 2010 and 2009, respectively.




Comparison of Years Ended December 31, 2009 and 2008




Revenues.Our revenues in 2009 increased by $0.3 million, or 0.9%, compared to 2008, with revenues attributable to product sales accounting for $29.6 million, an increase of $3.9 million, or 15.4%, compared to 2008, and revenues attributable to services accounting for $9.7 million, a decrease of $3.6 million, or 27.2%, compared to 2008. The increase in product sales revenue in 2009 was attributed mainly to market share gains with our stand-alone and integrated metrology products. The decrease in services revenues is attributed mainly to the expiration of service contracts in 2009 that were not renewed due to the downturn in industry as a result of low fab utilization rates in the beginning of 2009.




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 provisions for estimated future warranty costs for systems we have sold. Our cost of revenues attributable to product sales in 2009 was $12.7 million, an increase of $0.2 million, or 1.6%, compared to 2008. Our cost of revenues attributable to product sales, as a percentage of product revenues in 2009, was 42.9%, compared to 48.8% in 2008. Our cost of goods sold in 2008 included an inventory write-off of $1.4 million. Our gross margin attributable to product revenues in 2009 was 57.1%, compared to 51.2% in 2008. This increase in gross margins in 2009 is mainly related to an overall increase in our average selling price.




Our cost of revenues attributable to services in 2009 was $9.0 million, a decrease of $3.0 million, or 25.3%, compared to 2008. This decrease is mainly attributable to our on-going cost reductions to accommodate for the decline in service revenues. Our gross margin attributable to services revenues in 2009 was 7%, compared to 9.3% in 2008 as a result of our inability to fully align the expenses reduction to the reduction in sales.




30





Our overall gross profit increased by 35.4% to $17.5 million in 2009, compared to $13.0 million in 2008. Our overall gross margin was 44.7% and 33.3% of our total revenues in 2009 and 2008, respectively. The increase in overall gross margins in year 2009 is mainly attributable to the increase in the average selling prices of our products.




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 grants received or receivable from the Office of the Chief Scientist. Our net research and development expenses decreased by 20.2% to $6.9 million in 2009, compared to $8.6 million in 2008, after offsetting grants received or receivable from the Office of the Chief Scientist of $2.2 million in 2009 and $2.0 million in 2008. In 2009, net research and development expenses represented 17.4% of our revenues compared to 22.1% of our revenues in 2008. This decrease is mainly attributed to our on-going cost reduction efforts during 2009.




Approximately $3.6 million of our net research and development expenses in 2009 resulted from our research and development efforts relating to current integrated metrology and stand-alone products activities. Approximately $3.2 million of our net research and development expenses in 2009 were related to developing a technology infrastructure for next generation metrology tools platforms, mainly for stand-alone metrology products, and to creating a new technology infrastructure for scatterometry based metrology solutions.




Sales and Marketing.Sales and marketing expenses are mainly comprised of salaries and related costs for sales and marketing personnel, travel related expenses and overhead. They also include commissions to our representatives and sales personnel and royalties. Our sales and marketing expenses decreased by 19.8% to $6.0 million in 2009, compared to $7.5 million in 2008. The decrease in sales and marketing expenses is mainly attributed to our on-going cost reduction efforts during 2009. Sales and marketing expenses represented 15.3% and 19.2% of our revenues in 2009 and 2008, respectively. The decrease as a percentage of revenue is mainly related to the significant decrease in sales and marketing expenses in 2009 while revenues remained stable.




General and Administrative. General and administrative expenses are comprised of salaries and related expenses and other non-personnel related expenses such as legal expenses. Our general and administrative expenses decreased by 0.9% to $2.2 million in 2009, compared to $3.2 million in 2008. This decrease in mainly attributed to our on-going cost reduction efforts. General and administrative expenses represented 5.7% and 8.2% of our revenues in 2009 and 2008, respectively.




Financial Income, Net.Financial income, net, for year 2008, includes a gain of $1.4 million related to the sale of short term investments (Auction Rate Securities) that were impaired at the same amount in 2007. Excluding the gain or loss related to the Auction Rate Securities, financial income, net, in 2009 and 2008 was $0.2 million (for each year).




5.B
Liquidity and Capital Resources




As of December 31, 2010, we had working capital of approximately $65.4 million compared to working capital of $25.1 million as of December 31, 2009.




Cash and cash equivalents, short-term and long-term deposits as of December 31, 2010 were $61.6 million compared to $19.1 million as of December 31, 2009.




Trade accounts receivable increased from $11.5 million as of December 31, 2009 to $13.2 million as of December 31, 2010. This increase is mainly attributable to the increase in revenues in 2010 relative to 2009. Inventories increased from $3.9 million as of December 31, 2009 to $10.8 million as of December 31, 2010, mainly due to the increase in manufacturing volumes, in parallel to higher inventories at customer sites related to customer product evaluation and acceptance processes.




Operating activities in 2010 generated positive cash flow of $25.8 million compared to a negative cash flow of $1.8 million in 2009. The change in cash flow is mainly associated with the increase in profitability in 2010 relative to 2009.




31





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




2008


2009


2010Domestic


Abroad


Domestic


Abroad


Domestic


Abroad(in dollar thousands)Electronic equipment


968



3



463



19



1,872



53Office furniture and equipment


11



8



1



15



16



25Leasehold improvements


21



21



43



13



314



0Total


1,000



32



507



47



2,202



78





In 2010, the investment in capital expenditures was financed from our positive operating cash flow. The increase in capital expenditures for electronic equipment in 2010 is mainly attributable to an increase in capital expenditure of electronic equipment used for 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 $4 million on capital expenditures in 2011, mainly for information systems improvements (software and hardware) and electronic equipment used in our research and development labs and demonstration facilities.




Our principal liquidity requirement is expected to be for working capital and capital expenditures. We believe that our current cash reserves will be adequate to fund our planned 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, and the proceeds we realized from our follow-on offering, together with positive 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 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.




During 2007, short-term investments in the amount of $2.9 million in Auction Rate Securities experienced failed auctions. Accordingly, these investments were classified as long-term investments in our financial statements as of December 31, 2007. During 2008, our Auction Rate Securities were repurchased at their full par value, by the custodian of these investments, as part of a repurchase arrangement with that custodian. We did not incur any costs in connection with this repurchase arrangement, as it was based on a settlement arrangement between the custodian and the U.S. authorities. Accordingly, in our financial statements for 2008, we have reported a one-time gain of $1.4 million as a result of this arrangement. For additional information see Note 2G in the financial statements.




On February 9, 2010, we successfully consummated an underwritten public follow-on offering of 4,427,500 ordinary shares (including ordinary shares sold pursuant to the over allotment option) at a price per ordinary share of $4.15, in consideration of approximately $17.0 million, net.




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 62.




5.C
Research and Development, Patents and Licenses, etc.




For information regarding our research and development activities, see “Research and Development” starting on page 20.




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 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 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 5% on the revenues derived from using the grants until 100% of the grants are repaid. 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.




32





The terms of the grants under the law require that we manufacture the products developed with these grants in Israel. 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, only if prior approval is received from the Office of the Chief Scientist. This approval 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 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 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 to another Israeli company 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.




As of December 31, 2010, we received grants from the Office of the Chief Scientist in the aggregate amount of approximately $18.8 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%-3.5% of revenues derived from sales of products funded with these grants. As of December 31, 2010, our contingent liability to the Office of the Chief Scientist for grants received was approximately $14.6 million. See also Note 7A to our consolidated financial statements contained elsewhere in this report.


The funds available for grants from the Office of the Chief Scientist were reduced for 2004 and 2005, and the Israeli authorities have indicated that the government may further reduce or abolish grants of this kind in the future. Even if these grants are maintained, we might not receive them 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 the Chief Scientist, in 2010, we participated in a program, IMG4, sponsored by the Office of Chief Scientist. Under the terms of this program, we are cooperating with additional companies and research institutes in Israel, organized in a consortium, for the development of advanced techniques for improved tool control. The Office of the Chief Scientist is contributing 66% of the approved research and development budget for the research consortium and the members of the research consortium contributing the remaining 34%. No royalties from this funding are payable to the Israeli government, however, the provisions of the law and related regulations regarding the restrictions on the transfer of know-how outside of Israel do apply. 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. Since our collaboration with this consortium will not deal with issues that are part of our core technology, we believe that it will have no effect on our strong intellectual property portfolio. During 2010, we had received approximately $0.2 million in grants from the Office of Chief Scientist in connection with this program. The IMG4 program has ended during 2010.


5.D
Trend Information




For Information regarding most significant recent trends in our market, see “The World Economy - Update” starting on page 14.




5.E
Off-Balance Sheet Arrangements




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




33


5.F
Tabular Disclosure of Contractual Obligations




As of December 31, 2010 we had contractual obligations as described in the following table:




Payment due by PeriodTotal


Less than 1 year


1-3 years


3-5 years


More than 5 yearsOperating Lease Obligations

$
2,766


$
1,546


$
1,140


$
80


$
--Purchase Obligations


7,369



7,337



4



28



--Other Long Term Liabilities


23



--



23



--



--Total

$
10,158


$
8,883


$
1,167


$
108


$
--




Item 6.  Directors, Senior Management and Employees




6.A
Directors and Senior Management




The following is the list of senior management and directors as of March 1, 2011:




Name

Age

PositionMichael Brunstein

67

Chairman of the Board of DirectorsAlon Dumanis

60

DirectorDan Falk

66

External DirectorNaama Zeldis

47

External DirectorAvi Cohen

57

DirectorGabi Seligsohn

44

President and Chief Executive OfficerDror David

41

Chief Financial OfficerEitan Oppenhaim

45

Executive Vice President Global Business GroupGabi Sharon

48

Vice President OperationsBoaz Brill

46

Chief Technology OfficerHila Mukevisius

36

Vice President Human ResourcesTal Shmueli

47

Vice President Research and Development




Our directors (other than the external directors) serve as such until the next annual general meeting of our shareholders. Our external directors, in accordance with Israeli law, serve for a three-year term, which may be renewed for one additional three-year term and thereafter for additional three-year terms, if both the audit committee and the board of directors confirm that in light of the expertise and contribution of the external director, the extension of such external director’s term would be in the interest of our company. Mr. Dan Falk was elected in 2005 to serve for a three-year term that expired in 2008 and was re-elected in 2008 for an additional three-year term. Ms. Zeldis was elected in 2006 to serve for a three-year term that expired in 2009 and was re-elected in 2009 for an additional three-year term.




Dr. Michael Brunstein was named chairman of our board of directors in June 2006, after serving as member of our board of directors from November 2003. During the years 1990 and 1999, Dr. Brunstein served as 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 a board member of Ham-let Ltd., a company listed on the TASE. He is a chairman and serves on boards of directors of several privately owned companies. Dr. Brunstein holds a B.Sc. in Mathematics and Physics from the Hebrew University, Jerusalem, and a M.Sc. and a Ph.D. in Physics from Tel Aviv University.




Dr. Alon Dumanis has served as a director of Nova since 2002. He is the Chief Executive Officer of Crecor B.V, Docor International B.V, Docor Levi Lassen I BV, Docor Levi Lassen II BV and Docor International Management Ltd., all Dutch investment companies, subsidiaries of The Van-Leer Group Foundation. Dr. Dumanis is currently a chairman of XSight System, Softlib, Bondex, Clariton, DNR Imaging, and a member of the board of directors of Spectronix (TASE-SPCT),Aposense (TASE-APOS), Collplant (TASE-CLPT), Ice Cure (TASE-ICCM), and other Hi Tech companies in Docor’s investment portfolio. Dr. Dumanis is a former member of the board of directors of Tadiran Communications (TASE-TDCM), a former member of the board of directors of El Al Israel Airlines (TASE-LY), Protalix Biotherapeutics (NYSE-PLX),and a former member of the board of directors of Inventech Investments Co. Ltd. (TASE-IVTC). Previously, Dr. Dumanis was the Head of the Material Command in the Israel Air Force at the rank of Brigadier General. Dr. Dumanis currently serves as chairman and member of several national steering committees and is the author of many papers published in a number of subject areas, including technology and management. Dr. Dumanis holds a Ph.D. in Aerospace Engineering from Purdue University, West Lafayette, Indiana, USA.




34





Mr. Dan Falk was elected as the Company’s external director in accordance with the provisions of the Companies Law in 2005, and was re-elected for an additional term on September 25, 2008. 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.  Prior to that, Mr. Falk served as Executive Vice President and Chief Financial Officer 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., (all of which are companies publicly traded in the United States), Orad Hi-Tec Systems Ltd. (as chairman of the board of directors), Amiad Filtration Systems, Oridion Medical Ltd. (all of which are companies publicly traded in Europe) and Plastopil Ltd. (traded on the TASE). Mr. Falk’s son-in-law is a partner at Gross, Kleinhendler, Hodak, Halevy, Greenberg & Co., our outside counsel.


Ms. Naama Zeldiswas elected as the Company’s external director in accordance with the provisions of the Companies Law in 2006, and was re-elected for an additional term in 2009. Ms. Zeldis has been serving as Chief Financial Officer of Netafim Ltd. since December 2005. Prior to that, she served as Chief Financial Officer of EDS Israel, Radguard, and Director of Finance of RAD Data Communications. Ms. Zeldis is a former member of the board of directors and of the audit committee of Metalink. Ms. Zeldis holds a B.A. in Economics and an M.A. in Business Administration, majoring in Financing, from the Hebrew University of Jerusalem and a B.A. in Accounting from Tel-Aviv University.




Mr. Avi Cohenhas served as a director of Nova since 2008. Mr. Cohen serves as President and Chief Executive Officer at Orbit Technologies, a public company traded on the TASE. Orbit is a leading designer, developer, and manufacturer of a wide range of advanced communication systems for the commercial and defense markets. Prior to joining Orbit in December 2008, Mr. Cohen served as Chief Operating Officer and Deputy to the CEO at ECI Telecom Ltd. a leading supplier of best-in-class networking infrastructure equipment for carrier and service provider networks worldwide.  Prior to joining ECI in September 2006, Mr. Cohen served in a variety of management positions at KLA-Tencor.  From 2003 he was a Group Vice President, Corporate Officer and Member of the Executive Management Committee based at the corporate headquarters in the U.S.  During his tenure, he successfully led the creation of KLA-Tencor’s global Metrology Group.  From 1995 he was the President of KLA-Tencor Israel responsible for the Optical Metrology Division.  Before joining KLA-Tencor, Mr. Cohen also spent three years as Managing Director of Octel Communications, Israel, after serving as Chief Executive Officer of Allegro Intelligent Systems, which he founded and which was acquired by Octel.  Mr. Cohen holds B.Sc. and M.Sc. degrees in electrical engineering and applied physics from Case Western Reserve University, USA.




Mr. Gabi Seligsohn has served as the President and Chief Executive Officer since August 2006. Having joined Nova in 1998, Mr. Seligsohn has served in several key positions in the Company including as the Executive Vice President, Global Business Management Group from August 2005 to August 2006.  From August 2002 until August 2005 he was President of Nova’s U.S. subsidiary, Nova Measuring Instruments Inc. Prior to that he was Vice President Strategic Business Development at Nova Measuring Instruments 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 LL.B. from the University of Reading, Reading, England.




Mr. Dror Davidhas served as the Chief Financial Officer since November 2005. Mr. David joined Nova in April 1998, as the Company’s Controller, and since than served in various financial and operational positions, including the position of Vice President of Resources, in which he was responsible for the finance, operations, information systems and human resources functions of the Company. Mr. David was also a leading member in the Company’s initial public offering on NASDAQ in 2000 and the Company’s private placement in 2007. Prior to joining Nova, Mr. David spent five years in public accounting with Delloitte Touch in Tel Aviv, specializing in industrial high-tech companies. Mr. David is a Certified Public Accountant in Israel, holds a B.A. in Accounting and Economics from Bar Ilan University, and an M.B.A. from Derby University of Britain.




35





Mr.Eitan Oppenhaimhas served as the Executive Vice President Global Business Group since November 2010. From 2009 until 2010, Mr. Oppenhaim served as Corporate Vice President and Europe General Manager at Alvarion Ltd., a global leader in 4G wireless communications providing WiMAX solutions. During the years 2007 through 2009, Mr. Oppenhaim served as Vice President of sales and marketing at OptimalTest Ltd., a startup company which develops Test Management Solutions software for optimizing the test operation floor in the semiconductor industry. Prior to that, from  2002 till 2006,  Mr. Oppenhaim served as President of the Flat Panel Displays division at Orbotech Ltd., a leader company for Automated Optical Inspection systems. From 2001 till 2002, Mr. Oppenhaim served as  Managing Director of Asia Pacific at TTI Telecom International, a company which develops network management software solutions to telecom operators and service providers. Prior to that, from 1994 till 2001, Mr. Oppenhaim held several key sales positions at Comverse Network Systems Ltd., a supplier of value added srvices and customized solutions to telecom operators and service providers, and its subsidiary in Asia Pacific. Prior to joining Comverse, during the years 1983 and 1994, Mr. Oppenhaim served at the Israeli navy. Mr. Oppenhaim holds a BA in Economics and Accounting from the Haifa University, Israel and an MBA from Ben-Gurion University, Beer-Sheva, Israel.




Mr. Gabi Sharonhas served as Vice President of Operations since September 2006. Having joined Nova in 1995, Mr. Sharon served in several key positions in the Company including as Global Customer Support Manager from September 1995 to September 2004. From September 2004 until September 2006 Mr. Sharon managed the Product Development Division, and spearheaded the NovaScan 3090 product line and its successful market launch. For a period of two years, from 2004 to 2006, he also served as the Product Marketing Manager and led the initial penetration of the Copper CMP market.  Prior to joining Nova Mr. Sharon served as Project Manager in ECI Israel. Mr. Sharon holds a B.Sc. in Computer Science from Northeastern University, Boston, Massachusetts, and a M.Sc. in Technology Management from Polytechnic University, New York.




Dr. Boaz Brillhas served as Chief Technology officer since April 2010. Having joined Nova in 1998, Dr. Brill has served in several key positions in the Company including Vice President Technology Development. Dr. Brill was the lead scientist who managed Nova’s entry into the Optical CD market and developed the NovaScan 3090 platform. A well-known technologist, he headed Nova’s Physics department. From 1995 until 1999, Dr. Brill served as System Engineer and Project Manager at El-Op Ltd. Dr. Brill holds a B.Sc. in Physics and Mathematics from the Hebrew University, Jerusalem, M.Sc and Ph.D in Physics from the Weizmann Institute of Science, Rehovot, Israel and MBA from Bradford University, UK. He has published over 10 patents and patent applications, mostly in the field of Optical CD.


Ms. Hila Mukevisius has served as Vice President Human Resources since May 2008. Ms. Mukevisius joined Nova after eight years at Amdocs Ltd., a market leader in customer experience systems innovations, where she held several positions as HR Director of large scale global groups. Ms. Mukevisius holds a B.A. in Behavioral Science from the College of Management, Academic Studies, Tel Aviv, Israel, specializing in organization development.




Mr. Tal Shmuelihas served as Vice President of Research and Development since March 2011. Mr. Shmueli rejoined Nova in 2010 as Vice President Product Development. Prior to that, from 2008 till 2010, Mr. Shmueli served as Director of Hardware Development and Product Management at MDG Medical, a company which develops and markets unique technologies, solutions and services for the healthcare industry.  During the years 2006 and 2008, Mr. Shmueli served as Director of Product Management at CogniTens, a supplier of metrology solutions for the car industry. Prior to that, from 1993 till 2006, Mr. Shmueli held several positions at Nova, including product and technology management and support. Mr. Shmueli holds BSc. degree in Electrical Engineering from the Technion, Haifa, Israel.




Voting Agreement




We are not aware of any voting agreement currently in effect.




6.B
Compensation




The aggregate direct remuneration paid or payable to all persons who served in the capacity of executive officer during 2010 was approximately $2.17 million including approximately $0.45 million, which was set aside for pension and retirement benefits and including amounts expended by us for automobiles made available to our executive officers.




36





The total amount paid or payable to the directors, including external directors, for 2010 was $0.23 million.




As of March 1, 2011, 1,130,232 options to purchase our ordinary shares were outstanding to certain executive officers and directors (consisting of 12 persons), of which 451,818 options are currently exercisable or exercisable within 60 days of March 1, 2011.  See “Share Ownership” starting on page 39.




At the 2007 annual general meeting of the Company’s shareholders, the shareholders approved a new compensation arrangement for the Company’s directors (excluding the external directors, the chairman of the board of directors and, unless approved otherwise, any other director who is also an employee of the Company). At the 2008 annual general meeting of the Company’s shareholders, the shareholders approved the same compensation arrangement for the Company’s external directors.  The compensation arrangement includes:




1.
An annual payment of US$ 12,000 (in an equivalent amount in NIS), subject to the minimal and maximal payment restrictions applicable to the Company under the Companies Regulations (Rules Regarding Compensation and Expenses to an External Director), 2000, and the Companies Regulations (Relief for Public Companies with Shares Listed for Trading on a Stock Market Outside of Israel), 2000 (collectively, the “Regulations”).


2.
Additionally, the following payments (subject to the minimal and maximal payment restrictions applicable to the Company under the Regulations):




a.
for each meeting that the director or external director attends in person, an amount of US$ 600 (in an equivalent amount in NIS);




b.
for each execution of a written consent in lieu of a meeting, an amount of US$ 300 (in an equivalent amount in NIS); and




c.
for each meeting that the director or external director attends by teleconference, an amount of US$ 360 (in an equivalent amount in NIS).




3.
An annual award of an option to purchase up to 10,000 ordinary shares to be granted to each director or external director on the date of each annual general meeting at which such director or external director is elected or reelected. The exercise price of each option shall be determined pursuant to the Company’s Equity Based Compensation Policy.




In addition, at the 2008 annual general meeting, the shareholders approved a one-time additional award of an option to purchase up to 10,000 ordinary shares to each of Mr. Dan Falk and Ms. Naama Zeldis, our external directors. The exercise price of the option was determined pursuant to the Company’s Equity Based Compensation Policy.




In addition, at the 2008 annual general meeting, the shareholders approved an addition to the compensation package of Dr. Michael Brunstein, the chairman of our board of directors, of the following items: (i) an annual award of an option to purchase up to 10,000 ordinary shares to be granted to Dr. Brunstein on the date of each annual general meeting at which the chairman of the board of directors is elected or reelected. The exercise price of each option shall be determined pursuant to the Company’s Equity Based Compensation Policy. The proposed terms of the options (i.e., the amount, exercise price and vesting schedule) are identical to the terms of options currently granted to other directors on an annual basis; and (ii) a one-time additional award of an option to purchase up to 10,000 ordinary shares granted to Dr. Brunstein on September 25, 2008. The exercise price of the option was determined pursuant to the Company’s Equity Based Compensation Policy.




Between November 1, 2008 and October 31, 2009, the Company resolved to temporarily reduce the compensation awarded to all directors and officers of the Company in light of business conditions, excluding the compensation of external directors whose compensation was reduced between May 10, 2009 and October 31, 2009 according to guidance of the Israeli Securities Authority (since the compensation of external directors cannot be modified during the term of their service under the Israeli law, subject to a few statutory exceptions).




At the 2010 annual general meeting of the Company’s shareholders, the shareholders approved a biennial award of an option to purchase up to 75,000 ordinary shares to Dr. Brunstein on the date of every other annual general meeting at which the chairman of the board of directors is elected or reelected, starting with the 2010 annual general meeting (and thereafter in 2012). The exercise price of each option shall be determined pursuant to the Company’s Equity Based Compensation Policy. 25% of each option shall vest and become exercisable on the first anniversary of its grant date and thereafter 2.083% of each option shall vest and become exercisable at the end of each complete month following the first anniversary date. Accordingly, each option shall fully vest and become exercisable at the 4thanniversary date of its grant date. The above grant shall be in addition to the previously approved annual award of an option to purchase 10,000 of the Company’s ordinary shares.




37





6.C
Board Practices




Board of Directors’ Committees




The Company’s board of directors has appointed the following committees:




The Audit Committee is comprised of Dan Falk, Naama Zeldis and Avi Cohen. The audit committee is responsible to assist the board of directors in fulfilling its responsibility for oversight of the quality and integrity of accounting, auditing and financial reporting practices of the Company. 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 Brightman Almagor Zohar & Co., a member of Deloitte Touche Tohmatsu and to oversee the qualifications, independence, appointment, compensation and performance of the Company’s independent auditors. The functions of the audit committee according to Israeli Law are to approve related party transactions, and to locate and monitor deficiencies in the management of the Company, including in consultation with the independent auditors and the internal auditor, and to advise the board of directors on how to correct such deficiencies. The audit committee operates under a charter adopted by the board of directors.




TheCompensation Committeeis comprised of Avi Cohen, Dan Falk and Michael Brunstein. The function of the compensation committee is described in the approved charter of the committee, and includes assisting the board of directors in discharging its responsibilities relating to compensation of the Company’s directors and executives and the overall compensation programs. The primary objective of the committee is to oversee the development and implementation of the compensation policies and plans that are appropriate for the Company in light of all relevant circumstances and which provide incentives that further the Company’s long-term strategic plans and are consistent with the culture of the Company and the overall goal of enhancing enduring shareholder value.




TheNominating andCorporateGovernanceCommitteeis comprised of Alon Dumanis, Dan Falk and Michael Brunstein. The function of the nominating committee is described in the approved charter of the committee, and includes responsibility for identifying individuals qualified to become board members and recommending that the board of directors consider the director nominees for election at the general meeting of shareholders. The nominating and corporate governance committee is also responsible for developing and recommending to the board of directors a set of corporate governance guidelines applicable to the Company, periodically reviewing such guidelines and recommending any changes thereto.




On December 18, 2008, our board of directors resolved to abolish the investment committee. The matters that were under the scope of the investment committee will be brought under the direct authority of our board of directors, which from time to time may ask for an ad-hoc investment committee to be assembled. On September 7, 2010, our board of directors resolved to authorize the audit committee to fulfill the scope of the investment committee.




On August 2, 2010, our board of directors resolved to abolish the strategic committee. The matters that were under the scope of the strategic committee will be brought under the direct authority of our board of directors.




All committees are acting according to written charters that were approved by our board of directors.




A newly enacted amendment to the Companies Law will affect several corporate governance requirements under the Companies Law following the date of this report. For more information, see “Item 10.B Memorandum and Articles of Association – Amendment no. 16 to the Companies Law” starting on page 50 of this report.




Internal Auditor




Under the Companies Law, the board of directors must also appoint an internal auditor nominated by the audit committee. Our internal auditor is Mr. Guy Sapir, C.P.A (Isr) of Kesselman & Kesselman PwC Israel. The role of the internal auditor is to examine whether a company’s actions comply with the law and proper business procedure. The internal auditor may not be an interested party or office holder, or a relative of any interested party or office holder, and may not be a member of the company’s independent accounting firm or its representative. The Companies Law defines an interested party as a holder of 5% or more of the shares or voting rights of a company, any person or entity that has the right to nominate or appoint at least one director or the general manager of the company or any person who serves as a director or as the general manager of a company.




38





6.D
Employees




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




As of December 31,2008


2009


2010Total Personnel


225



227



279Located in Israel


147



159



201Located abroad


78



68



78In operations


56



53



71In research and development


59



64



78In global business


92



93



113In general and administration


18



17



17




We were a member of the Industrialists Association in Israel, an employer’s union until December 31, 2006. Under applicable Israeli law, we and our employees are subject to protective labor provisions such as restrictions on working hours, minimum wages, paid vacation, sick pay, severance pay and advance notice of termination of employment as well as equal opportunity and anti-discrimination laws. Orders issued by the Israeli Ministry of Industry, Trade and Labor make certain industry-wide collective bargaining agreements applicable to us. These agreements affect matters such as cost of living adjustments to salaries, length of working hours and week, recuperation and travel expenses. As of December 31, 2010, to the best of our knowledge, we have been providing our employees with benefits and working conditions that are at least as favorable as those found in the collective bargaining agreements. In Israel, Nova is subject to the instructions of the Extension Order in the Industrial Field for Extensive Pension Insurance 2006 according to the Israeli Collective Bargaining Agreements Law, 1957 (the “Extension Order”). The Extension Order ensures the pension insurance of most employees which fall under its criteria.




6.E
Share Ownership




The following table sets forth information regarding the beneficial ownership of our ordinary shares as of March 1, 2011 by our executive officers and directors:




Beneficial ownership of shares is determined in accordance with the rules of the SEC and generally includes any shares over which a person exercises sole or shared voting or investment power. Ordinary shares that are subject to warrants or options that are presently exercisable or exercisable within 60 days of the date of March 1, 2011 are deemed to be outstanding and beneficially owned by the person holding the options for the purpose of computing the percentage ownership of that person, but are not treated as outstanding for the purpose of computing the percentage of any other person.




Based on information provided to us, each shareholder in the table below has sole voting and investment power for the shares shown as beneficially owned by them. Percentage ownership is based on 26,157,505 ordinary shares outstanding as of March 1, 2011.




Executive Officers and Directors:

Number


PercentGabi Seligsohn(1*)


291,947



1.12
%12 directors and officers as a group(2)


513,079



1.96
%


_______________________


* All other directors and executive officers each beneficially owned less than 1% of the Company’s shares.





(1) Includes 277,486 shares subject to options that are immediately exercisable or exercisable within 60 days of March 1, 2011 (expiration dates: 2011-2019; exercise prices ($/share): 1.25-4.01).




(2) Includes 451,818 shares subject to options that are immediately exercisable or exercisable within 60 days of March 1, 2011 (expiration dates: 2011-2020; exercise prices ($/share): 0.43-4.78).




39




Employee Benefit Plans




Through December 31, 2010, options to acquire 9,061,820ordinary shares had been issued, of which 3,261,524 options to acquire ordinary shares were exercised, 4,165,104 were cancelled, 937,856 options were unvested and 697,336 were exercisable, as of December 31, 2010. As of December 31, 2010, 308,530 restricted share units, or RSU’s, had been issued, of which 76,878 had vested and none of which had been cancelled.




The share option plans active throughout 2010, are described below:




Option Plan 7A - As of December 31, 2010, options to purchase 600,000 ordinary shares at exercise prices of $4.01 and $5.15, the fair market value of Nova’s stock on the date of grant were granted, of which 83,170 options were exercised, 63,425 were exercisable and 453,405 options had been cancelled. On September 29, 2005, our shareholders approved amendments to the plan allowing our board of directors 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. We do not intend to grant any further options or shares under this plan;




Option Plan 7B - As of December 31, 2010, options to purchase 650,000 ordinary shares at an exercise price of $3.40, the fair market value of Nova’s stock on the date of grant were granted, of which 115,975 options were exercised, 58,250 were exercisable and 475,775 had been cancelled. On September 29, 2005, our shareholders approved amendments to the plan allowing our board of directors 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. We do not intend to grant any further options or shares under this plan;




Option Plan 7C - As of December 31, 2010, options to purchase 153,000 ordinary shares at an exercise price of $2.20, the fair market value of Nova’s stock on the date of grant were granted, of which 30,548 options were exercised and 122,452 options had been cancelled. No option was exercisable as of December 31, 2010. We do not intend to grant any further options or shares under this plan;




Option Plan 8 - As of December 31, 2010, options to purchase 1,496,620 ordinary shares at an exercise prices ranging from $1.79 to $2.87, the fair market value of Nova’s stock based on the date of grant, were granted. As of December 31, 2010, 549,651 options were exercised, 358,166 options were exercisable, 554,843 options had been cancelled and 33,960 were unvested. We do not intend to grant any further options or shares under this plan;




2007 Incentive Plan - The maximum number of ordinary shares to be issued under the plan, which was adopted by our shareholders on October 25, 2007, is 2,500,000, subject to future increases or decreases by the Company. As of December 31, 2010, options to purchase 1,361,100 ordinary shares at an exercise prices which range from $0.43 to $7.40, the fair market value of Nova’s stock based on the dates of grant, were granted under this plan of which, as of December 31, 2010, 105,373 options were exercised,  134,336 options had been cancelled and 903,896 were unvested. As of December 31, 2010,308,530 RSU’s had been issued, of which 76,878 had vested and none of which had been cancelled.




On December 20, 2006, the board of directors resolved to amend the Company’s incentive plans to clarify that the blackout period pursuant to the Company’s blackout policy shall be excluded from the 30-day exercise period allowed under the various incentive plans following the termination of employment.




On February 19, 2007, the board of directors adopted an Equity Based Compensation Policy, according to which the exercise price of granted options will be as provided by the applicable incentive plan, provided, however, that in the event that the grant approval takes place during a blackout period, the exercise price of the options granted will be equal to the closing price of our ordinary shares on NASDAQ on the trading day immediately following the last day of the blackout period (with the exception of approvals subject to shareholder approvals, in which case, the exercise price shall be the closing price on the day of the shareholder approval).




40





The following table summarizes information about share options outstanding as of December 31, 2010:




Outstanding as of

December 31, 2010


Exercisable as of

December 31, 2010Range of exerciseprices


Number outstanding


Weighted

average

remaining

contractual life


Weighted

average

exercise

price


Number

exercisable


Weighted

average

exercise

price(US dollars)





(in years)


(US dollars)





(US dollars)0.43-1.90



747,969



5.52



1.09



335,455



1.202.18-2.87



275,048



3.39



2.86



240,206



2.863.40



58,250



0.92



3.40



58,250



3.404.01-4.78



225,305



7.43



4.01



49,305



4.015.15-5.48



15,000



2.35



5.26



10,000



5.156.20-6.70



299,500



9.64



6.37



-



-7.4



10,000



9.92



7.40



-



-1,631,072



6.00



2.96



693,216



2.23





Item 7.  Major Shareholder and Related Party Transactions




A.           Major Shareholders




The following table sets forth certain information regarding the beneficial ownership of our outstanding ordinary shares as of March 1, 2011 (unless otherwise stated below) for each person who we know beneficially owns five percent or more of the outstanding ordinary shares.




Beneficial ownership of shares is determined under rules of the SEC and generally includes any shares over which a person exercises sole or shared voting or investment power.In addition, the following table includes the number of shares underlying options and warrants that are currently exercisable or excercisable within 60 days of March 1, 2011, if any. Ordinary shares subject to these warrants are deemedto be outstanding for the purpose of computing the ownership percentage of the person holding these options, but are not deemed to be outstanding for the purpose of computing the ownership percentage of any other person. Applicable percentages are based on 26,157,505 ordinary shares outstanding as of March 1, 2011.




Name

Number of Ordinary

Shares Beneficially

Owned


Percentage of Ordinary

Shares

Beneficially OwnedClal Electronics Industries Ltd. (1)


2,174,476



8.31
%Federated Investors, Inc. (2)


1,792,249



6.85
%





(1)
The information is based upon Amendment No. 6 to Schedule 13D filed with the SEC by, among others, Clal Electronics Industries Ltd., or “CEI”, on March 21, 2011 and information that was provided by Clal Industries and Investments Ltd. (“Clal”). The principal parent companies of the IDB Group are IDB Holding Corporation Ltd., or “IDBH”, and its majority-owned subsidiary, IDBD Corporation Ltd., or “IDBD”. Clal and CEI (a wholly owned subsidiary of Clal) are majority-owned subsidiaries of IDBD. IDBH is controlled as follows:




·
Ganden Holdings Ltd., or “Ganden”, which is a private Israeli company controlled by Nochi Dankner (who is also the chairman of IDBH, IDBD and Clal) and his sister Shelly Bergman, holds, as of March 21, 2011, directly and through a wholly-owned subsidiary, approximately 54.7% of the outstanding shares of IDBH (of which, approximately 17.5% of the outstanding shares of IDBH are held directly and approximately 37.2% of the outstanding shares of IDBH are held through Ganden Investments I.D.B. Ltd., or “Ganden Investment”, a private Israeli company, which is an indirect wholly owned subsidiary of Ganden). In addition, Shelly Bergman holds, through a wholly owned company, approximately 4.2% of the outstanding shares of IDBH;




·
Avraham Livnat Ltd., or “Livnat”, which is a private company controlled by Avraham Livnat (one of whose sons, Zvi Livnat, is a director and executive vice president of IDBH, Deputy Chairman of IDBD, co-chief executive officer of Clal, and another son, Shay Livnat, is a director of IDBD and Clal) holds, directly and through a wholly-owned subsidiary, approximately 13.3% of the outstanding shares of IDBH (of which, approximately 1.1% are held directly and approximately 10.2% of the outstanding shares of IDBH are held through Avraham Livnat Investments (2002) Ltd., or “Livnat Investment”, a private Israeli company, which is a wholly owned subsidiary of Livnat); and




41


·
Manor Holdings BA Ltd., or “Manor”, a private company controlled by Ruth Manor (whose husband, Isaac Manor, is deputy chairman of IDBH and a director of IDBD and Clal, and whose son, Dori Manor, is a director of IDBH, IDBD and Clal) holds, directly and through a majority-owned subsidiary, approximately 13.3% of the outstanding shares of IDBH (of which, approximately 3.1% are held directly and approximately 10.2% of the outstanding shares of IDBH are held through Manor Investments - IDB Ltd. , or “Manor Investments”, a private Israeli company which is controlled by Manor).



Subsidiaries of Ganden, Livnat and Manor have entered into a shareholders agreement with respect to shares of IDBH constituting 31.0%, 10.3% and 10.3%, respectively, of the outstanding shares of IDBH for the purpose of maintaining and exercising control of IDBH as a single group of shareholders. Their additional holdings in IDBH are not subject to the shareholders agreement. The term of the shareholders agreement expires in May 2023.



Based on the foregoing, IDBH (by reason of its control of IDBD and by reason of IDBD’s control of Clal and CEI), Ganden, Livnat and Manor (by reason of their control of IDBH), Mr. Nochi Dankner, Ms. Shelly Bergman, Mr. Avraham Livnat and Ms. Ruth Manor (by reason of their control of Ganden, Livnat and Manor, respectively) may be deemed to share with CEI the power to vote and dispose of our shares held by CEI. The address of CEI is: 3 Azrieli Center, Tel Aviv 67021, Israel.



On March 10, 2010, Clal, through CEI, effected the sale of 1,000,000 ordinary shares. On March 11, 2010, Clal, through CEI, fully exercised a warrant for 872,092 ordinary shares on a cashless basis, and as a result of which was issued 336,134 ordinary shares.



In February 2011, Clal sold 650,000 of our ordinary shares.




(2)
The information is based upon Schedule 13G filed with the SEC by Federated Investors, Inc., Voting Shares Irrevocable Trust, John F. Donahue and Rhodora J. Donahue, on February 9, 2011.


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




To our knowledge, the significant changes in the percentage of ownership held by our major shareholders during the past three years have been: (i) the increase in the percentage of ownership held by CEI in 2007 following the consummation of the transactions under that certain Share Purchase Agreement entered into by the Company and four investors, including CEI, on February 28, 2007. For additional information regarding this Share Purchase Agreement, see “Related Party Transactions” below; the decrease in the percentage of ownership held by CEI following the sale of our ordinary shares in 2010 and 2011;  (ii) the decrease in the percentage of ownership held by Tamir Fishman Ventures II, L.L.C., Shai Saul, Michael Elias, Tamir Fishman & Co. Ltd., Eldad Tamir and Danny Fishman in 2009, following the sale of our ordinary shares; (iii) the decrease in the percentage of ownership held by Austin W. Marxe and David Greenhouse in 2010, following sales of our ordinary shares. As reported on Amendment No. 8 to Schedule 13G filed with the SEC on February 10, 2011 by Messrs. Austin W. Marxe and David Greenhouse, as of January 31, 2011, Messrs. Marxe and Greenhouse beneficially owned  4.1% % of our ordinary shares; (iv) the decrease in the percentage of ownership held by Teuza - A Fairchild Technology Venture Ltd. in 2010, following sales of our ordinary shares; and (v) the decrease in the percentage of ownership held by Rima Management, LLC in 2010 and 2011, following sales of our ordinary shares. On January 10, 2011 Rima Management, LLC exercised warrants for 406,975 ordinary shares on a cash basis and on January 28, 2011 Rima Management, LLC exercised warrants for 174,418 ordinary shares on a cash basis. As a result 581,393 ordinary shares were issued.


As of March 1, 2011, our ordinary shares were held by 33 registered holders. Based on the information provided to us by our transfer agent, as of March 1, 2011, 29 registered holders were U.S. holders and held approximately 4.44% of outstanding ordinary shares (not including shares held by CEDE & Co.).


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.




B.           Related Party Transactions




In 2007, 2008 and 2009, we obtained directors’ and officers’ liability insurance for our officers and directors with coverage in an aggregate amount of $10,000,000. This directors and officers’ liability insurance was presented and approved by the audit committee and the board pursuant to requirements of the Companies Law and according to the resolution of the 2007 annual general meeting, under which the aggregate annual premium to be paid by the Company will not exceed 2% of the aggregate coverage of the directors and officers’ insurance policies and the aggregate coverage of the directors and officers’ insurance policies will not exceed the greater of $10 million or 20% of the Company’s shareholder equity.




42





In February 2010, we obtained an excess layer to our current directors’ and officers’ liability insurance with coverage in an aggregate amount of $5,000,000 (in addition to our aforementioned $10,000,000 insurance coverage). This excess layer of the directors and officers’ liability insurance was presented and approved by the audit committee and the board. At the 2010 annual general meeting, the shareholders approved and ratified the purchase of this excess layer insurance policy of $5 million with respect to director’s and officers’ liability and approved the company’s future purchase of insurance policies with respect to director’s and officers’ liability for any coverage period ending no later than December 31, 2015, which terms shall be approved by the company’s audit committee and the board of directors, provided, that the aggregate annual premium to be paid by the Company will not exceed 1.5% of the aggregate coverage of the directors’ and officers’ insurance policies and the aggregate coverage of the directors’ and officers’ insurance policies will not exceed the greater of $25 million or 30% of the company’s shareholder equity. In February 2011, we obtained directors’ and officers’ liability insurance for our officers and directors with coverage in an aggregate amount of $25,000,000. This excess layer of the directors’ and officers’ liability insurance was presented and approved by the audit committee and the board.


In addition, we undertook to indemnify our officers and directors. Following the 2005 amendment to the Companies Law, on August 31, 2006, the shareholders at the annual general meeting approved an amended letter of indemnification to be given to our directors and officers. The aggregate indemnification amount that the Company will pay to all its officers and directors pursuant to these letters of indemnification shall not exceed $10,000,000 or 30% of the Company’s shareholders equity, according to the most recent consolidated financial statement prior to the date of indemnification payment, the higher of the two. Prior to that, we undertook to indemnify our officers and directors up to an aggregate amount of $15,000,000.




For information relating to option granted to officers and directors, see “Share Ownership” starting on page 39.




On August 31, 2006, our shareholders approved an agreement with Dr. Michael Brunstein, our chairman of the board of directors. The term of engagement commenced as of June 19, 2006 and continues for an unlimited period, unless terminated in certain circumstances as stated in the agreement. Pursuant to the agreement, Dr. Brunstein is being paid a gross annual fee of $110,000 payable monthly in NIS and was granted options to purchase up to 150,000 ordinary shares under our Stock Option Plan No. 8. The employment agreement contains a change of control provision pursuant to which the vesting of the 150,000 options shall be accelerated in certain circumstances.




On October 25, 2007, our shareholders approved a new compensation arrangement for the Company’s directors (excluding the external directors, the chairman of the board of directors and, unless approved otherwise, any other director who is also an employee of the Company), pursuant to which the director compensation package shall include the following items: (1) an annual payment of $12,000 (in an equivalent amount in NIS), however, not more than the annual payment allowed under the Companies Regulations (Rules Regarding Compensation and Expenses to an External Director), 2000, or the Regulations, in the case of dually listed companies; (2) the following payments (but in each case not more than the applicable payment allowed under the Regulations in the case of dually listed companies): (i) for each meeting that the director attends in person, an amount of $600 (in an equivalent amount in NIS); (ii) for each execution of a written consent in lieu of a meeting, an amount of $300 (in an equivalent amount in NIS); and (iii) for each meeting that the director attends by teleconference, an amount of $360 (in an equivalent amount in NIS); and (3) an annual grant of options to purchase up to 10,000 ordinary shares of the Company to be granted to each director on the date of each annual general meeting at which such director is elected or reelected. The exercise price of the options shall be determined pursuant to the Company’s Equity Based Compensation Policy.




On September 25, 2008, our shareholders approved the same compensation arrangement as was approved to the other directors on October 25, 2007 for the Company’s external directors. In addition, on September 25, 2008 our shareholders approved a one-time additional award of an option to purchase up to 10,000 ordinary shares to each of Mr. Dan Falk and Ms. Naama Zeldis, our external directors. The exercise price of the option was determined pursuant to the Company’s Equity Based Compensation Policy.




43





In addition, on September 25, 2008, our shareholders approved an addition to the compensation package of Dr. Michael Brunstein, the chairman of our board of directors, of the following items: (i) an annual award of an option to purchase up to 10,000 ordinary shares to be granted to Dr. Brunstein on the date of each annual general meeting at which the chairman of the board of directors is elected or reelected. The exercise price of each option shall be determined pursuant to the Company’s Equity Based Compensation Policy. The proposed terms of the options (i.e., the amount, exercise price and vesting schedule) are identical to the terms of the options currently granted to other directors on an annual basis; and (ii) a one-time additional award of an option to purchase up to 10,000 ordinary shares granted to Dr. Brunstein on September 25, 2008. The exercise price of the option was determined pursuant to the Company’s Equity Based Compensation Policy.




On August 3, 2009, our audit committee and board of directors approved the Company’s engagement with Bright View Systems Ltd., to license the use of certain optical instrumentation developed by the Company. Such approval was necessary in light of the fact that Dr. Giora Dishon was a director both of the Company and Bright-View. In addition, Dr. Dishon is a shareholder of Bright-View and holds less than 5% of its equity.




On June 24, 2010, our shareholders approved a biennial award of an option to purchase up to 75,000 ordinary shares to Dr. Michael Brunstein, the chairman of our board of directors, during his term as the chairman of the board of directors on the date of every other annual general meeting at which the chairman of the board is elected or reelected starting with the 2010 annual general meeting (and thereafter in 2012). The exercise price of each option shall be determined pursuant to the Company’s Equity Based Compensation Policy. 25% of each option shall vest and become exercisable on the first anniversary of its grant date and thereafter 2.083% of each option shall vest and become exercisable at the end of each complete month following the first anniversary date. Accordingly, each option shall fully vest and become exercisable at the 4thanniversary date of its grant date. The above grant shall be in addition to the previously approved annual award of an option to purchase 10,000 of the Company’s ordinary shares.




7.C
Interest of Experts and Counsel




Not applicable.




Item 8.  Financial Information




8.A
Consolidated Statements and Other Financial Information




See “Financial Statements” on page 65 of this report and pages F-1 through F-26.


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 significant legal proceedings, apart from those mentioned below.




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.




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 “Israeli Taxation” starting on page 51.




The distribution of dividends may also be limited by the 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 Amended and Restated Articles of Association provide that dividends will be paid at the discretion of, and upon resolution by, our board of directors.




Export Sales




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




44


8.B
Significant Changes




Not applicable.




Item 9.  The Offer and Listing




9.A
Offer and Listing Details




The information presented in the table below presents, for the periods indicated, the reported high and low market prices on The NASDAQ Global Market of our ordinary shares. The shares began trading on NASDAQ 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 market prices on the Tel Aviv Stock Exchange.


NASDAQ Global MarketPrice per share (US$)High

LowYearly highs and lows2006
2.90

1.452007
3.10

2.102008
2.55

0.412009
6.55

0.682010
8.48

3.63Quarterly highs and lows2009First quarter
1.00

0.34Second quarter
1.21

0.55Third quarter
2.75

0.89Fourth quarter
6.55

2.602010First quarter
6.72

4.23Second quarter
6.19

3.63Third quarter
6.89

3.86Fourth quarter
8.48

5.472011First quarter (until March 28, 2011)
11.44

8.20Monthly highs and lowsSeptember 2010
6.28

4.55October 2010
6.22

5.47November 2010
7.29

5.95December 2010
8.48

6.71January 2011
10.18

8.20February 2011
11.44

9.05March 2011 (until March 28, 2011)
10.50

8.50
   45
  Tel Aviv Stock ExchangePrice per share (NIS)High

LowYearly highs and lows2006
12.79

8.082007
13.75

8.502008
9.79

1.852009
24.24

1.532010
30.50

14.50Quarterly highs and lows2009First quarter
3.80

1.89Second quarter
8.69

2.80Third quarter
10.00

3.60Fourth quarter
24.24

9.712010First quarter
25.94

15.80Second quarter
22.38

14.50Third quarter
25.20

15.40Fourth quarter
30.50

20.002011First quarter (until March 28, 2011)
40.99

29.20Monthly highs and lowsSeptember 2010
22.10

17.37October 2010
22.90

20.00November 2010
25.95

21.77December 2010
30.50

24.40January 2011
37.48

29.20February 2011
40.99

33.20March 2011 (until March 28, 2011)
37.44

30.51




9.B
Plan of Distribution




Not applicable.




9.C
Markets




Our ordinary shares are quoted on The NASDAQ Global Market and the Tel Aviv Stock Exchange under the symbol “NVMI.”




9.D
Selling Shareholders




Not applicable.




9.E
Dilution




Not applicable.




9.F
Expenses on the Issue




Not applicable.




Item 10. Additional Information




10.A
Share Capital




Not applicable.




10.B
Memorandum and Articles of Association




Set forth below is a summary of certain provisions of the Company’s Amended and Restated Articles of Association, as adopted by the Company’s shareholders on September 25, 2008, 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 Amended and Restated Articles of Association and such law. On September 25, 2008, our shareholders adopted the Amended and Restated Articles of Association of the Company (for the purposes of this Item, the “Amended Articles”).




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




Purpose of the Company.  The purposes of the Company, as provided by Article 4 of our Amended Articles, 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.




46





Approval of Related Party Transaction; Corporate Borrowings.The 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 for a transaction between the company and its office holder or between the company and another person in which the office holder has a personal interest that is not an “extraordinary transaction,” unless the Amended Articles 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 shares held by shareholders who do not have a personal interest in approving the transaction attending in person or represented by proxy must vote in favor of the proposal (shares held by abstaining shareholders are not considered), or the aggregate number of shares held by such shareholders voted against the proposal must not exceed one per cent (1%) of a company’s voting rights.




Under our Amended Articles, a transaction by the Company with an office holder including transactions concerning compensation of non-director office holders, and a transaction between the Company and a third person in which an office holder of the Company has a personal interest, which is not an extraordinary transaction, will require only the approval of our board of directors or a committee authorized by our board of directors.




Interested board members may not vote on extraordinary transactions.  Arrangements regarding the compensation of directors require approval by the audit committee, board of directors and shareholders. Arrangements as to compensation of officer employment terms, if considered “extraordinary transaction”, require approval by the audit committee and board of directors.




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. 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 duties which exceed the duties imposed upon them under Israeli law, the maximum amount payable to the external directors is NIS 115,400 per annum and NIS 3,470 per meeting. The approval of the shareholders of the Company is required for such compensation, unless it is between the maximum and fixed amounts set forth in these regulations. Alternatively, the compensation of external directors may be linked to the compensation of other directors subject to certain restrictions. Additionally, external directors may be 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. In 2008, these regulations were amended to allow an increased compensation to external directors who are considered “expert external directors” under these regulations.




Share Capital.  The Company currently has one class of ordinary shares, 0.01 NIS par value per share. The Amended Articles provide that the board of directors may decide on a distribution, subject to the provisions set forth under the Companies Law and the Amended Articles.  Under the 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 at all shareholders meetings.




47





Changes of Rights of Holders of the Shares.According to the Amended Articles, any change in the rights and privileges of the holders of any class of shares shall require the approval of a class meeting of such class of shares by a simple majority (unless otherwise provided by the Companies Law or the regulations thereto or by the terms of issue of the shares of that class).




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 review the Company’s financial statements and to transact any other business required pursuant to the Amended Articles or to the Companies Law, 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. A special 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 the Amended Articles, 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 one day thereafter at the same time and place or to such other day, time and place as our board of directors may indicate in a notice to the shareholders. 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. The Companies Law and regulations determine that prior notice of no less than 21 days should be given to the company’s shareholders, prior to convening a meeting. In the event that the issue to be resolved is an issue subject to the Israeli proxy rules, a notice of no less than 35 days should be given to the company’s shareholders. In some cases a prior notice of not less than 14 days may be given to the company’s shareholders.




Subject to anti-terror legislations, 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 Amended Articles.




Board of Directors.The Amended Articles provide that directors may be elected either at our annual general meeting or a special meeting of shareholders by a vote of the holders of more than 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 the Amended Articles.  Each of our directors holds office until the next annual general meeting of shareholders. However, in accordance with the Companies Law, our external directors serve for three years, which may be renewed for one additional three year term and thereafter for additional three year terms, if both the audit committee and the board of directors confirm that in light of the expertise and contribution of the external director, the extension of such external director’s term would be in the interest of our company.  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 provides that those positions may be held by the same person for periods not exceeding three years each if approved by a majority of the company’s shareholder, including at least two thirds of the voting shareholders present (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.




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 a special meeting of our shareholders in a number and manner stipulated by law, namely, for a term of three years which may be renewed for additional three year terms 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 shares held by shareholders 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 held by such shareholders 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.




48





An external director is qualified for nomination as an external director, only if he/she has either professional qualifications or accounting and financial expertise. At least one of the external directors must have accounting and financial expertise. However, a company whose shares are traded in certain exchanges outside of Israel, including The NASDAQ Global Market, such as our company, is not required to nominate at least one external director who has accounting and financial expertise as long as another independent director for audit committee purposes who has such expertise serves on the board of directors pursuant to the applicable foreign securities laws. In such case all external directors will have professional qualification.




Regulations adopted under the Companies Law 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 field 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)
A senior position in the business management of a corporation which has a significant scope of business;




(b)
A senior public position or in a senior role in the public service; or




(c)
A senior position in the company’s major fields of business.




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 Amended Articles.




In 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 of directors determined that each of Mr. Dan Falk and Ms. Naama Zeldis has accounting and financial expertise as described in the regulations promulgated pursuant to Companies Law, and that, therefore, the requirements of the minimum number of board members that need to have accounting and financial expertise, as set by the board of directors, has been met.




On September 29, 2008, Amendment No. 8 to the Companies Law came into effect. The amendment states that a publicly traded company will be able to determine the number of independent directors that will serve on the company’s board of directors. The amendment also sets a recommendation as to the number of independent directors a public company should appoint to their board: (i) companies with a controlling shareholder – one third; and (ii) other companies – a majority of the board. A majority of our board members are independent as required by NASDAQ rules which are different than the independence standard of the Companies Law.




49





Changes in Capital. Our share capital may be increased or decreased by a vote of our shareholders in accordance with the Companies Law.




Acquisition of a Controlling Stake.According to the CompaniesLaw, 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 more than 45% 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 an offer without such objection being deemed as a 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 they are held by the purchaser.




Acquisition. The Companies Law requires an acquirer of a public company’s shares who wishes to effect a squeeze out transaction to acquire at least 95% of all outstanding shares in which case shareholder are granted appraisal rights under the Companies Law.




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 court may delay or prevent the merger if the court concludes 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 ofthe 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.




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 in the year preceding the merger, exceeds NIS 150 million (approximately $38 million an amount which is adjusted on an annual basis)andthe annual sales volume in Israel of at least two of the companies which are parties to such transaction exceeds NIS 10 million each (approximately $2.6 million 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.




Amendment no. 16 to the Companies Law




On March 7, 2011 amendment no. 16 (“Amendment 16”) to the Companies Law was enacted by the Israeli Knesset. Amendment 16, which will come into effect on May 14, 2011, places a special emphasis on the autonomy of the board of directors and the external directors and on the composition and responsibilities of the audit committee.




50





Under Amendment 16, among others: (i) the approval of certain interested party transactions will require the affirmative vote of a majority of the shares and in addition either that (a) the majority (rather than one third) of the shares held by shareholders who do not have a personal interest in the transaction attending in person or represented by proxy have voted in favor of the proposal (shares held by abstaining shareholders shall not be considered) or (b) that the total number of disinterested shares voted against the proposal does not exceed 2% (rather than 1%) of the aggregate voting rights; (ii) the approval of the appointment of an external director will require the affirmative vote of a majority of the shares and in addition either that (a) the majority (rather than one third) of the shares held by shareholders 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 (b) that the total number of disinterested shares voted against the proposal does not exceed 2% (rather than 1%) of the aggregate voting rights; (iii) the majority of members of the audit committee shall be independent directors (as defined under Amendment 16), and the audit committee chairman shall be an external director (which is currently the composition of our audit committee); (iv) the quorum required to determine a decision of the audit committee shall be not less than a majority of the independent directors, including at least one external director; and (v) the audit committee shall determine whether certain related party transactions are considered extraordinary transactions for the purpose of the Companies Law and should be approved as such.




10.C
Material Contracts




On February 28, 2007, we entered into a Share Purchase Agreement with four investors, including Clal Electronics Industries Ltd., pursuant to which such investors purchased in the aggregate 1,937,983 ordinary shares of the Company, at a price of $2.58 per share, for gross proceeds of $5.0 million. In connection with this transaction, we issued warrants to these investors to purchase 1,453,485 additional ordinary shares at an exercise price of $3.05 per share. On May 11, 2007, we filed a registration statement on Form F-3 to register for resale the shares sold (including the shares underlying the warrants) pursuant to the Share Purchase Agreement.




On February 4, 2010, we entered into an Underwriting Agreement with Needham & Company, LLC and Roth Capital Partners LLC, for the sale of 3,850,000 ordinary shares of the company, with an additional 577,500 ordinary shares to be sold pursuant to an over allotment option. On February 9, 2010, we successfully consummated an underwritten public follow-on offering of 4,427,500 ordinary shares (which amount of shares included ordinary shares sold pursuant to the over allotment option) at a price per ordinary share of $4.15, in consideration of approximately $17.0 million, net.




10.D
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.




10.E
Taxation




Israeli Taxation




The following is a summary of the material Israeli tax laws applicable to us, and some Israeli Government programs benefiting us. This section also contains a discussion of some Israeli tax consequences to persons owning our ordinary shares. This summary does not discuss all the aspects of Israeli tax law that may be relevant to a particular investor in light of his or her personal investment circumstances or to some types of investors subject to special treatment under Israeli law. Examples of this kind of investor include traders in securities or persons that own, directly or indirectly, 10% or more of our outstanding voting capital, all of whom are subject to special tax regimes not covered in this discussion. Some parts of this discussion are based on a new tax legislation which has not been subject to judicial or administrative interpretation. The discussion should not be construed as legal or professional tax advice and does not cover all possible tax considerations.




SHAREHOLDERS ARE URGED TO CONSULT THEIR OWN TAX ADVISORS AS TO THE ISRAELI OR OTHER TAX CONSEQUENCES OF THE PURCHASE, OWNERSHIP AND DISPOSITION OF OUR ORDINARY SHARES, INCLUDING, IN PARTICULAR, THE EFFECT OF ANY FOREIGN, STATE OR LOCAL TAXES.




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General Corporate Tax Structure in Israel




Israeli companies are generally subject to corporate tax  on their taxable income at the rate of 25% for the 2010 tax year. This rate was reduced to 24% in 2011 and is scheduled to be  gradually reduced to 18% by 2016 (2012 – 23%, 2013 – 22%, 2014 – 21%, 2015 – 20%, 2016 and thereafter – 18%). Israeli companies are generally subject to capital gains tax at the corporate tax rate. However, the effective corporate tax rate payable by a company that derives income from an Approved Enterprise/Benefited Enterprise (as further discussed below) may be considerably lower.




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




Tax benefits prior to the 2005 Amendment




The Law for the Encouragement of Capital Investments, 1959, generally referred to as the “Investments Law ”, provides that a capital investment in eligible facilities may, upon application to the Investment Center of the Ministry of Industry, Trade and Labor of the State of Israel the (“Investment Center ”), be granted the status of 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, e.g., the equipment to be purchased and utilized pursuant to the program.




A company owning an Approved Enterprise is eligible for a combination of grants and tax benefits (the “Grant Track”). The tax benefits under the Grant Track include accelerated depreciation and amortization for tax purposes, as well as the taxation of income generated from an Approved Enterprise at the maximum corporate tax rate of 25%, for a certain period of time. The benefit period is ordinarily seven years commencing with the year in which the Approved Enterprise first generates taxable income. The benefit period is limited to 12 years from the earlier of the commencement of production by the Approved Enterprise or 14 years from the date of approval of the Approved Enterprise.




The tax benefits under the Investments Law also apply to income generated by a company from the grant of a usage right with respect to know-how developed pursuant to the Approved Enterprise, income generated from royalties, and income derived from a service which is auxiliary to such usage right or royalties, provided that such income is generated within the ordinary course of business of the company investing in the 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 average of the applicable rates. The Tax Benefits under the Investments Law are not, generally, available with respect to income derived from products manufactured outside of Israel. In addition, the Tax Benefits available to a company investing in an Approved Enterprise are contingent upon the fulfillment of conditions stipulated in the Investments Law and related regulations and the criteria set forth in the specific certificate of approval, as described above. In the event that a company does not meet these conditions, it would be required to refund the amount of tax benefits, plus a consumer price index linked adjustment and interest.




A company which qualifies as a foreign investment company (a “FIC”) will be eligible for a three-year extension of tax benefits following the expiration of the seven-year period referenced above. In addition, in the event that the level of foreign ownership in an Approved Enterprise reaches 49% or higher, the corporate tax rate applicable to income earned from the Approved Enterprise is reduced as follows:




% of Foreign Ownership
Tax Rate49% or more but less than 74%
20%74% or more but less than 90%
15%90% or more
10%





A company qualifies as a FIC if (i) it has received at least NIS 5 million in loans (for a minimum period of three years) or as investment in share capital from a foreign resident who is consequently entitled to at least 25% of the “rights” in the company (consisting of profit sharing rights, voting rights and appointment of directors) , or (ii) if a foreign resident has purchased the company’s shares from an existing shareholder, consequently entitling the foreign shareholder to at least 25% of such rights in the company provided that the company’s outstanding and paid-up share capital exceeds NIS 5 million.




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Additionally, a company owning an Approved Enterprise on or after April 1, 1986, may elect to forgo its entitlements to grants and tax benefits under the Grant Track and apply for alternative package of tax benefits for a benefit period of between seven and ten years (the “Alternative Track”). Under the Alternative Track, a company’s undistributed income derived from the Approved Enterprise will be exempt from corporate tax for a period of between two and ten years, starting from the first year the company derives taxable income under the Approved Enterprise program. The length of time of this exemption will depend on the geographic location of the Approved Enterprise within Israel and the type of the approved enterprise. After the exemption period lapses, the company will be eligible for the reduced tax rate of 25% (or a lower rate in the case of a FIC) for the remainder of the benefit period.




The Company has elected to be taxed under the Alternative Track. A company that has elected the Alternative Track and subsequently pays a dividend out of income derived from the Approved Enterprise during the tax exemption period will be subject to corporate tax on the amount which is determined by the distributed amount grossed up with the effective corporate tax rate which would have been applied had the company not elected the Alternative Track, which is at referred above ranged between 10%-25%. Dividends paid out of income derived from an Approved Enterprise are generally subject to withholding tax at source at the reduced rate of 15%, if the dividend is distributed during the tax exemption period or within 12 years thereafter. In the event, however, that the company qualifies as a FIC, there is no such time limitation.




Under the Alternative Track, dividends paid by a company are considered to be attributable to income received from the entire company and the company’s effective tax rate is the result of a weighted average of the various applicable tax rates, excluding any tax-exempt income. Under the Investments Law, a company that has elected the Alternative Track is not obliged to distribute retained profits, and may generally decide from which year’s profits to declare dividends




We currently intend to reinvest any income derived from our Approved Enterprise program and not to distribute such income as a dividend.




Tax benefits under the 2005 Amendment




An amendment to the Investments Law, which effective as of April 1, 2005, has changed certain provisions of the Investments Law. An eligible investment program under the Amendment qualifies for benefits as a “Benefited Enterprise” (rather than as an Approved Enterprise which status is still applicable for investment programs approved prior to December 31, 2004 and/or investment programs under the Grant Track). According to the amendment, only Approved Enterprises receiving cash grants require the prior approval of the Investment Center.




The duration of the tax benefits described herein is limited to the earlier of seven or ten years (depending on the geographic location of the Approved Enterprise within Israel) from the Commencement Year (as described below) or 12 years from the first day of the Year of Election. Commencement Year is defined as the later of the first tax year in which a company had derived liable income for tax purposes from the Benefited Enterprise, or the year of election which is the year in which a company requested to have the tax benefits apply to the Benefited Enterprise. The tax benefits granted to a Benefited Enterprise are determined, depending on the geographic location of the Benefited Enterprise within Israel, according to one of the following, which may be applicable to us:




(i) Similar to the currently available Alternative Track, exemption from corporate tax may be available on undistributed income for a period of two to ten years, depending on the geographic location of the Benefited Enterprise within Israel, and a reduced corporate tax rate of 10% to 25% for the remainder of the benefit period, depending on the level of foreign investment in each year. Benefits may be granted for a term of seven to ten years, depending on the level of foreign investment in the company. If the company pays a dividend out of income derived from the Benefited Enterprise during the tax exemption period, such income will be subject to deferred corporate tax with respect to the amount distributed (grossed up with the effective corporate tax rate which would have applied had the company not enjoyed the exemption) at the rate which would have applied had such company had the status of a Benefited Enterprise. The company is required to withhold tax on such distribution at a rate of 15%; or




(ii) A special track which enables companies owning facilities in certain geographical locations in Israel to pay corporate tax at a flat rate of 11.5% on income the Benefited Enterprise (the “Ireland Track”). The benefit period is for ten years. Upon payment of dividends, the company is required to withhold tax on such dividend at a rate of 15% for Israeli residents and at a rate of 4% for foreign residents.




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Generally, a company that is Abundant in Foreign Investment (owned by at least 74% foreign shareholders and has undertaken to invest a minimum sum of $20 million in the Benefited Enterprise) is entitled to an extension of the benefit period by an additional five years, depending on the rate of its income that is derived in foreign currency.




As a result of the amendment, tax-exempt income generated under the provisions of the Investments Law, as amended, will subject us to taxes upon distribution or liquidation and we may be required to record deferred tax liability with respect to such tax-exempt income.




Currently, we have three Approved Enterprises under the Investments Law, which entitle us to certain tax benefits. Each of these Approved Enterprises is under the Alternative Track, which allows us, inter alia, a two year period of exemption of taxes for undistributed income pertaining to these enterprises. The two year exemption period of these Approved Enterprises has not yet commenced.




To date, the Company has not had earnings attributable to Approved Enterprise programs.




On December 29, 2010, the Israeli Parliament approved an amendment to the Investment Law (the “New Amendment”). The New Amendment significantly revising the tax incentive regime in Israel, commencing on January, 1 2011.




The New Amendment introduced a new status of “Preferred Enterprise”, replacing the existed status of “Benefited Enterprise”. Similarly to “Beneficiary Company”, a Preferred Company is an industrial company meeting certain conditions (including a minimum threshold of 25% export). However, under the New Amendment the requirement for a minimum investment in productive assets in order to be eligible for the benefits granted under the Investments Law as with respect to “Benefited Enterprise” was cancelled.




Preferred Company is entitled to a reduced flat tax rate with respect to the income attributed to the Preferred Enterprise, at the following rates:




Tax Year
Development Region “A”
Other Areas within Israel2011-2012
10%
15%2013-2014
7%
12.5%2015 onwards
6%
12%




In addition, the New Amendment introduced a new status of “Special Preferred Company” which is an Industrial company meeting, in addition to the conditions prescribed for “Preferred Company” certain additional conditions (including that the total preferred enterprise income of the preferred enterprise is at least NIS 1.5 billion in the given tax year). The tax rate applicable for a period of 10 years to income generated by such an enterprise will be reduced to 5%, if located in Development Region “A”, or to 8%, if located in other area within the State of Israel.




Dividend distributed from income which is attributed to “Preferred Enterprise” or “Special Preferred Enterprise” will be subject to withholding tax at source at the following rates: (i) Israeli resident corporation – 0%, (ii) Israeli resident individual – 15% (iii) non-Israeli resident - 15%, subject to a reduced tax rate under the provisions of an applicable double tax treaty.




The New Amendment also revised the Grant Track under to apply only to approved programs located in Development Region “A” and shall provide not only cash grants (as prior to the Amendment) but also the granting of loans. The rates for grants and loans shall not be fixed but up to 20% of the amount of the approved investment (may be increased with additional 4%). In addition, a company owning a Preferred Enterprise under the Grant Track may be entitled also to the tax benefits which are prescribed for a Preferred Company.




The provisions of the New Amendment shall not apply to existed “Benefited Enterprise” or “Approved Enterprise” which will continue to be entitled to the tax benefits under the Investment Law in effect prior to the New Amendment unless the company owning such enterprise has otherwise elected by filing with the Israeli Tax Authority not later than the date prescribed for the filing of the company’s annual tax return for the respective year to apply the provisions of the New Amendment (such election cannot be later rescinded). A company owning a Benefited Enterprise or Approved Enterprise which made such election by July 30, 2015, will be entitled to distribute income generated by the Approved/Benefited Enterprise to its Israeli company shareholders tax free.




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Law for the Encouragement of Industry (Taxes), 1969




We believe that we qualify as an “Industrial Company” within the meaning of the Law for the Encouragement of Industry (Taxes), 1969, or the Industry Encouragement Law. The Industry Encouragement Law defines “Industrial Company” as an Israeli resident company, of which 90% or more of its income in any tax year (exclusive of income from certain defense loans), capital gains, interest and dividends is generated from an “Industrial Enterprise” that it owns. An “Industrial Enterprise” is defined as an enterprise whose principal activity in a given tax year is industrial manufacturing.




An Industrial Company is entitled to certain tax benefits, including: (i) a deduction of the cost of purchases of patents, know-how and certain other intangible property rights (other than goodwill) used for the development or promotion of the Industrial Enterprise over a period of eight years, beginning from the year in which such rights were first used, (ii) the right to elect to file consolidated tax returns with additional Israeli Industrial Companies controlled by it, and ( iii) the right to deduct expenses related to public offerings in equal amounts over a period of three years beginning from the year of the offering.




Eligibility for benefits under the Encouragement of Industry Law is not contingent upon the approval of any governmental authority.




There is no assurance that we qualify or will continue to qualify as an Industrial Company or that the benefits described above will be available in the future.




Taxation of the Company Shareholders




Capital Gains




Capital gain tax is imposed on the disposal of capital assets by an Israeli resident, and on the disposal of such assets by a non- Israel resident if those assets are either (i) located in Israel; (ii) are shares or a right to a share in an Israeli resident corporation, or (iii) represent, directly or indirectly, rights to assets located in Israel. The Israeli Income Tax Ordinance distinguishes between “Real Gain” and the “Inflationary Surplus”. Real Gain is the excess of the total capital gain over Inflationary Surplus computed generally on the basis of the increase in the Israeli CPI between the date of purchase and the date of disposal.




The capital gain accrued by individuals on the sale of our ordinary shares will be taxed at the rate of 20%. However, if the individual shareholder is a “Controlling Shareholder” (i.e., a person who holds, directly or indirectly, alone or together with other, 10% or more of one of the Israeli resident company’s means of control) at the time of sale or at any time during the preceding 12 months period such gain will be taxed at the rate of 25%. The Real Capital Gain accrued on the sale of an asset purchased prior to January 1, 2003 will be subject to a tax at a weighted rate.  The marginal tax rate for individuals (up to 45% in 2010) will be applied to the portion of the gain amount which bears the same ratio to the total gain realized as the ratio which the holding period commencing at the acquisition date and terminating on January 1, 2003 bears to the total holding period.  The remainder of the gain realized will be subject to capital gains tax at the rates applicable to an asset purchased after January 1, 2003.




The real capital gain derived by corporation will be generally subject to a corporate tax rate (25% in 2010, 24% in 2011).




Individual and corporate shareholder dealing in securities in Israel are taxed at the tax rates applicable to business income - 24% tax rate in 2011 (25% in 2010) for a corporation and a marginal tax rate of up to 45% in 2010 and 2011 for individual. Notwithstanding the foregoing, capital gain derived from the sale of our ordinary shares by a non-Israeli shareholder may be exempt under the Israeli Income Tax Ordinance from Israeli taxation provided the following cumulative conditions are met: (i) the shares were purchased upon or after the registration of the securities on the stock exchange (this condition shall not apply to shares purchased on or after  January 1, 2009), (ii) the seller does not have a permanent establishment in Israel to which the derived capital gain is attributed, and (iii) if the seller is a corporation, less than 25% of its means of control are held, directly and indirectly, by Israeli resident shareholders. In addition, the sale of shares may be exempt from Israeli capital gain tax under the provisions of an applicable tax treaty. For example, the U.S.-Israel Double Tax Treaty exempts U.S. resident from Israeli capital gain tax in connection with such sale, provided (i) the U.S. resident  owned, directly or indirectly, less than 10% of an Israeli resident company’s voting power  at any time within the 12 month period preceding such sale; (ii) the seller, being an individual, is present in Israel for a period or periods of less than 183 days at the taxable year; and (iii) the capital gain from the sale was not derived through a permanent establishment of the U.S. resident in Israel.




55





Either the purchaser, the Israeli stockbrokers or financial institution through which the shares are held is obliged, subject to the above mentioned exemptions, to withhold tax upon the sale of securities from the real capital gain at the corporate tax rate (24% in 2011) in respect of a corporation and 20% in respect of an individual.




At the sale of securities traded on a stock exchange a detailed return, including a computation of the tax due, should be filed and an advanced payment should be paid on January 31 and June 31 of every tax year in respect of sales of securities made within the previous six months. However, if all tax due was withheld at source according to applicable provisions of the Israeli Income Tax Ordinance and regulations promulgated thereunder the aforementioned return should not be filed and no advance payment should be paid. Capital gain is also reportable on the annual income tax return.




Dividends




We have never paid cash dividends. A distribution of dividend by our company from income attributed to an Approved Enterprise/Benefited Enterprise (either to individual or corporation) will be generally subject to tax in Israel at the rate of 15% (or 4% under the Ireland track), subject to a reduced rate under the provisions of any applicable double tax treaty. A distribution of dividend by our company from income attributed to a Preferred Enterprise will subject to tax in Israel at the following rates: Israeli resident individual - 15%, Israeli resident company – 0% and exempted for an Israeli resident company, foreign resident – 15%, subject to a reduced rate under the provisions of any applicable double tax treaty. A distribution of dividend from income, which is not attributed to an Approved Enterprise/Benefited Enterprise to an Israeli resident individual, will generally be subject to income tax at a rate of 20%. However, a 25% tax rate will apply if the dividend recipient is a “Controlling Shareholder” at the time of distribution or at any time during the preceding 12 months period. If the recipient of the dividend is an Israeli resident corporation, such dividend will be exempt from income tax provided the income from which such dividend is distributed was derived or accrued within Israel.




Under the Israeli Income Tax Ordinance, a non-Israeli resident (either individual or corporation) is generally subject to an Israeli income tax on the receipt of dividends at the rate of 20% (25% if the dividends recipient is a “Controlling Shareholder” (as defined above), at the time of distribution or at any time during the preceding 12 months period); those rates are subject to a reduced tax rate under the provisions of an applicable double tax treaty. Thus, under the U.S.-Israel Double Tax Treaty the following rates will apply in respect of dividends distributed by an Israeli resident company to a U.S. resident: (i) if the U.S. resident is a corporation which holds during that portion of the taxable year which precedes the date of payment of the dividend and during the whole of its prior taxable year (if any), at least 10% of the outstanding shares of the voting stock of the Israeli resident paying corporation and not more then 25% of the gross income of the Israeli resident paying corporation for such prior taxable year (if any) consists of certain type of interest or dividends – the tax rate is 12.5%, (ii) if both the conditions mentioned in section (i) above are met and the dividend is paid from an Israeli resident company’s income which was entitled to a reduced tax rate applicable to an Approved Enterprise – the tax rate is 15%, and (iii) in all other cases, the tax rate is 25%. The aforementioned rates under the Israel U.S. Double Tax Treaty will not apply if the dividend income was derived through a permanent establishment of the U.S. resident in Israel.




Our company is obligated to withhold tax, upon the distribution of a dividend attributed to an Approved Enterprise's/Benefited Enterprise's income, from the amount distributed, at the following rates: (i) Israeli resident corporation – 15%, (ii) Israeli resident individual – 15%, and (iii) non-Israeli resident – 15% (4% under the Ireland Track), subject to a reduced tax rate under the provisions of an applicable double tax treaty. If a dividend is distributed from an income attributed to the Preferred Enterprise, the following withholding tax rates will apply: (i) Israeli resident corporation – 0%, (ii) Israeli resident individual – 15% (iii) non-Israeli resident - 15%, subject to a reduced tax rate under the provisions of an applicable double tax treaty. If the dividend is distributed from an income not attributed to the Approved Enterprise/Benefited Enterprise, the following withholding tax rates will apply: (i) Israeli resident corporation – 0%, (ii) Israeli resident individual – 20% (iii) non-Israeli resident - 20%, subject to a reduced tax rate under the provisions of an applicable double tax 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 repayable in non-Israeli currency at the rate of exchange prevailing at the time of conversion. However, Israeli income tax is generally required to have been paid or withheld on these amounts. In addition, the statutory framework for the potential imposition of currency exchange control has not been eliminated, and may be restored at any time by administrative action.




56





U.S. Taxation




The following discussion describes certain material United States (“U.S.”) federal income tax consequences of the purchase, ownership and disposition of our ordinary shares.




For purposes of this discussion, a “U.S. holder” is a beneficial owner of ordinary shares who or which is any of the following for U.S. federal income tax purposes:




·
a citizen or resident of the U.S. or someone treated as a U.S. citizen or resident of the U.S.;




·
a corporation (or another entity taxable as a corporation for U.S. federal income tax purposes) created or organized in or under the laws of the U.S., any state thereof, or the District of Columbia;




·
an estate, the income of which is subject to U.S. federal income taxation regardless of its source; or




·
a trust, if (a) a U.S. court is able to exercise primary supervision over its administration and one or more U.S. persons have the authority to control all of its substantial decisions, or (b) the trust was in existence and treated as a U.S. person on August 20, 1996 and has a valid election in effect under applicable Treasury Regulations (as defined below) to be treated as a U.S. person.




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 Company’s 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”), Treasury Regulations promulgated under the Code by the U.S. Treasury Department (including proposed and temporary regulations) (the “Treasury Regulations”), rulings, current administrative interpretations and official pronouncements by the Internal Revenue Service (the “IRS”), and judicial decisions, all as currently in effect and all of which are subject to differing interpretations or to change, with a retroactive effect. Such changes could materially and adversely affect the tax consequences described below. No assurance can be given that the IRS would not assert, or that a court would not sustain, a position contrary to any of the tax consequences described below.




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 (by voting power or value) 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 U.S. dollar;




·
persons who acquire their ordinary shares in a compensatory transaction;




·
broker-dealers;




·
insurance companies;




·
regulated investment companies;




·
real estate investment companies;




·
traders who elect to mark-to-market their securities;




·
tax-exempt organizations;




·
banks or other financial institutions;




·
U.S. expatriates; and




·
persons subject to the alternative minimum tax.




57





HOLDER RELIANCE ON TAX STATEMENTS




THIS SUMMARY OF MATERIAL UNITED STATES FEDERAL INCOME TAX CONSIDERATIONS IS FOR GENERAL INFORMATION ONLY AND IS NOT TAX ADVICE. EACH HOLDER SHOULD CONSULT ITS TAX ADVISOR WITH RESPECT TO THE PARTICULAR TAX CONSEQUENCES TO IT OF AN INVESTMENT IN THE ORDINARY SHARES, INCLUDING THE EFFECTS OF APPLICABLE UNITED STATES FEDERAL INCOME TAX LAWS AS WELL AS ANY TAX CONSEQUENCES ARISING UNDER THE UNITED STATES FEDERAL ESTATE OR GIFT TAX RULES OR UNDER THE LAWS OF ANY FOREIGN, STATE OR LOCAL JURISDICTION OR UNDER ANY APPLICABLE TAX TREATY.




Availability of Reduced Tax Rates




U.S. legislation 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 may be eligible for this reduced rate.  Subject to the discussion below, dividends, if any, may 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 “Dividends” on page 56. In general (and subject to the passive foreign investment company (“PFIC”) rules discussed below), any 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. If holding period and other requirements are met, dividends paid to non-corporate U.S. holders in taxable years beginning no later than December 31, 2012 should generally qualify for the reduced maximum tax rate of 15% as long as our common shares remain “readily tradable on an established securities market in the United States,” provided that we are not considered a PFIC (as discussed below) in the taxable year in which the dividend is paid or in any preceding taxable year. 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, and as long-term capital gain if the U.S. holder’s holding period exceeds one year, from the deemed disposition of the ordinary shares (subject to the PFIC rules discussed below). 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 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 the income of U.S. holders and the day the NIS are converted into U.S. dollars or are otherwise 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 may also be impacted by the tax treaty between the United States and Israel), 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 (subject to the PFIC rules discussed below), 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.




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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.




Passive Foreign Investment Companies




In general, a foreign (i.e., non-U.S.) corporation will be a passive foreign investment company (a “PFIC”) for any taxable year in  which, after applying the relevant look-through rules with respect to the income and assets of its subsidiaries, either (1) 75% or more of its gross income in the taxable year is “passive income,” or (2) assets held for the production of, or that produce, passive income comprise 50% or more of the average of its total asset value in the taxable year. 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 includes assets held for the production of, or that produce dividends, interest, royalties, rents, annuities, and other income included in the income test. In determining whether we meet the assets test, cash is considered a passive asset and the total value of our assets generally will be treated as equal to the sum of the aggregate fair market value of our outstanding stock plus our liabilities. If we own at least 25% (by value) of the stock of another corporation, we will be treated, for purposes of the PFIC tests, as owning our proportionate share of the other corporation’s assets and receiving our proportionate share of the other corporation’s income. 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 ineligible for any preferential tax rate otherwise applicable to any “qualified dividend income” or capital gains, and 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. These adverse tax consequences associated with PFIC status could result in a material increase in the amount of tax that a U.S.holder would owe and an imposition of tax earlier than would otherwise be imposed and additional tax form filing requirements.Under recently passed legislation, unless otherwise provided by the IRS, if a corporation is classified as a PFIC, a U.S. holder will generally be required to file an informational return annually to report its ownership interest in such entity.




Status of Nova as a PFIC. Under the income test, less than 75% of our gross income was passive income in 2010.For 2010, while we continued to have substantial amounts of cash and short-term deposits and the market value of our ordinary shares continued to be volatile and decreased, a determination of the value of our assets by reference to the average 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 2010. Nonetheless, there is a risk that we were a PFIC in 2010 or we will be a PFIC in 2011 or subsequent yearsbecause there are no definitive rules regarding the manner in which a company should value its assets for purposes of the PFIC asset test.For example, taking into account our existing cash balances, if the value of our stock were to decline materially, it is possible that we could become a PFIC in 2011 or a subsequent year.  Additionally, due to the complexity of the PFIC provisions and the limited authority available to interpret such provisions, there can be no assurance that our determination regarding our PFIC status could not be successfully challenged by the IRS.




Available Elections. If we become 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 in order to mitigate the adverse tax consequences of PFIC status.




59





If a U.S. holder makes a qualified electing fund election (a “QEF election”) for its ordinary shares that is effective from the first taxable year that the U.S. holder holds our ordinary shares and during which we are a PFIC, the electing U.S. holder will avoid the adverse consequences of our being classified as a PFIC but will instead be required to include in income a pro rata share of our net capital gain, if any, and other earnings and profits (“ordinary earnings”) as long-term capital gains and ordinary income, respectively,on a current basis, in each case whether or not distributed, in the taxable year of the U.S. holder in which or with which our taxable year ends. A subsequent distribution of amounts that were previously included in the gross income of U.S. holders should not be taxable as a dividend to those U.S. holders who made a QEF Election.  In the event we incur a net loss for a taxable year, such loss will not be available as a deduction to an electing U.S. holder, and may not be carried forward or back in computing our net capital gain or ordinary earnings in other taxable years.  The tax basis of the shares of an electing U.S. holder generally will be increased by amounts that are included in income, and decreased by amounts distributed but not taxed as dividends, under the QEF rules described above.In order to make (or maintain) a QEF election, the U.S. holder must annually complete and file IRS Form 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 records to be examined to verify such information. Therefore, we will monitor our PFIC status and make a disclosure to our shareholders if we determine that we have become a PFIC. If we are a PFIC for any year and you make a request to us in writing at the address on the cover of 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.




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 the IRS consents to revocation of the election. If you make a QEF election and we cease to be classified 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 are not classified as a PFIC. Therefore, if we – after ceasing to be classified as a PFIC – again are classified 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 U.S. holders making QEF elections in such tax year and any subsequent tax years in which we are classified 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 U.S. holders making a QEF election for each tax year in which we are classified 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. If a U.S. holder makes a valid mark-to-market election with respect to our ordinary shares for the first taxable year of the U.S. holder in which the U.S. holder holds (or is deemed to hold) our ordinary shares and for which we are determined to be a PFIC, such holder generally will not be subject to the PFIC rules described above in respect to its common 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. 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.




60





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.




New Legislation regarding Medicare Tax




For taxable years beginning after December 31, 2012, a U.S. holder that is an individual or estate, or a trust that does not fall into a special class of trusts that is exempt from such tax, will be subject to a 3.8% tax on the lesser of (1) the U.S. holder’s “net investment income” for the relevant taxable year and (2) the excess of the U.S. Investor’s modified adjusted gross income for the taxable year over a certain threshold (which, in the case of individuals, will be between $125,000 and $250,000 depending on the individual’s circumstances).  A U.S. holder’s “net investment income” may generally include its dividend income and its net gains from the disposition of shares, unless such dividends or net gains are derived in the ordinary course of the conduct of a trade or business (other than a trade or business that consists of certain passive or trading activities).  If you are a U.S. holder that is an individual, estate or trust, you are urged to consult your tax advisors regarding the applicability of the Medicare tax to your income and gains in respect of your investment in the shares.




Withholdable Payments to Foreign Financial Entities and Other Foreign Entities




Under recently enacted legislation, a non-U.S. holder may be subject to a U.S. federal withholding tax at a rate of 30% on certain payments made beginning January 1, 2013 to certain non-U.S. entities if certain disclosure requirements related to U.S. accounts maintained by, or the U.S. ownership of, the non-U.S. holder are not satisfied.  Such payments would include U.S.-source dividends and the gross proceeds from the sale or other disposition of our common stock that can produce U.S.-source dividends.  Non-U.S. holders should consult their own tax advisors regarding the effect, if any, of such withholding taxes on their ownership and disposition of our common stock.




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 IRS and possible U.S. federal backup withholding at the rate of 28%. Certain holders (including, among others, corporations) are generally not subject to information reporting and backup withholding.  A U.S. holder generally will be subject to backup withholding if such holder is not otherwise exempt and such holder:
  ·
fails to furnish its taxpayer identification number, or TIN, which, for an individual, is ordinarily his or her social security number,
  ·
furnishes an incorrect TIN,
  ·
is notified by the IRS that it is subject to backup withholding because it has previously failed to properly report payments of interest or dividends, or
  ·
fails to certify, under penalties of perjury, that it has furnished a correct TIN and that the IRS has not notified the U.S. holder that it is subject to backup withholding.


Any U.S. holder who is required to establish exempt status generally must file IRS Form W-9 (“Request for Taxpayer Identification Number and Certification”).




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 IRS and furnishing any required information.


10.F
Dividends and Paying Agents




Not applicable.




61


10.G
Statements by Experts




Not applicable.




10.H
Documents on Display




The documents referred to herein, including the Amended Articles, 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 Commission.  Reports and other information provided to the Commission by the Company may be inspected and copied at the public reference facilities maintained by the Commission at Room 1024, 100 Fifth Street, N.E., Washington, D.C. 20549.  Information on the operation of the public reference facilities may be obtained by calling the Commission at 1-800-SEC-0330. In addition, certain of the Company’s reports filed with the Commission are available on-line at www.sec.gov.




10.I
Subsidiary Information




Not applicable.




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 Currency Fluctuation




Substantially all of our sales are made in U.S. dollars. Over 50% of our expenses in 2010 were in dollars or in NIS linked to the dollar. The remaining expenses were in currencies other than the U.S. dollar, and mainly NIS. The dollar cost of our operations in countries other than the U.S., is negatively influenced by any devaluation of the U.S. dollar against other currencies. During 2010, the value of the U.S. dollar devaluated against the NIS by 5.98%, and against the Yen by approximately 12.86%. The value of the U.S. dollar devaluated against the Euro by approximately 6.5%. During the first six months of 2010 the value of the U.S. dollar revaluated against the NIS by approximately 2.6%, devaluated against the Yen by approximately 4.91% and against the Euro by 14.24%. During the last six months of 2010 the value of the U.S. dollar devaluated against the NIS by approximately 8.4%, against the Yen by approximately 8.36% and revaluated against the Euro by approximately 9.03%. During the first 2 months of 2011, the U.S. dollar continued to revaluate by 2.0% against the NIS, by 2.91% against the Euro and by 1.0% against the Yen.




As of December 31, 2010, 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 were affected by the currency fluctuations in 2010 and are expected to continue to be affected by such currency fluctuations in 2011.




In 2008, the Company entered into currency-forward transactions and currency-put options (NIS/dollar, Euro/dollar, Yen/dollar) of approximately $33.6 million with settlement date through 2008 designed to reduce cash-flow exposure to the impact of exchange-rate fluctuations on firm commitments of approximately $33.6 million. In accordance with ASC 815-10 the Company recorded in 2008 a decrease of approximately $0.4 million in fair market value in “Other Comprehensive Income”.




In 2009, the Company entered into currency-forward transactions and currency-put options (NIS/dollar, Euro/dollar, Yen/dollar) of approximately $12.5 million with settlement dates through 2009, designed to reduce cash-flow exposure to the impact of exchange-rate fluctuations on firm commitments of approximately $12.5 million. In accordance with ASC 815-10 the Company recorded in 2009 an increase of approximately $0.2 million in fair market value in “Other Comprehensive Income”




62





In 2010, the Company entered into currency-forward transactions and currency-put options (NIS/dollar, Euro/dollar, Yen/dollar) of approximately $21.7 million with settlement dates through 2010, designed to reduce cash-flow exposure to the impact of exchange-rate fluctuations on firm commitments of approximately $21.7 million. In accordance with ASC 815-10 the Company recorded in 2010 an increase of approximately $0.3 million in fair market value in “Other Comprehensive Income”.




Short-term exposures to changing foreign exchange rates are primarily due to operating cash flows denominated in foreign currencies and transactions denominated in non-functional currencies. Our most significant foreign currency exposures are related to our operations in Israel. We have used foreign exchange forward contracts to partially cover known and anticipated exposures. We estimate that an instantaneous 10% depreciation in this currency of this country from its level against the dollar as of December 31, 2010, with all other variables held constant, would decrease the fair value of our net assets denominated in foreign currency, held at December 31, 2010, by approximately $ 0.4 million.




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 net proceeds of $49.0 million.




Item 15.  Controls and Procedures




(a)       Our management, including our chief executive officer and chief financial officer, has evaluated the effectiveness of our disclosure controls and procedures as of December 31, 2010. Based on such review, our chief executive officer and chief financial officer have concluded that we have in place effective controls and procedures designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act of 1934, as amended, is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure, and is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms.




(b)        Our management, under the supervision of our chief executive officer and chief financial officer, is responsible for establishing and maintaining adequate internal control over our financial reporting, as defined in Rules 13a-15(f) and 15d-15(f) of the Securities Exchange Act of 1934, as amended. The Company’s internal control over financial reporting is defined as a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Internal control over financial reporting includes policies and procedures that:




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





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




63





Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we evaluated the effectiveness of our internal control over financial reporting as of December 31, 2010 based on the framework for Internal Control-Integrated Framework set forth by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, our management concluded that the Company’s internal controls over financial reporting were effective as of December 31, 2010.




(c)         Brightman Almagor Zohar & Co., an independent registered accounting firm and a member firm of Deloitte Touche Tohmatsu, has issued an attestation report on the effectiveness of our internal control over financial reporting, as stated in their report included herein. See “Report of Independent Registered Public Accounting Firm” on page F-3.


(d)        There were no changes in our internal controls over financial reporting identified with the evaluation thereof that occurred during the period covered by this annual report that have materially affected, or are reasonable likely to materially affect our internal control over financial reporting.




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, Mr. Dan Falk.  Mr. Dan Falk is an independent director as such term is defined by Rule 5605(a)(2) 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://www.nova.co.il under “Corporate”.




Item 16C.Principal Accountant Fees and Services




During each of the last two fiscal years, Brightman Almagor Zohar & Co., an independent registered accounting firm and a member firm of Deloitte Touche Tohmatsu (“Brightman Almagor Zohar & Co.”) has acted as the our registered public accounting firm and independent auditors.




Audit Fees




Brightman Almagor Zohar & Co. billed the Company approximately $94,000 and $46,000 for audit services for fiscal 2010 and for 2009, respectively, including fees associated with the annual audit and reviews of the Company’s quarterly consolidated financial results submitted on Form 6-K, consultations on various accounting issues and performance of local statutory audits.The audit fees in 2010 include fees associated with the audit of management assessment of internal control over financial reporting.




Audit-Related Fees




Brightman Almagor Zohar & Co. did not bill for any audit-related services in 2010 or 2009, except as included under the caption “Audit Fees”.




Tax Fees




Brightman Almagor Zohar & Co. did not bill the Company for any tax advice services for fiscal year 2010 or 2009.




All Other Fees




Other than Audit Fees and Tax Fees described above, Brightman Almagor Zohar & Co. billed the Company approximately $18,000 for SEC compliance related services and services related to the Office of Chief Scientist and Investment Center, for each fiscal 2010 and 2009.




Pre-Approval Policies for Non-Audit Services




Prior to the engagement of Brightman Almagor Zohar & Co. 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 2010 and 2009, the Company’s audit committee approved all of the services provided by Brightman Almagor Zohar & Co.




64





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 2010, neither the Company nor any affiliated purchaser (as defined in the Exchange Act) purchased any of the Company’s ordinary shares.




Item 16F.  Changes in Registrant’s Certifying Accountant




None.




Item 16G.  Corporate Governance




There are no significant ways in which the Company’s corporate governance practices differ from those followed by domestic companies listed on The NASDAQ Global Market.




PART III




Item 17.    Financial Statements




Not applicable.




Item 18.    Financial Statements




See pages F-1 through F-26.




Item 19.    Exhibits




See Exhibit Index.




65





NOVA MEASURING INSTRUMENTS LTD.





CONSOLIDATED FINANCIAL STATEMENTS


AS OF DECEMBER 31, 2010









NOVA MEASURING INSTRUMENTS LTD.





CONSOLIDATED FINANCIAL STATEMENTS


AS OF DECEMBER 31, 2010





Contents




PageReport of Independent Registered Public Accounting Firm
F-2Consolidated Financial StatementsBalance Sheets - December 31, 2010 and 2009
F-4Statements of Operations - Years Ended December 31, 2010, 2009 and 2008
F-5Statements of Changes in Shareholders’ Equity and Comprehensive Income (Loss) - Years Ended December 31, 2010, 2009 and 2008
F-6Statements of Cash Flows - Years Ended December 31, 2010, 2009 and 2008
F-7 - F-8Notes to Consolidated Financial Statements
F-9 - F-26





F - 1











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 31,2010 and 2009 and the related statements of operations, changes in shareholders' equity and comprehensive income, and cash flows for each ofthe three years in the period ended December 31, 2010. These financial statements are the responsibility of the Company's management. Ourresponsibility 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. 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 present fairly, in all material respects, the consolidated financial position of the Company and its subsidiaries as of December 31, 2010 and 2009 and the consolidated results of their operations and their consolidated cash flows for each of the three years in the period ended December 31, 2010, in conformity with accounting principles, generally accepted in the United States of America.
 
 We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2010, based on the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 29, 2011, expressed an unqualified opinion on the Company’s internal control over financial reporting.
  /s/ Brightman Almagor Zohar & Co.
 Brightman Almagor Zohar & Co.
 Certified Public Accountants
 A member firm of Deloitte Touche Tohmatsu
 Tel Aviv, Israel
 March 29, 2011




F - 2





REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
 To the Shareholders of Nova Measuring Instruments LTD.
 
 We have audited the internal control over financial reporting Nova Measuring Instruments LTD. and subsidiaries (the “Company”) as of December 31, 2010, based on criteria established in Internal Control — Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting.Our responsibility is to express an opinion on the Company’s internal control over financial reporting basedon our audit.
 
 We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Thosestandards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financialreporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting,assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on theassessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides areasonable basis for our opinion.
 
 A company’s internal control over financial reporting is a process designed by, or under the supervision of, the company’s principal executive and principal financial officers, or persons performing similar functions, and effected by the company’s board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
 
 Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
 
 In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2010, based on the criteria established in Internal Control — Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission.
 
 We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements as of and for the year ended December 31, 2010 of the company and our report dated March 29, 2011 expressed an unqualified opinion on those financial statements.
  /s/ Brightman Almagor Zohar & Co.
 Brightman Almagor Zohar & Co.
 Certified Public Accountants
 A member firm of Deloitte Touche Tohmatsu
 Tel Aviv, Israel
 March 29, 2011


F - 3





NOVA MEASURING INSTRUMENTS LTD.


CONSOLIDATED BALANCE SHEETS


(In thousands, except share data)


As of December 31,2010


2009CURRENT ASSETSCash and cash equivalents

$
25,394


$
9,861Short-term interest-bearing bank deposits


35,562



8,607Trade accounts receivable , net of allowance for doubtful accounts of $122 and $115, respectively


13,162



11,545Inventories (Note 3)


10,849



3,949Other current assets


1,736



1,72886,703



35,690LONG-TERM ASSETSLong-term interest-bearing bank deposits


631



561Other long-term assets


163



142Severance pay funds (Note 6)


2,786



2,3683,580



3,071FIXED ASSETS, NET (Note 4)


3,094



2,163Total assets

$
93,377


$
40,924CURRENT LIABILITIESTrade accounts payable

$
9,956


$
3,715Deferred revenues


3,397



1,671Other current liabilities (Note 5)


7,908



5,23721,261



10,623LONG-TERM LIABILITIESLiability for employee severance pay (Note 6)


3,709



3,168Deferred revenue


--



183Other long-term liability


23



353,732



3,386COMMITMENTS AND CONTINGENCIES (Note 7)SHAREHOLDERS’ EQUITY (Note 8)Ordinary shares, NIS 0.01 par value - authorized 40,000,000shares, 25,374,844 shares issued and outstanding at December 31,2010 and

issued 19,976,924 shares and 19,974,695 outstanding at December 31,2009


71



56Additional paid-in capital


104,661



85,675Accumulated other comprehensive income


338



45Accumulated deficit


(36,686
)


(58,861
)Total shareholders’ equity


68,384



26,915Total liabilities and shareholders’ equity

$
93,377


$
40,924





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




F - 4





NOVA MEASURING INSTRUMENTS LTD.


CONSOLIDATED STATEMENTS OF OPERATIONS


(In thousands, except per share data)











Year ended December 31,2010


2009


2008REVENUES:Products

$
71,790


$
29,639


$
25,673Services


14,830



9,679



13,29686,620



39,318



38,969COST OF REVENUES:Products


29,056



12,732



12,527Inventory write-off and inventory purchase commitment losses(Note 3)


-



-



1,400Services


10,148



8,999



12,05939,204



21,731



25,986GROSS PROFIT


47,416



17,587



12,983OPERATING EXPENSES:Research and development, net of participation by the Office of theChief Scientist of $2,212 , $2,209 and $2,002, respectively (Note 7a)


12,445



6,865



8,606Sales and marketing


10,133



6,014



7,503General and administrative


2,968



2,240



3,199Impairment loss on intangibles and equipment related to Hypernex assets and liabilities acquisition


--



--



63325,546



15,119



19,941OPERATING INCOME (LOSS)


21,870



2,468



(6,958
)INTEREST INCOME, NET


305



163



171GAIN ON SHORT TERM INVESTMENTS


--



--



1,366305



163



1,537NET INCOME (LOSS) FOR THE YEAR

$
22,175


$
2,631


$
(5,421
)NET INCOME  (LOSS) PER SHARE:Net income (loss) per share:Basic

$
0.91


$
0.14


$
(0.28
)Diluted

$
0.86


$
0.13


$
(0.28
)Shares used in calculation of net income (loss) per share:Basic


24,448



19,473



19,369Diluted


25,692



20,089



19,369





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




F - 5





NOVA MEASURING INSTRUMENTS LTD.


CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY AND COMPREHENSIVE INCOME (LOSS)


(In thousands)




AccumulatedOrdinary


Additional


other





Total


TotalShares


Paid-in


Comprehensive


Accumulated


Comprehensive


Shareholders’Number


Amount


Capital


Income (loss)


Deficit


Income (loss)


Equity (loss)Balance as of January 1, 2008


19,369


$
55


$
83,401


$
199


$
(56,071
)




$
27,584Employee share-based plans


9



(*) -



12














12Amortization of deferred stock based compensation










556














556Change in fair market value of hedging derivatives














(390
)





$
(390
)


(390
)Net loss for the year


















(5,421
)


(5,421
)


(5,421
)Total comprehensive loss





















$
(5,811
)


(5,811
)Balance as of December 31, 2008


19,378


$
55


$
83,969


$
(191
)

$
(61,492
)





$
22,341Employee share-based plans


599



1



1,252














$
1,253Amortization of deferred stock based compensation










454















454Change in fair market value of hedging derivatives














236






$
236



236Net income for the year


















2,631



2,631



2,631Total comprehensive income





















$
2,867



2,867Balance as of December 31, 2009


19,977


$
56


$
85,675


$
45


$
(58,861
)





$
26,915Shares issued in public offering


4,428



12



16,956















16,968Exercise of warrants


336



1



















1Employee share-based plans


557



2



1,320















1,322Shares issued under employee share-based plans


77



(*)



















-Amortization of deferred stock based compensation










710















710Increase in fair market value of derivatives














293






$
293



293Net income for the year


















22,175



22,175



22,175Total comprehensive income





















$
22,468


$
22,468Balance as of December 31, 2010


25,375


$
71


$
104,661


$
338


$
(36,686
)





$
68,384




(*)  Less than $1




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




F - 6





NOVA MEASURING INSTRUMENTS LTD.


CONSOLIDATED STATEMENTS OF CASH FLOWS


(In thousands)








Year ended December 31,2 0 1 0


2 0 0 9


2 0 0 8CASH FLOWS – OPERATING ACTIVITIESNet income (loss) for the year

$
22,175


$
2,631


$
(5,421
)Adjustments to reconcile net income (loss) to net cash from (used in) operations:Depreciation and amortization


1,260



1,254



1,320Impairment of intangibles and fixed assets






-



643Amortization of deferred stock-based compensation


710



454



556Increase (decrease) in liability for employee termination benefits, net


108



(159
)


33Gain on short-term investments


-



-



(1,366
)Net recognized losses on investments


-



-



66Decrease (increase) in trade accounts receivables


(1,617
)


(8,762
)


6,363Decrease (increase) in inventories


(7,526
)


2,695



1,330Decrease (increase) in other current and long term assets


197



(421
)


247Increase (decrease) in trade accounts payables and other long term liabilities


6,242



234



(4,013
)Increase (decrease) in other current liabilities


2,740



1,169



(3,371
)Increase (decrease) in short and long term deferred income


1,543



(882
)


339Net cash from (used in) operating activities


25,832



(1,787
)


(3,274
)CASH FLOWS – INVESTING ACTIVITIESIncrease in short-term interest-bearing bank deposits


(26,955
)


(8,510
)


(97
)Decrease in short-term investments


-



-



32Proceeds from held to maturity securities


-



-



3,701Proceeds from long term investments


-



-



2,928Proceeds from long-term interest-bearing bank deposits


-



-



1,643Investment in long-term interest-bearing bank deposits


(70
)


(17
)


-Purchase of fixed assets


(1,565
)


(403
)


(944
)Net cash from (used in) investing activities


(28,590
)


(8,930
)


7,263CASH FLOWS – FINANCING ACTIVITIESShares issued in a public offering


16,968



-



-Shares issued under employee share-based plans


1,323



1,253



12Net cash from financing activities


18,291



1,253



12Increase (decrease) in cash and cash equivalents


15,533



(9,464
)


4,001Cash and cash equivalents – beginning of year


9,861



19,325



15,324Cash and cash equivalents – end of year

$
25,394


$
9,861


$
19,325




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




F - 7





NOVA MEASURING INSTRUMENTS LTD.


CONSOLIDATED STATEMENTS OF CASH FLOWS


(In thousands)





SCHEDULE A -NON CASH ACTIVITIES




Year ended December 31,2 0 1 0


2 0 0 9


2 0 0 8Transfer of assets from inventory to fixed assets

$
626


$
218


$
402


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





F - 8




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 Ltd. (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 recent years, the Company expanded its product offering to include stand alone systems.



The Company continues 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. The subsidiaries (the “subsidiaries”) are engaged in pre-sale activities and providing technical support to customers.



The ordinary shares of the Company are traded on The NASDAQ Global Market since April, 2000 and 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.




C.
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 uses 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 Accounting Standards Codification Topic No. 830 (“ASC 830”), “Foreign Currency Translation”. Net financing income includes translation gains (losses), which were immaterial for all years presented.




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





A.
Principles of Consolidation and Basis of Presentation



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.



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:




B.
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.




C.
Allowance for Doubtful Accounts



The allowance for doubtful accounts is computed on the specific identification basis.




D.
Held to Maturity, Short-Term and Long-Term Investments



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.



Short-term investments include investments in debt securities with maturities of more than three months but less than one year. Long-term investments include investments in debt securities with maturities of more than one year.



Auction-rate securities represent interests in collateralized debt obligations, a portion of which are collateralized by pools of residential and commercial mortgages, interest-bearing corporate debt obligations, and dividend-yielding preferred stock. Liquidity for these auction-rate securities typically is provided by an auction process that resets the applicable interest rate at pre-determined intervals, usually every 7, 28, 35 or 90 days. Because of the short interest rate reset period, the Company has historically recorded auction-rate securities in current short-term investments. As of December 31, 2007, the Company held auction-rate securities which have experienced a failed reset process and were deemed to have experienced an other-than-temporary decline in fair value. Accordingly, in 2007, the Company recorded an impairment charge of $1,366 to reduce the carrying value of the auction-rate securities the Company holds, and the Company determined that the impairment charge is other-than-temporary in nature in accordance with ASC 320-10, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments”.




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.)





D.
Held to Maturity, Short-Term and Long-Term Investments (Cont.)



In October 2008, the Company sold all of its remaining auction-rate securities to a third party, at their original par value. As a result, the Company recorded a gain on investments of $1,366 million in year 2008; the Company had no additional investments in these securities since then.





E.
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.
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. Estimated useful life, in years, is as follows:




YearsElectronic equipment
3-7Office furniture and equipment
7-17





Leasehold improvements are amortized using the straight-line method, over the shorter of the lease term or the useful lives of the improvements.



In accordance with ASC 360-10, “Accounting for Impairment or Disposal of Long-Lived Assets”, 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. During 2008 the Company recorded impairment charges of $633, with respect to fixed assets acquired in 2006.




G.
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.







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.)





H.
Revenue Recognition



Revenues from the sale of products are recognized when all the following criteria have been met: a persuasive evidence of an arrangement exists, delivery has occurred, the price is fixed or determinable, collection of resulting receivables is probable and there are no remaining significant obligations. ASU No. 2009-13,”Revenue Recognition (Topic 605) Multiple-Deliverable Revenue Arrangements” requires allocation of arrangement consideration among the separate units of accounting based on their relative selling prices. The selling price for each unit of accounting is determined using either vendor specific objective evidence of selling price, third party evidence of selling price or the vendor’s best estimate of estimated selling price for that deliverable. Use of the residual method is prohibited.



ASU No. 2009-14, “Certain Revenue Arrangements that Include Software Elements” (“ASU 2009-14”) modifies the scope of the software revenue recognition guidance to exclude (a) non-software components of tangible products and (b) software components of tangible products that are sold, licensed, or leased with tangible products when the software components and non-software components of the tangible product function together to deliver the tangible product’s functionality.



When the Company is unable to establish relative selling price using Vendor Specific Object Evidence (“VSOE”) or Third party evidence (“TPE”), the Company uses estimated selling price (“ESP”) in its allocation of arrangement consideration. The objective of ESP is to determine the price at which the Company would transact a sale if the product or service were sold on a stand-alone basis. ESP could potentially be used for new or customized products.



Revenues from 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.




I.
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 - 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.)





J.
Income Taxes



The Company accounts for income taxes utilizing the asset and liability method in accordance with ASC 740-10, “Accounting for Income Taxes. 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 more likely than not based on available evidence.



ASC 740-10, “Accounting for Uncertainty in Income Taxes”, contains a two-step approach to recognizing and measuring uncertain tax positions accounted for in accordance with ASC 740-10, “Accounting for Income Taxes.” The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount which is more than 50% likely of being realized upon ultimate settlement.




K.
Equity-Based Compensation



The Company accounts for equity based compensation using ASC 718-10 “Share-Based Payment,” which requires companies to recognize the cost of employee services received in exchange for awards of equity instruments based upon the grant-date fair value of those awards.



Stock Options



Under ASC 718, the fair market value of each option grant is estimated on the date of grant using the “Black-Scholes option pricing” method with the following weighted-average assumptions:




2010Risk-free interest rate
2.35%Expected life of options
6.25 yearsExpected volatility
81.77%Expected dividend yield
0%





F - 13


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.
Earnings per Share



Earnings per share are presented in accordance with ASC 260-10, “Earnings per Share.” Pursuant to which, basic earnings (loss) per share excludes the dilutive effects of convertible securities and is computed by dividing income (loss) available to common shareholders by the weighted-average number of ordinary 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 the year 2008. The number of potentially dilutive securities excluded from diluted earnings per share due to the anti-dilutive effect amounted to 226,500 in 2008, 2,453,000 in 2009 and 490,500 in 2010.




M.
Derivative Financial Instruments



ASC 815-10, “Accounting for Derivative Instruments and Hedging Activities” as amended by ASC 815-10-15 and ASC 815-10-15-96, 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.



For derivative instruments that are designated and qualify as a cash flow hedge (i.e., hedging the exposure to variability in expected future cash flows that is attributable to a particular risk), the effective portion of the gain or loss on the derivative instrument is reported as a component of other comprehensive income and reclassified into earnings in the same period or periods during which the hedged transaction affects earnings. The remaining gain or loss on the derivative instrument in excess of the cumulative change in the present value of future cash flows of the hedged item, if any, is recognized in current earnings during the period of change. See Note 12 for disclosure of the derivative financial instruments in accordance with such pronouncements.




N.
New Accounting Pronouncements



In December 2010, the FASB amended its guidance on goodwill and other intangible assets. The amendment modifies Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts. For those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if there are qualitative factors indicating that it is more likely than not that a goodwill impairment exists.



The qualitative factors are consistent with the existing guidance which requires goodwill of a reporting unit to be tested for impairment between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. This amendment was effective for the Company’s annual reporting period ending December 31, 2010. The amendment did not have an impact on the Company’s financial position, results of operations or cash flows.




F - 14




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.
New Accounting Pronouncements (Cont.)



In January 2010, the FASB issued ASU No. 2010-06, “Fair Value Measurements and Disclosures”, that requires reporting entities to make new disclosures about recurring or nonrecurring fair-value measurements including significant transfers into and out of Level 1 and Level 2 fair-value measurements and information on purchases, sales, issuances, and settlements on a gross basis in the reconciliation of Level 3 fair-value measurements. The FASB also clarified existing fair-value measurement disclosure guidance about the level of disaggregation, inputs, and valuation techniques. The new and revised disclosures are required to be implemented in interim or annual periods beginning after December 15, 2009, except for the gross presentation of the Level 3 rollforward, which is required for annual reporting periods beginning after December 15, 2010. The adoption of this update did not have material impact on the Company’s consolidated financial statements.





NOTE 3  -   INVENTORIES




A.


As of December 31,2 0 1 0


2 0 0 9Raw materials

$
1,425


$
917Work in process


3,931



2,116Finished goods


5,493



916$
10,849


$
3,949




B.
In the year ended December 31, 2008 the Company wrote-off inventories in the amount of $1,400.





NOTE 4  -   FIXED ASSETS, NET




As of December 31,2 0 1 0


2 0 0 9Cost:Electronic equipment

$
9,891


$
8,043Office furniture and equipment


677



692Leasehold improvements


2,444



2,13113,012



10,866Accumulated depreciation and amortization:Electronic equipment


7,443



6,276Office furniture and equipment


632



647Leasehold improvements


1,843



1,7809,918



8,703Net book value

$
3,094


$
2,163





F - 15


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 1 0


2 0 0 9Accrued salaries and fringe benefits

$
3,936


$
2,611Accrued warranty costs (See B below)


2,347



963Governmental institutions


890



844Other


735



819$
7,908


$
5,237





B.
Accrued warranty costs:




As of December 31,2 0 1 0


2 0 0 9Balance as of beginning of year

$
963


$
877Services provided under warranty


(1,869
)


(959
)Changes in provision


3,253



1,045Balance as of end of year

$
2,347


$
963





NOTE 6  -   LIABILITY FOR EMPLOYEE SEVERANCE PAY, 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 expenses amounted to $844, $692 and $858 for year 2010, 2009 and 2008, respectively.




NOTE 7  -   COMMITMENTS AND CONTINGENCIES





A.
The Company has received grants in the aggregate amount of $18,746 from the OCS, as its participation of up to 60% 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. Royalty expense amounted to $130 and $71 for the years 2010 and 2009, respectively. The balance of the contingent liability to the OCS as of December 31, 2010 was approximately $14,586 (December 31, 2009: $13,391).





F - 16




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




NOTE 7 -   COMMITMENTS AND CONTINGENCIES (Cont.)





B.
The Group rents its facilities under various operating lease agreements, which expire on various dates, the latest of which is in 2013. The minimum rental payments are as follows:





Year2011

$
9912012

$
7382013

$
62





Rental expense for the facilities amounted to $1,125, $1,096 and $1,239 for 2010, 2009 and 2008, respectively.





NOTE 8   -   SHAREHOLDERS’ EQUITY





A.
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.




B.
Secondary Public Offering



On February 9, 2010, the Company issued 4,427,500 ordinary shares in an underwritten public offering for a net consideration of $16,968.




C.
Share Purchase Agreement



On February 28, 2007, the Company entered into Share Purchase Agreement with four investors for the private placement of 1,937,983 ordinary shares of the Company, at a price of $2.58 per share, for gross proceeds of $5,000. As part of the transaction, the Company issued warrants to the investors for the purchase of 1,453,485 additional ordinary shares at an exercise price of $3.05 per share. On March 13, 2007, the shares were issued and the proceeds from the private placement were received. 336,134 warrants were exercised by one investor on March 11, 2010.




D.
Employee Incentive Plans



The Company’s Board of directors approves, from time to time, employee incentive plans, the last of which was approved in October 2007. Employee incentive plans include stock options, restricted stock units and restricted stock awards.




F - 17




NOVA MEASURING INSTRUMENTS LTD.
 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
 (in thousands, except share and per share data)
  NOTE 8 -   SHAREHOLDERS’ EQUITY (Cont.)





D.
Employee Incentive Plans (Cont.)



Stock Options



The following table summarizes the effects of stock-based compensation resulting from the application of ASC 718 included in the Statements of Operations as follows:





Year ended December 31,2 0 1 0


2 0 0 9


2 0 0 8Cost of Revenues:Product Sales

$
97


$
82


$
43Services


35



35



28Research and Development expenses


313



211



103Sales and Marketing expenses


141



89



55General and Administration expenses


124



37



327Total

$
710


$
454


$
556




Compensation cost related to share incentives is recognized in operating results (included in cost of revenues, research and development, selling and marketing, general and administrative expenses) under ASC 718  in 2010 was $ 710, in 2009 was $ 454 and in 2008 was $ 556.





Stock options usually vest over four years and their term may not exceed 10 years. The exercise price of each option is usually the market price of the underlying share at the date of each grant.





Through December 31, 2010, 9,061,820 share options have been issued under the plans, of which 3,261,524 options have been exercised, 4,165,104 options have been cancelled, and 697,336 options were exercisable as of December 31, 2010.





The weighted average fair value (in dollars) of the options granted during 2010 , 2009 and 2008, according to Black-Scholes option-pricing model, amounted to $4.06 , $0.72  and $0.82 per option, respectively. Fair value was determined on the basis of the price of the Company’s share.





F - 18




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


NOTE 8 -   SHAREHOLDERS’ EQUITY (Cont.)





D.
Employee Incentive Plans (Cont.)




Summary of the status of the Company’s share option plans as of December 31, 2010, 2009 and 2008, as well as changes during each of the years then ended, is presented below:




2 0 1 0


2 0 0 9


2 0 0 8Share


Weighted

average

exercise


Share


Weighted

average

exercise


Share


Weighted

average

exerciseoptions


price


options


price


options


priceOutstanding - beginning of year


1,827,862



1.99



2,122,534



2.42



2,910,368



2.69Granted


490,500



5.66



626,600



1.01



244,000



1.35Exercised


557,407



2.45



598,585



2.10



8,921



2.03Cancelled


129,883



1.73



322,687



2.53



1,022,913



.932Outstanding - year end


1,631,072



2.96



1,827,862



1.99



2,122,534



2.42Options exercisable at year-end


697,336



2.23



852,559



2.77



1,385,700



2.61





The following table summarizes information about share options outstanding as Of December 31, 2010:





Outstanding as of


Exercisable as ofDecember 31, 2010


December 31, 2010Range of exercise


Number


Weighted

average

remaining

contractual


Weighted

average

exercise


Number


Weighted

average

exerciseprices


outstanding


life


price


exercisable


price(US dollars)





(in years)


(US dollars)





(US dollars)0.43-1.90



747,969



5.52



1.09



335,455



1.202.18-2.87



275,048



3.39



2.86



240,206



2.863.40



58,250



0.92



3.40



58,250



3.404.01-4.78



225,305



7.43



4.01



49,305



4.015.15-5.48



15,000



2.35



5.26



10,000



5.156.20-6.70



299,500



9.64



6.37



-



-7.4



10,000



9.92



7.40



-



-1,631,072



6.00



2.96



693,216



2.23





F - 19





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




NOTE 8  -   SHAREHOLDERS’ EQUITY (Cont.)





D.
Employee Incentive Plans (Cont.)



Restricted Stock Awards

As part of the acquisition of HyperNex’s assets and the assumption of most of its liabilities the Company granted 392,000 restricted stock awards to certain of its employees who were formerly employed by HyperNex. The restricted stock awards (the “Award Shares”) are ordinary shares of the Company that vested over a period of up to 3 years from the grant date. Vesting of the Award Shares is subject to each employee’s continuing service to the Company. The compensation expense related to these awards was determined using the market value of the Company’s ordinary shares on the date of the grant; compensation was recognized over the service period.



Restricted Share Units

Restricted Share Units (“RSU”) grants are rights to receive shares of our common stock on a one-for-one basis and vest 25% on each of the first, second, third and fourth anniversaries of the grant date and are not entitled to dividends or voting rights, if any, until they are vested. The fair value of the RSU awards is being recognized on a straight-line basis over vesting period. As of December 31, 2010 308,530 RSU’s, had been issued 76,878 RSU’s had been vested none of which had been cancelled. As of December 31, 2009, 307,530 RSU’s, had been issued none of which had vested or had been cancelled.





NOTE 9  -   INCOME TAXES





A.
Law for the Encouragement of Capital Investments – 1959



Part of the Company’s investment in equipment has received approvals in accordance with the Law for the Encouragement of Capital Investments, 1959 (“Approved Enterprise” status) in three separate investment plans. The Company has chosen to receive its benefits through the “Alternative Benefits” track, and, as such, is eligible for various benefits. These benefits include accelerated depreciation of fixed assets used in the investment program, as well as a full tax exemption on undistributed income in relation to income derived from the first plan for a period of 4 years and for the second and third plans for a period of 2 years. Thereafter a reduced tax rate of 25% will be applicable for an additional period of up to 3 years for the first plan and 5 years for the second and third plans, commencing with the date on which taxable income is first earned but not later than certain dates.The first plan benefit period has already expired. The benefit periods of the second and third plans have not yet commenced.



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.








F - 20





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




NOTE 9  -   INCOME TAXES (Cont.)





A.
Law for the Encouragement of Capital Investments – 1959 (cont.)



In the case of foreign investment of more than 25%, the tax benefits are extended to 10 years, and in the case of foreign investment ranging from 49% to 100% the tax rate is reduced on a sliding scale to 10%. The benefits are subject to the fulfillment of the conditions of the letter of approval.



On April 1, 2005, an amendment to the Investment Law came into effect (“the Amendment”) and has significantly changed the provisions of the Investment Law. The Amendment limits the scope of enterprises which may be approved by the Investment Center by setting criteria for the approval of a facility as a Privileged Enterprise, such as provisions generally requiring that at least 25% of the Privileged Enterprise’s Income will be derived from export. Additionally, the Amendment enacted major changes in the manner in which tax benefits are awarded under the Investment Law so that companies no longer require Investment Center approval in order to qualify for tax benefits. However, the Investment Law provides that terms and benefits included in any certificate of approval already granted will remain subject to the provisions of the law as they were on the date of such approval. Therefore, the Israeli companies with Approved Enterprise status will generally not be subject to the provisions of the Amendment.



As a result of the amendment, tax-exempt income generated under the provisions of the new law, will subject the Company to taxes upon distribution or liquidation.



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.



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).



In the event of distribution by the Company of a cash dividend out of retained earnings that were tax exempt due to its approved enterprise status, the Company would have to pay a 25% corporate tax on the income from which the dividend was distributed. A 15% withholding tax may be deducted from dividends distributed to the recipients.



To date, the Company has not had earnings attributable to Approved Enterprise programs.





F - 21




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


NOTE 9 -   INCOME TAXES (Cont.)





A.
Law for the Encouragement of Capital Investments – 1959 (cont.)



On January 6, 2011 an amendment to the Law for the Encouragement of Capital Investment-1959 (the "Law") was published. The amendment has a substantial effect on the current provisions of the Law. The followings are the major changes in the amendment:




1.
A company located in Preferred Area A can file for both grants and tax benefits.




2.
The requisites for benefits were changed with most significant change is that the Minimum investment requirement was removed. In addition the definition of Approved entity was changed.




3.
The income attribution based on revenues was cancelled, the result is that Approved entity would be taxable on it entire income at a fixed rate.




4.
Tax exemption was cancelled.




5.
Dividend payable from preferred income would be tax exempted.




6.
The Grant Rate out of the approved investment would be up to 24%.




The Tax rates applicable to Approved Industrial Enterprise would be 6% and 12% for those located in Preferred Area A or elsewhere, respectively, with effectiveness for the taxable year of 2015 and onwards. Prior to 2015 the following tax rates will be applicable:




For the years 2011-2012 10% and 15% respectively and for the years 2013-2014 7% and 12.5% respectively.





To date, the Company did not have earnings attributable to Approved Enterprise programs.





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.





F - 22




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


NOTE 9 -   INCOME TAXES (Cont.)





C.
Deferred Taxes



Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company and its subsidiary deferred tax assets are as follows:




As of December 31,2 0 1 0


2 0 0 9Israel net operating loss carry-forwards (*)

$
7,170


$
19,507U.S. net operating loss carry-forwards


29



57Temporary differences relating to reserve and allowances


1,413



1,474Total net deferred tax asset before valuation allowance


8,612



21,038Valuation allowance


(8,612
)


(21,038
)Net deferred tax asset

$
-


$
-





(*)
Deferred taxes were calculated based on 12% tax rate as of December 31, 2010and 25% as of December 31,2009.




Under ASC 740-10, deferred tax assets are to be recognized for the anticipated tax benefits associated with net operating loss carry-forwards and deductible temporary differences; unless it is more-likely-than-not that some or all of the deferred tax assets will not be realized. The adjustment is made by a valuation allowance. Since the realization of the net operating loss carry-forwards and deductible temporary differences is not considered more likely than not, a valuation allowance has been established for the full amount of the tax benefits.



The Company has accumulated losses for Israeli income tax purposes as of December 31, 2010, 2009 and 2008 in the amount of approximately $60,000, $78,000 and $72,000, respectively. These losses may be carried forward and offset against taxable income in the future for an indefinite period.




D.
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 carry-forward.




E.
Tax Assessments



The Company received final tax assessments through tax year 2001. One subsidiary received final tax assessments through tax year 2007. The other subsidiaries did not receive final tax assessments since their incorporation




F - 23




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





NOTE 9  -   INCOME TAXES (Cont.)





F.
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 27% for the 2008 tax year ending at 25% for the 2010 tax year.



On July 23, 2009, the Israel Economic Efficiency Law (Legislation Amendments for Applying the Economic Plan for 2009 and 2010), 2009 (the 2009 Amendment), became effective, stipulating, among other things, an additional gradual decrease in tax rates in 2011 and thereafter, as follows: 2011—24%, 2012—23%, 2013—22%, 2014—21%, 2015—20% and 2016 and thereafter—18%. Deferred income tax balances have been adjusted accordingly; the effect of such adjustment was not material.




NOTE 10 -   GEOGRAPHIC AREAS AND MAJOR CUSTOMERS




A.
Sales by geographic area (as percentage of total sales):




Year ended December 31,2 0 1 0


2 0 0 9


2 0 0 8%


%


%USA


40



27



50Europe


2



3



8Japan


5



12



17Asia Pacific excluding Japan


53



58



25Total


100



100



100





B.
Sales by major customers (as percentage of total sales):




Year ended December 31,2 0 1 0


2 0 0 9


2 0 0 8%


%


%Customer A


17



21



37Customer B


3



4



9Customer C


8



5



10Customer D


24



46



9Customer E


13



-



-Customer F


15



-



-Others


20



24



35Total


100



100



100





F - 24




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


NOTE 10 -     GEOGRAPHIC AREAS AND MAJOR CUSTOMERS (Cont.)





C.
Assets by location



Substantially all fixed assets are located in Israel.




NOTE 11 -    TRANSACTIONS AND BALANCES WITH RELATED PARTIES





The total directors’ fees (including the chairman of the Board) for the year 2010 amounted to $227 (2009 - $210, 2008 - $247). The number of stock options granted to directors in 2010 amounted to 125,000 (70,000 were granted in 2009 and 120,000 were granted in 2008). Revenue from sales to a related party in 2009 amounted $26.




NOTE 12 -     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, 2010, 2009 and 2008 the fair market value of the Company’s financial instruments did not materially differ from their respective book value.




B.
Hedging activities



In 2008, the Company entered into currency-forward transactions and currency-put options (NIS/dollar, Euro/dollar, Yen/dollar) of $33,633 with settlement date through 2008-2009 designed to reduce cash-flow exposure to the impact of exchange-rate fluctuations on firm commitments of $33,633. In accordance with ASC 815-10 the Company recorded in 2008 a decrease of $390 in fair market value in “Other Comprehensive Income”.



In 2009, the Company entered into currency-forward transactions and currency-put options (NIS/dollar, Euro/dollar, Yen/dollar) of $12,457 with settlement date through 2009-2010 designed to reduce cash-flow exposure to the impact of exchange-rate fluctuations on firm commitments of $12,457. In accordance with ASC 815-10 the Company recorded in 2009 an increase of $236 in fair market value in “Other Comprehensive Income”.




F - 25





NOTE 12 -     FINANCIAL INSTRUMENTS (Cont.)





B.
Hedging activities (cont.)



In 2010, the Company entered into currency-forward transactions and currency-put options (NIS/dollar, Euro/dollar, Yen/dollar) of $21,710 with settlement date through 2010-2011 designed to reduce cash-flow exposure to the impact of exchange-rate fluctuations on firm commitments of $21,710. In accordance with ASC 815-10 the Company recorded in 2010 an increase of $293 in fair market value in “Other Comprehensive Income”.




F - 26





SIGNATURES





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


NOVA MEASURING INSTRUMENTS LTD.By:
/s/ Gabi SeligsohnGabi SeligsohnPresident and Chief Executive Officer


Date:  March 30, 2011




66





EXHIBIT INDEX





Number
Description1.1
Amended and Restated Articles of Association (incorporated by reference to Exhibit 1.1 to the Company’s Annual Report on Form 20-F for 2008 filed with the Securities and Exchange Commission on March 30, 2009).4.1
Option Plan 7A (incorporated by reference to Exhibit 4.1. to the Company’s Registration Statement on Form S-8 filed with the Securities and Exchange Commission on May 17, 2004 (File No. 333-115554)).4.2
Option Plan 7B (incorporated by reference to Exhibit 4.1 to the Company’s Registration Statement on Form S-8 filed with the Securities and Exchange Commission on March 7, 2005 (File No. 333-123158).4.3
Option Plan 7C (incorporated by reference to Exhibit 4.20 of the Company’s Annual Report on Form 20-F filed with the Securities and Exchange Commission on June 29, 2006).4.4
Option Plan 8 (incorporated by reference to Exhibit 4.1 to the Company’s Registration Statement on Form S-8 filed with the Securities and Exchange Commission on December 29, 2005 (File No. 333-130745).4.5
2007 Incentive Plan (incorporated by reference to Exhibit 99.1 to the Company’s Registration Statement on Form S-8 filed with the Securities and Exchange Commission on November 5, 2007 (File No. 333-147140)).4.6
Letter of Indemnification and Exculpation for certain directors, officers and/or employees (incorporated by reference to Appendix C to the Company’s Report on Form 6-K filed with the Securities and Exchange Commission on July 7, 2006).4.7
Summary of Lease Agreements between Nova and Ef-Shar Ltd. (incorporated by reference to Exhibit 4.10 to the Company’s Annual Report for 20-F for 2007 filed with the Securities and Exchange Commission on March 28, 2008).4.8
Underwriting Agreement, dated February 4, 2010, by and among the Company, Needham & Company, LLC and Roth Capital Partners LLC (incorporated by reference to Exhibit 1.1 to the Company’s Report on Form 6-K filed with the Securities and Exchange Commission on February 4, 2010).4.9
Summary of Amended Lease Agreement, dated October 30, 2010, by and between Nova and Ef-Shar Ltd. (filed herewith).8.1
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).13.2
Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith).15.1
Consent of Brightman Almagor & Co. (filed herewith).